Category Archives: Company Analysis

Allstate (ALL)

lake

One of my favorite spots on a perfect fall day. Onto the analysis . . . 

Key Statistics

Enterprise Value = $27.791 billion

Operating Income = $4.283 billion

EV/Operating Income =6.48x

Price/Revenue = .73x

Earnings Yield = 12%

Debt/Equity = 27%

The Company

Allstate is the 4th biggest insurance company in the United States (as measured by market capitalization) and their main focus is automobile and homeowners insurance. Interesting bit of history: Allstate was established in 1931 by Sears. Allstate originally marketed policies via mail and the Sears catalog, which was revolutionary at the time. After 62 years of operating within Sears, it was spun off in 1993.

Market sentiment is relatively weak against Allstate. The stock is down 20% over the last year. The stock has been punished due to rising interest rates and various extreme weather events over the previous few years. There is also fear that the rise of autonomous vehicles will afflict Allstate’s insurance premiums in the long run.

My Take

From a quantitative perspective, Allstate appears to be an excellent company at a bargain price. At a P/E of 9, this compares to an industry average of 16.05. On a price/revenue basis, Allstate currently trades at 73% of revenue, compared to an industry average of 127%.  The forward P/E is presently 9, implying that Allstate is expected to maintain its current level of profitability by most analyst estimates. Allstate’s present valuation also compares favorably to its history. Allstate’s average P/E over the last 5 years is 13, 44% higher than current levels. On an EV/EBIT basis, Allstate’s average multiple in the previous 5 years was 8.5, which is 31% higher than current levels.

Allstate is also a well-run company. The F-Score is presently 7, which places it at a high degree of financial quality. Allstate also achieves better results than its competitors, producing a return on assets of 3.31% compared to an industry average of 1.91%. It delivers these results without excessive leverage, with a debt/equity ratio of 27%.

Allstate also grows organically with the economy, with operating income and revenues steadily increasing over time. The share price has increased with the growth in business over time.

allstate

Regarding short-term risks, the Fed is signaling that the rate hikes will end, which ought to stop the pressure on its bond and loan portfolio. There is also the risk of extreme risk events, such as terrible weather events in the upcoming year. That is a constant risk for insurance companies that don’t vary much from year to year and is built into Allstate’s pricing models. With a history going back 87 years, I’m reasonably sure that Allstate can handle a bad hurricane season, for instance.

As for long-term risks, the fears about the rise of autonomous vehicles seem silly to me. We are a long way off from widespread adoption of autonomous cars, considering that most people keep their cars for 11 years. Even when autonomous vehicles are widely adopted, you will still need someone to sue when the car gets into an accident. Even if the car can drive itself, the driver’s insurance is still going to be held responsible when the car makes an error. I don’t think we’ll ever see a day when it will be legal for the driver to hang out in the back seat drinking whiskey while the car whisks away to its destination with the driver completely free of responsibility.

In short, Allstate is a well run, defensive pick that is experiencing organic growth and currently trades at an attractive discount to average valuations within the industry and Allstate’s history.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Manpower Group (MAN)

handshake

Key Statistics

Enterprise Value = $5.113 billion

Operating Income = $856.8 million

EV/Operating Income = 5.96x

Price/Revenue = .21x

Earnings Yield = 13%

Debt/Equity = 40%

The Company

Manpower Group is a global staffing company. They provide recruiting services. They place a broad and diverse group of workers, from office staff to industrial workers. They also have a rights management unit, which provides consulting for workforce issues, such as advice to improve overall productivity.

This is not a “good business” with high returns on invested capital. Its earnings are driven by the cyclical nature of the global employment trends. However, Manpower has been in business for 75 years and has a strong global footprint, with a concentration in Europe. 13% of their revenue is from the United States, 13% is from Asia & the Middle East, and the remainder is from Europe. They have a particularly big focus in France, where 26% of their revenue comes from.

Manpower is in the most cyclical industry that there is: staffing. Their fortunes are dictated by the performance of demand for global employment. The company has performed well as unemployment rates fell in Europe and the United States. Employment in the European Union peaked at 11% in the middle of 2013 and is now down to 6.8%. In the United States, unemployment peaked at 10% and is now down to 4%.

The stock has been punished all year long. From its peak of $136 in January 2018, it is now down to $73.16.

My Take

In the quantitative sense, Manpower is a compelling bargain. The current P/E of 7.93 compares to Manpower’s 5-year average of 15.69 and an industry average of 24.14. Analysts don’t anticipate a significant decline in earnings. The stock currently has a forward P/E of 8.83. Additionally, the current EV/EBIT of 5.96 compares to a 5-year average of 9.27, which represents a 55% discount.

A bet on Manpower is obviously a bet on the US and Europe avoiding a recession in 2019. The economies of the United States and Europe are tied at the hip. A recession in the United States will likely coincide with a recession in Europe. There are indeed exceptions to this synergy, such as the 2011-13 period, when Europe languished while the recovery remained strong in the United States, but for the most part, they are closely correlated. Manpower’s performance is primarily dictated by the employment fortunes of these companies, as you can see in the below.

unemploymentincome

As I’ve stated elsewhere, I do not think that we will experience a recession in the upcoming year. The 2-year vs. 10-year treasury yield, along with the 3-month vs. 10-year treasury yield, has not yet inverted. Typically, after the inversion, the US has 1-2 years before the recession begins. Usually, the unemployment rate doesn’t start ticking up until immediately before the recession. This means that Manpower group is likely getting into the best part of the employment cycle at an attractive valuation.

The market is apparently concerned that Manpower’s earnings and cash flows are at a cyclical peak. I believe we are close to a cyclical peak, but I think a lousy period for Manpower is likely 2-3 years away and is not imminent. In the meantime, I think this is an attractive bargain with the wind at is back.

Manpower has a strong footprint in temporary hiring. This is a segment of Manpower’s business that will likely benefit from where I think we are in the cycle: a period when temporary workers will be in demand as firms struggle to retain employees.

Overall, I believe Manpower will benefit from where we are in the cycle in the upcoming 1-2 years. I am purchasing the stock with a margin of safety, with the stock trading significantly below its historical valuation multiples.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

 

 

MetLife (MET)

fall

Key Statistics

Enterprise Value = $46.727 billion

Operating Income = $5.65 billion

EV/Operating Income = 8.27x

Price/Revenue = .70x

Earnings Yield = 11%

Debt/Equity = 36%

The Company

Met Life is a massive global insurance firm. Their $457 billion bond portfolio makes them one of the biggest institutional investors in the United States. Their business spans the globe with operations in the United States, Asia, EMEA, and Latin America.

A major focus for MetLife is group insurance for large corporations. Another important segment is pension risk transfer when MetLife assumes the pension risk of another company. Another segment is structured settlement, in which MetLife will take on large class action legal claims.

Like Unum Group, shares have languished due to concerns about its long-term care insurance reserves. In other words, with people living longer and medical care costs rising, the market is worried that MetLife doesn’t have enough capital set aside to deal with these concerns. These concerns have caused many insurance names to lag the S&P 500 in the past year and MetLife has not been immune to the pain In the last year, the stock is down 8.39% while the S&P 500 is up 15.67%.

My Take

Cheap insurance stocks are a large segment of my portfolio. I currently own Aflac, Unum Group, Reinsurance Group of America, and MetLife. I like insurance for several reasons: it is boring, it is profitable, and beaten up insurance companies almost always tend to recover unless there is a black swan event or they have been playing it fast and loose with risk management.

As for the long-term care anxieties, I have no idea if MetLife has sufficient capital set aside. What I do know is that long-term care represents only 15% of MetLife’s business and it looks to me like the concerns are already built into the stock price.

Despite the pressures on the stock and worries about long-term care, revenues and profits are up over the last year. In the most recent quarter, year/year revenues are up 38.23% and EPS is up 3.75%.

Met Life is a high-quality firm. Their Piotroski F-Score is currently an excellent 7. Their debt/equity ratio is currently 36%, implying that they have a relatively safe balance sheet.

My main attraction to Met Life is its high level of shareholder yield. In the last year, MetLife has bought back 5% of the outstanding shares and delivers a dividend yield of 3.60%. The share buybacks show no signs of letting up. In May, the company announced a $1.5 billion share buyback.

With most of my picks, I buy ugly situations and wait for significant multiple appreciation once the concerns fade away. I am looking for gains of 50-100%. With Met Life, I’m not expecting those kinds of gains. While moderate multiple appreciate is possible, my expectation is that MetLife has a low probability of blowing up and, in the meantime, it will continue to aggressively return capital to shareholders and ought to deliver an attractive rate of return.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Reinsurance Group of America (RGA)

measurement

Key Statistics

Enterprise Value = $10.10 billion

Operating Income = $1.159 billion

EV/Operating Income = 8.71x

Price/Revenue = .73x

Earnings Yield = 19%

Debt/Equity = 41%

The Company

RGA is a Missouri based holding company for multiple reinsurance entities all over the world.

What is reinsurance? Simply put, reinsurance is insurance for insurance companies. Typically, insurance companies buy reinsurance policies to cover themselves in the event of catastrophic losses that occur outside of the assumptions in their risk models. Insurance companies would depend on reinsurance after an extreme event – a major disaster like a historically unprecedented hurricane, earthquake, or a terrorist attack.

RGA is unique in that it focuses on insurance for claims related to health insurance and life insurance. One example of this niche is their focus is longevity reinsurance, a business where RGA insures health insurance companies for the risk that insured people will live longer than the models project. (If Ray Kurzweil’s predictions are true, RGA is screwed. I don’t think we will find the fountain of youth anytime soon, though.) Another area that they focus on is “asset-intensive reinsurance,” which insures annuities for the possibility that their annuity returns might fall short and annuitants will live longer.

RGA has often changed its ownership structure. RGA initially went public in 1993 after years as a division of General American Life Insurance Company (General American retained a majority stake in the company after it went public). It operated publicly from 1993 until 2000, at which point MetLife bought it and took it private. MetLife then spun off RGA in 2008, and it has operated as an independent public company ever since.

A key risk for RGA would be a global disaster affecting human mortality. An example would be a pandemic. Bill Gates has sounded the alarm on this issue for a long time. In addition to an event causing mass casualties, such an event would also create chaos in the financial markets, which would affect RGA’s investment portfolio. A bet on RGA is a bet that such an extreme event won’t happen in the near future.

Reinsurance is also a dull, slow-growing industry that doesn’t command high multiples. Regardless of this, it is essential for insurance companies to maintain reinsurance policies to protect themselves.

My Take

RGA operates a good business that has been steadily growing since it was spun off in 2008. It has grown premiums and investment income steadily since going public, as you can see from the below chart (in billions of dollars):

rgarevenue

While the industry grows slowly, it grows steadily and methodically as the need for insurance grows and more of the world’s population enters the middle class, creating a need for insurance where none existed in the past. Each year, 160 million people globally become middle class. As they enter the middle class, they need home insurance, car insurance, and health insurance. As demand for insurance grows, demand for reinsurance grows. Because RGA has a global footprint, they benefit from the global growth in insurance, as you can see from their results over the last decade.

RGA trades at a discount to industry averages. The average price/revenue for the industry is 1.37 compared to .73 for RGA. The price/revenue multiple implies that RGA’s stock has an 87% upside. From a P/E multiple standpoint, RGA trades at 5.37x versus an industry average of 19.48, giving the stock a 262% upside potential.

Much of RGA’s high earnings in the last year are due to positive gains realized from the tax bill. Even with temporary tax gains taken into consideration, RGA’s forward P/E of 12 is still a discount from the industry average. RGA also trades at a discount to book value, which is currently $147 per share.

RGA is not only at a discount to the industry average, but it is also posting better results than industry peers. RGA achieved a 21% return on equity last year, which is better than the industry average of 6.71%.

RGA compares favorably to two of its biggest competitors, Everest Re and Renaissance Re, both of which paradoxically trade at a higher valuation. Concerning return on assets, RGA beats both of them. RGA delivered a 2.97% ROA in the last year, compared to 1.4% for Everest and -1.55% compared to Renaissance.

comparison

In short, I think RGA represents an attractive discount to the valuation of its peers even though it is performing better than them. Simple multiple appreciation could provide an attractive return for RGA.

I also think it is a possibility that RGA could be bought by a larger insurance company, as it was back in 2000 by Met Life.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Micron (MU)

chip

Key Statistics

Enterprise Value = $59.959 billion

Operating Income = $13 billion

EV/Operating Income = 4.6x

Price/Revenue = 2.23x

Earnings Yield = 20%

Debt/Equity = 26%

The Company

Micron is a rapidly growing semiconductor manufacturer. It represents everything that investors are supposed to love in 2018. Micron manufactures semiconductors for everything from supercomputers to smartphones with a particularly strong niche in memory products.

Business has been fantastic over the last few years, driven by the global growth in tech spending. From 2016 levels, 2017 sales were up by 64%.

The business is in the midst of a massive boom, with revenues and earnings growing every quarter. The Q3 earnings report was the best in Micron’s history, pulling in $7.7 billion in revenue and $3.10 in earnings per share.

My take

In the current tech-obsessed mood, Micron is the kind of business that Wall Street should be infatuated with, but it’s not. Micron currently trades at an absurd P/E of 5.10 compared to industry average of 30.10, a discount of 83%. Micron’s 5-year average P/E is 14.58. An increase to this level would be a 185% increase from current levels.

The crazy valuation is not a result of a sell-off. Micron’s stock price has done well over the last few years. This is an odd situation where the actual earnings growth over the last few years has outpaced the stock price.

The major risk is that Micron’s business is at a cyclical peak. This is a view I am very sympathetic towards. Micron is mired in an extremely cyclical business. In the last twelve months, Micron posted a crazy operating margin of 46%, which is destined to decline. Eventually, the market will become saturated and prices will decrease.

Where are we in Micron’s business cycle? I have no idea. It’s entirely possible that we are at the peak in this business cycle for Micron. It’s also possible that we are in an early inning. I don’t know. The thing is: no one else knows, either.

This is also an industry facing constant and relentless pricing pressure. That’s why a ’90s supercomputer can now fit into your pocket. Tech gets better and cheaper as time goes by. It’s a bad place to be.

semi

Tech hardware: not a great business

This is a cyclical business with long-term pricing pressure on the downside. This begs the question: why am I buying this thing?

In my view, even if Micron’s business is at a cyclical peak and they are poised to lose pricing power: at 5x earnings, does it matter? What will the multiple go up to, 8x? 10x? That’s still very cheap for an S&P 500 tech company that is growing earnings and cash flow at such a rapid rate.

Why isn’t the same mentality applied to other amazing mega cap semiconductor companies like Nvidia, trading at a multiple of 39x earnings? Or Intel, trading at 19.85x earnings?

The expectations embedded in the stock price completely discount the possibility that the Micron’s good times might last longer. At such a cheap price, I am willing to take the other side of that trade.

There are no signs of financial distress with Micron, with a nearly perfect F-Score of 8 and a debt to equity ratio of 26%. Micron’s solid balance sheet and strong financial position also limit the possibility of a major blow up, limiting the risk on the downside.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

United Therapeutics (UTHR)

dna

Key Statistics

Enterprise Value =$4.454 billion

Operating Income = $998.2 million

EV/Operating Income = 4.46x

Price/Revenue = 3.06x

Earnings Yield = 13%

Debt/Equity = 10%

The Company

United Therapeutics is a biotech firm founded in 1996 by Martine Rothblatt. Rothblatt’s daughter suffered from pulmonary hypertension (high blood pressure within the arteries of the lung), and she founded United Therapeutics to try to find a treatment. They succeeded in creating Remodulin, which was approved by the FDA in 2002. UTHR sells many other drugs, but Remodulin remains the blockbuster core of the business. In 2017, it represented 39% of total revenue.

More recently, in 2015, the FDA approved one of UTHR’s latest drugs: Unituxin. Unituxin is a treatment for neuroblastoma, cancer affecting the kidney. Children often have this cancer. Unituxin helps the immune system fight cancer.

A few years ago, UTHR was a richly valued growth stock. To put the growth into perspective, in 2002 the company generated $50 million in sales. Last year, sales were $1.7 billion. In 2015, it traded at a P/E ratio of 50.

Since the 2015 peak, the stock is down 17%.

What happened? Several patents expired in 2017 and UTHR is facing increased competition from generics. Growth has slowed down, and the market is worried that there aren’t enough drugs in the pipeline to keep the growth going.

My Take

Growth for UTHR likely won’t continue at the intense pace of the last twenty years. The thing is: at this price; it doesn’t need to. The stock is priced like it is a dying business that is being destroyed by competition as if it is one of my beleaguered retail picks fighting the Amazon juggernaut. In reality, this is a Phil Fisher company trading at a Ben Graham price.

The stock now trades at a P/E of 7.63 (down from its 50x peak in 2015). The average for the biotech industry is 29.45, meaning that UTHR trades at a 74% discount to this. It is also a free cash flow machine generating an 11% yield based on its current enterprise value. The 5-year average P/E for UTHR is about 18.55 (which seems like a proper valuation for a growth company). An increase to 18.55 would be a 143% increase from current levels.

In the most recent quarter, year over year sales was mostly flat, and earnings were down. The recent performance deepens the worries that UTHR’s best days are in the past.

The consensus price implies that UTHR has nothing in the pipeline. In reality, they spent $264 million on research in 2017. They are working on many new drugs, but one of the most exciting areas of research is the manufacturing of organs. They are trying to develop the ability to generate engineered lungs, hearts, and kidneys. If they succeed, such a development could save a tremendous number of lives over the long run and, of course, generate significant business for the company.

UTHR is valued as if it is roadkill. It is priced for a no-growth future. Based on its past results and research pipeline, this seems to me like an unlikely fate. With a solid balance sheet and low valuation, the prospects of a significant decline are low. Meanwhile, any whiff of good news on the research front could send the company to a more normal valuation, potentially a 100%+ gain from current levels.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

 

Sanderson Farms (SAFM)

chicken

Key Statistics

Enterprise Value = $2.084 billion

Operating Income = $358.54 million

EV/Operating Income = 5.81x

Price/Revenue = .69x

Earnings Yield = 12%

Debt/Equity = 0%

The Company

Sanderson Farms is a classic, easy to understand, all American business.

Founded in 1947, it is the third largest poultry producer in the United States. Principal competitors include Tyson, Purdue, Pilgrim’s Pride. The company isn’t hated, but it is ignored because it is relatively small and operates in a commoditized industry that isn’t particularly glamorous.

With that said, they have a long operating history and have run the company with excellence and integrity throughout their history. They grow the company organically with cash flow, as opposed to relying on debt to fuel growth.

One factor fueling Sanderson’s recent price decline has been worries about Trump tariffs. This is bizarre because nearly all of Sanderson’s operations and customers are within the United States and tariffs will have little impact. While Sanderson sells some of their products to intermediaries who export overseas, most of their chickens are produced and sold here in the U.S. Regardless, Wall Street traders target the industry as a whole with a narrative, without regard to the underlying fundamentals of the individual companies within that group.

My Take

This isn’t the first time that I owned this stock. It was a part of the original lineup of stocks I purchased for this account in December 2016. I owned it through 8/30/17 and sold for a decent profit. The stock had an epic run up in 2017, and I got out when I thought the valuation no longer made sense.

Since then, the stock slid down to a level that I think is below its intrinsic value, bottoming at $95.97 in June. Since then, the price has hovered around $100. I picked up 16 shares on 8/15 @ $100.57.

From a relative valuation standpoint, Sanderson is cheaper than the industry as a whole. The current P/E is 8.54, while the industry average is 19.25. On a price/sales basis, it is .69x vs. an industry average of 1.49x.

Growth for Sanderson mirrors growth in the chicken industry, which ebbs and flows in the short term, but the long-term trajectory is towards growth. People aren’t going to stop eating chicken. With a growing global middle class, demand for chicken is only going to increase over time.

“People need to eat” is a familiar refrain when discussing the cyclicality of other industries vs. food essentials. Sanderson’s sales increase organically nearly every year (including during the Great Recession). Sales are up 94% over the last 10 years. Any earnings loss is usually caused by gyrations in chicken prices, which inevitably resolve themselves. With no debt, Sanderson can handle these temporary losses. With a solid product that will never go away and no debt, Sanderson should weather any recession with ease. Over the long term, it should continue to grow organically as it has since the 1940s.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Thor Industries (THO)

rv

Key Statistics

Enterprise Value = $5.048 billion

Operating Income = $684.85 million

EV/Operating Income = 7.37x

Price/Revenue = .6x

Earnings Yield = 9%

Debt/Equity = .04%

The Company

Thor Industries, Inc. makes and sells recreational vehicles. They operate two principal segments: towable recreational vehicles and motorized ones. Business has been excellent in recent years due to twin demographic trends. To sum it up: Millennials are living in RV’s and taking wake-up selfies next to the Grand Canyon, while Boomers are retiring and using them for vacations. Cheap oil has also buoyed the expansion.

While the company has been consistently growing sales and earnings at a rapid rate for every year of the expansion, it currently trades at a 66% discount from its 52-week high set back in February. 2017 was the company’s best year in its history and investors are concerned they won’t be able to keep up the pace. The stock sold off because of fears over the Trump administration’s steel and aluminum tariffs.

My Take

Thor is not the kind of company that I usually buy. It is a fast-growing, well-performing firm. It certainly looks like a “wonderful company at a bargain price.” Thor is performing significantly better than most companies trading at a P/E of 11, EV/OpIncome of 7.37x and 60% of sales. It’s average P/E for the last five years was 16.62, which seems reasonable for its quality. Multiple expansion alone to its average level would fuel a 51% rise in price from current levels.

Thor is also outperforming its competitors in the RV industry. For the last ten years, it has maintained a 16.69% rate of growth in comparison to 9.41% for the industry as a whole and 12.25% in comparison to its biggest competitor (Winnebago). It is also achieving these results with less leverage. Thor has a low debt/equity ratio of .04%. Winnebago, in comparison, has a debt/equity ratio of 50%.

Sales have organically grown with every year in this expansion, and they appear to be increasing. Sales have increased by 123% from 2013. Earnings are up 147% over the same period. With an F-score of 7 and a Z-score of 7.98, the company is financially healthy.

One risk is that we have a recession, as that would trigger a contraction in credit availability for RV purchases. Of course, a recession is a risk for everything that I own.

Another risk factor is that the RV industry might be at a cyclical peak. 2017 was the best year for the RV industry in history, with $20 billion in sales and 504,600 units sold. Despite this, I think that the industry still has a lot of room to grow in popularity. I think it will have a continued appeal for families, Millennials who want to unplug, and Boomers who are retiring.

According to the RV industry association (I know, they have a bit of a bias), RV camping trips are much cheaper than the typical family vacation. Family RV trips are probably much more pleasant, too. Everyone hates flying, but I’m sure that flying with your kids in tow is a particularly miserable experience. So, this ought to have an appeal to families. Boomers continue to retire and they should continue to drive the growth of the industry.

The recent sell-off looks like a severe overreaction to some bad macroeconomic news with little regard to the actual performance of the underlying company. While tariffs are a problem, I don’t think they can derail this exceptional business that is being buoyed by a favorable business climate in the United States and current demographic trends.

Random

Speaking of RV’s, I can’t talk about them without thinking of this video:

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Ultra Clean Holdings Inc. (UCTT)

chip

Key Statistics

Enterprise Value = $556.88 million

Operating Income = $97.56 million

EV/Operating Income = 5.71x

Price/Revenue = .62x

Earnings Yield = 14%

Debt/Equity = 13%

The Company

Ultra Clean Holdings, Inc. is a small but global player in the semiconductor industry. They sell equipment used to manufacture semiconductors. This includes things like precision robotics, gas delivery systems, wafer cleaning, chemical delivery, and a variety of other tech that I have a limited understanding of. What I do understand is that the semiconductor industry is booming, Ultra Clean is at a dirt cheap valuation, and they’re a key player in creating the technology used in the manufacture of semiconductors.

Sentiment

The stock is down 9.2% over the last year. While the decline was only 9.2% over the last year, this ignores the wild ride. From June 2017 through the October 2017 peak, the stock rallied from $18.75 to a peak of $33.60, at which point the stock declined 49% to its present levels.

Why did the stock endure such a decline? Mainly, a series of earnings reports created doubts that Ultra could maintain its high level of recent growth. A 2 cent earnings miss in October 2017 triggered a 27% selloff. A 1 cent earnings miss in January caused another 34% drop. While earnings missed slightly, revenues increased by 42% year over year in the January earnings report.

My Take

I typically avoid stocks in rapidly growing industries. Growth tends to fall apart as a rule of nature. Contrary to popular sentiment, capitalism and the price system actually work. Growth is also usually rewarded by rich valuations because investors extrapolate the present into the future. For that reason, growth is rarely worth paying a premium for unless you have unique insight into why the growth will persist.

With that said, the EV/OpIncome 5.7x valuation of Ultra is simply too cheap to ignore. I’m not paying anything for the growth rate. Ultra is priced like one of my failing retail stocks that are getting crushed by competition with Amazon. In contrast, this is a company that grew revenues by 64% in FY 2017 compared to FY 2016. The growth is continuing, with the recent year over year quarters showing a 42% gain in revenue. The minor earnings slips look to me like they are simply a result of expenses that are necessary to keep up with the torrid pace of business growth. Cap-Ex increased from $7 MM in 2016 to $16 MM in 2017. Research & development increased from $9 MM to $11.6 MM. COGS went from $475 MM to $756 MM. While the growth in expenses is high and is leading to some minor earnings volatility, they seem to be growing organically with the growth of the business. Managing expenses in a business that is growing by 40% is a hard task. Of course, Wall Street is demanding and unforgiving boss.

This is a situation where minor earnings volatility is leading to roller-coaster stock price volatility and an opportunity for value investors.

The risk here is that the demand for semiconductors falls apart. I have zero insight into whether the demand will continue to grow at its torrid pace, but I do notice that semiconductor demand is tied closely to global economic growth, which doesn’t show any signs of letting up at the moment. With that said, at a debt to equity ratio of 13%, $162 MM in cash compared to $55 MM of debt, Ultra doesn’t look like a company that will fall apart once the demand cycle for semiconductors inevitably falls.

If semiconductor demand continues to be strong, slightly better expense management should cause an EPS beat, which could send the stock back to a reasonable valuation and its 52-week high. The 52-week high was $33, which would be a 100% increase from present levels. The 5-year average P/E is a very high 37x. Currently, the stock trades at 7x. Even if the stock increased to a multiple of only 20x, this would be an increase of 185%.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Big Lots (BIG)

biglotselkton

Big Lots in Elkton, MD

Key Statistics

Enterprise Value = $1.859 billion

Operating Income = $274.5 million

EV/Operating Income = 6.77x

Price/Revenue = .32x

Earnings Yield = 10%

Debt/Equity = 25%

The Company

Big Lots is a large discount retailer. They operate 1,400 stores throughout the continental United States along with a smaller operation (89 stores) in Canada. Big Lots sells everything from candy to furniture, all at a steep discount. Traditionally, Big Lots acquired their inventory by taking advantage of closeout situations. A closeout is a situation where a major vendor wants to bulk dump the last of their inventory on a firm like Big Lots. Big Lots buys the inventory in bulk (it can be completely random – like Keurig machines or inflatable pools) at a steep discount, and they sell the items to their customer at a low price.

This isn’t the only way that Big Lots acquires inventory, but closeouts have traditionally been the core of their business. Their big sales on closeout items are typically what attract customers to the store, who also make impulse purchases on goods that aren’t as attractively priced. Quickly perusing deals on their website, you’ll see that they frequently sell goods at a discount to both Wal Mart and Amazon.

Inventory management and ability to secure merchandise deals are a major part of their business. They have a long track record of successfully navigating this difficult industry, with the business dating back to 1967.

Sentiment

The stock is down 12.8% in the last year and is 35.9% off its 52-week high which was reached in January of this year. The stock is afflicted by the “retailpocalypse” sentiment. At the first sign of trouble, retail stocks are absolutely crushed in this environment.

The past two earnings reports were greeted with horror by Wall Street, hence the steep discount from the 52-week high and ultra cheap valuation. In the most recent earnings report, earnings were down 39% from the same quarter a year ago. Revenue was also slightly off.

My Take

Big Lots is priced like a business that is in severe distress even though it isn’t. Wall Street overreacted to the recent earnings reports just because they are on high alert about any minor hiccup in the retail sector. It’s a good company in a hated industry.

At the current P/E of 10.41, if the stock returned to its average valuation over the last 5 years (16.41), it would be a 57% increase from current levels. For what it’s worth, management expects to earn $4.50 per share this year, which is pretty close to what it made last year. They are not warning of significant deterioration. If the business situation improved just a little bit, I don’t see why the stock couldn’t return to its average valuation multiple.

One of the major risks facing Big Lots is a trade war. They are heavily dependent on cheap goods from overseas markets to support their pricing model. If a trade war truly did happen, Big Lots would be harmed. At the moment, the threats going back and forth between the United States and China seem small and are likely posturing.

Interestingly, Big Lots actually delivers higher returns on capital than its biggest competitor, Wal Mart. Big Lots earned a 10% return on assets, compared to Wal Mart’s 4.43%. Wal Mart’s operating margin is presently 4.3% compared to Big Lot’s margin of 5.24%. Indeed, Big Lots is hanging in there and doing well even though it is competing with brutal competitors: Wal Mart, Amazon, and dollar stores.

There are also no signs of financial distress: they have a 25% debt-to-equity ratio, an F-Score of 5 and Altman Z-Score of 6.88. The decline in the stock seems driven solely by a minor drift down in performance, nothing major.

Like Aaron’s, I think Big Lots is a company that should benefit at this point in the economic expansion. Discount retailing is an industry that should thrive as the lower and middle class begin to feel more confident about their jobs and spend more money on discretionary items.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.