Under Armour (UA)

I thought I’d put together a quick overview on my thoughts at this point. The short has worked out pretty nicely.  I covered a small part of the position immediately after the earnings call, but now I’m regretting it. I didn’t believe the weakness in the price would be this pronounced.

The inventory buildup was extraordinarily bad this quarter. Accounts receivable continue to build – write off is looking more and more likely. Connected fitness continues to suck money out of profitable businesses for an uncertain payoff. And perhaps worst of all, the capex is going through the roof as UA builds out its massive new HQ. I respect Kevin Plank for what he’s doing for Baltimore in Port Covington, but I have to wonder if he isn’t taking his eye off the ball a bit.

My downside target based on a 30 PE of 2018 earnings gave me a stock price of $25-26. The upside was $50-51 based on a 40 PE of 2018 earnings if margins ever come back to historic highs. Is the short still worth it?

One thing I’m working on is holding my winners. I’ve noticed a consistent pattern of getting out of my positions months before the trend ends. I think there is a realistic possibility that Under Armour overshoots to the downside. After all, the company still has write-offs of inventory and accounts receivable that will pressure margins for the foreseeable future.

I recently went to an Academy near my apartment, and half of the (nearly empty) floor was covered in Under Armour merchandise. The channels are full. The company says it can expand the number of channels, but I have doubts regarding the potential sales of these channels. Kohl’s isn’t going to sell as much Under Armour as Macy’s.

UA is constrained until international and DTC grow big enough to overcome the relatively weaker North America sales.

As for the buyout rumors, I am pretty confident these are floated by traders with long positions looking to offload. 1) I really really don’t think Kevin Plank would ever want to sell. He has a specific vision and almost certainly wouldn’t trust someone else to execute this. 2) Who would buy? I really doubt Nike would be interested, especially at these prices. No one else is big enough. Maybe a PE firm would be crazy enough to do it, but again, I think Kevin Plank would fight like hell before being subjected to the oversight of a PE manager.

I think there’s a good chance that UA breaks technical resistance at $30, and then who knows where it stops? So I’m holding, although at a slightly smaller position.

Advanced Drainage, Discover, and Under Armour

Advanced Drainage Systems (WMS)

As I wrote about before, I think WMS represents an excellent short. Jeremy Raper on SA and utah1009 on VIC wrote some great, detailed write ups on it, and I’d recommend you read those. Basically, it is fundamentally overvalued, has significant accounting issues, and a large amount of convertible bonds that can add 38% to the market cap that many analysts miss. Analysts are projecting huge margin gains on the back of drops to the material cost.
In addition, the CEO Joe Chlapaty owns a significant amount of stock (13%) and probably drew some margin to get that much, so it is one of those stocks that could run into a CEO-margin-call issue if it starts falling very fast.
If you take out some of the more absurd add-backs to EBITDA, add in the extra convertible shares, and value the company based on its comparables, you get a price ~ $12.
The drop in material costs has been boosting the gross margin significantly, and macro tailwinds in construction have been holding up revenues enough to keep the stock moving higher the last several months, putting me well underwater on my short position. However, after negative earnings announcements by U.S. Concrete, Martin Marietta, and others in the construction industry, all the stocks have taken a bath. I added a bit to my short in the mid-20’s after reading USCR’s conference call.
U.S. Concrete is particularly relevant to WMS because WMS makes plastic pipes used to replaced concrete ones. The price of concrete has been soaring, which boosts demand for WMS’s plastic pipes. This is coming at the same time that the price of polyethylene has been dropping, which boosts WMS gross margin.
The construction industry in general was pretty hot Q4 2015 – Q1 2016. The BEA data from Q1 showed that the biggest gains in GDP came from the construction industry. I think its slowing down as the latest housing starts from Q2 2016 show. USCR and Martin Marietta maintain that the slowdown in construction is a temporary blip related to weather. Maybe it is, maybe it isn’t. Either way, WMS ought to announce pretty crumby earnings tomorrow, which should be a nice time to take some profits.
Discover Financial Services (DFS)

Discover is an interesting idea. It trades at a discount to AXP, 2.25X Book vs AXP’s 2.91 X Book, despite being essentially the same business model*. AXP has an E/A ratio of 12.9% and DFS has an E/A of 13.1%.
It originates the credit card loans and holds them, unlike V and MA, which originate and sell off the loans. But the great thing about Discover’s business is they generally go after very credit-worthy customers.
The stock has taken a hit, in my opinion, over two issues – the recent loss of exclusivity with Sam’s Club, and an expectation that the lower than average loan losses will reverse in the next credit cycle. Both are reasonable concerns, but the even if the company takes a pretty big hit on these, say 20-30% of earnings wiped out, it is still going to be trading at a PE in the low teens, and a cash flow yield in the 8-10% range. I am perfectly happy to take the possibility of a drawdown of 20% over the next year for the chance to own a security that is essentially yielding 10+% a year for the foreseeable future, and with a substantial possibility of a re-rating to a 7-8% yield.
I think the business is good enough to trade at a higher multiple, a P/E something like 15X and a cash flow yield around 7-8%, or a 12-13X P/FCF, compared to its current P/E of 11 and its current P/FCF of 8.65. It could probably rise to AXP’s price to book, though I think even AXP could go a little higher on that ratio.
On top of that, technically, the chart looks great. It’s made a nearly perfect inverted head and shoulders over the past year, with a neckline around $56. It just broke through the neck line over the past couple of weeks. This is generally a pretty positive sign, and it gives you a natural stop, so it is an easy stock to set up a large size in – you know exactly at what point the thesis is invalidated and you need to get out.
Let’s say you couldn’t get out, or you hate using technicals. In a downside scenario, an upcoming recession, if you take it for granted we don’t have a 2008-09 style recession in our near future, I don’t think DFS would trade for less than 1.5X book, even if earnings collapse and loan losses go up a lot, which gives you $40 a share. In an upside scenario, 3X book, you get exactly $80 a share. This upside target at 3X book also roughly corresponds to a 15X earnings multiple.
3X book may seem high for a company that is essentially a bank. But consider this: banks with 10% ROEs and a high E/A ratio routinely trade for 1.5X book. Discover has a 20% ROE and a very high E/A so a 3X book doesn’t seem unreasonable.
The odds then appear roughly 50/50. Then look at the macro. The BEA released real consumer spending numbers that were surprisingly positive for the second quarter, and I think consumer spending was a key driver of the latest rise in the stock market. This actually bodes well for another upturn in the cycle, despite narrowly missing a recession earlier this year.

So you get a mildly positive macro tailwind, a positive technical indicator, and good fundamentals, with a worst-case downside about equal to the best-case upside. DFS makes for a good bet.

* So okay, AXP might be a little better business. The ROE at AXP is 25%, so maybe it deserves a higher P/Book than DFS. But AXP probably has upside too – it is trading at a discount to its own historical multiples on P/Book and P/E.

UA

UA is starting to stress me out. The latest quarterly earnigns really bore out core points of my short thesis – the accounts receivable continue to rise, and inventories continue to climb, with management making a mountain of excuses. But I was troubled by one comment they made on the call. Management compared the amount of distribution outlets UA has to the amount that Nike has, with the argument they still had substantial room to expand distribution.
A big chunk of my thesis was that UA had benefitted for years from growth in distribution channels. But I figured that it was running out of new channels to grow into, and would start to suffer lower growth. I also postulated that the recent Sports Authority’s bankruptcy and weak same-store sales from the department stores were contributing to the bigger charge-offs and inventory build-up, and I thought that management was trying to obfuscate this by announcing they were changing their inventory management system.
The problem with this thesis is that if UA can still expand distribution – like they just announced with Kohl’s – there may be a while left before the negative fundamentals start to catch up.

I also made a cardinal mistake when I thought about UA earlier this year. I made the assertion that industry growth in athleisure was about 10%, and UA had been growing for 25-30% for years because of its market share growth and distribution channel expansion. Eventually, if the latter was coming to an end, and the former was being challenged by new entrants, then UA revenue growth would ultimately slow to 10%. As such, it did not deserve a premium P/E multiple to NKE and definitely did not deserve a premium multiple to LULU. Moreover, as LULU took back market share after its latest turnaround strategies set in, UA would suffer. This was the basis of my short position, and where I was figuring my profit targets for the trade.
The fault was that I didn’t consider that instead of UA’s P/E multiple falling, the P/E multiple of LULU and NKE could RISE to match that of UA. And that is essentially what happened, the returns of LULU and NKE have been exceptional, while UA just stayed flat. In retrospect, the smarter play would have been a pair trade, short UA and long LULU. I just have difficulty paying 40X earnings for any company, even fast growing ones with positive underlying market dynamics.
One last thing that’s making me nervous is David Einhorn’s Q2 letter. I noticed he just wrote that Greenlight closed out their UA short. I don’t think he has a crystal ball any more than the rest of us, but Greenlight is a bunch of incredibly smart people who have a long history of shorting successfully, and if they think the risk/reward is gone from the trade in the high 30’s, who am I to say that there is more potential for this thing to fall? The last time I held on to a trade after Einhorn closed out his short was Mobileye, and I got crushed by the subsequent rally.
Here are the parts of the thesis that are still intact. Lululemon is still taking back market share. I don’t think the Stephen Curry line will be as profitable as the Jordan line, despite expectations of analysts to the contrary.
But the most important component is this: 5-6 years ago, Under Armour had a unique proprietary product that no one had ever seen before and that everyone wanted. Now that sweat-wicking material is being copied everywhere for dirt cheap prices, and UA has to compete by making incremental improvements that really won’t move the needle on consumer preference. Even it’s biggest customer, Dick’s Sporting Goods, is moving aggressively with their own athleisure line. This is a substantial change in the business model – it’s never good for business to compete with your customers.
It’s the classic problem of an innovator – eventually, everyone catches on to the basic innovation, and the company is now left spending tons on R+D for small gains while competitors take market share. UA is betting hard on “connected fitness”, taking on debt to buy MyFitnessPal, but it will be a long time before these initiatives are a contributor to revenues, and in the meantime it’s a drag on the bottom line, while the top-line is under attack.
The technicals on this one are interesting. The stock is stuck in a wedge. Being at the bottom of the wedge, its prudent to at least take some off the table – it’s more likely to bounce back up into the wedge than it is to break lower.  But as the wedge narrows, there is an increasing probability of a large price move in either direction.

Brexit and Shorts

So I turned very negative on U.S. stocks during May. Part of it was seeing the apocalyptic presentation by Stan Druckenmiller at Sohn, and reading the piece in the WSJ about Soros coming back to fund management after an 8 year hiatus, but it also arose from an inherent belief that stocks are expensive, we are in a bear market, and earnings have gone lower for 3 quarters in a row.

The liquidity situation is hard to read. The Fed is the big question mark and biggest decider. Capex and inventories are rising, which suck liquidity out of markets. Earnings are falling, which obviously leaves less cash available for pouring back into markets.

But on the other side of the equation, buybacks and M&A are continuing at a torrid pace, often funded by the excess cash on balance sheets and corporate debt. So there remains a positive force to buoy the markets. If this stops, the market will tank.

Brexit clearly wasn’t anticipated by the market. I don’t think the actual event is all that significant, but I think it provided a catalyst for a market that was looking for a reason to fall. I didn’t have any currency positions, because I didn’t have any conviction as to how the vote would end up. I’m going to use the weekend to rethink my views on currencies and see if I can come up with a thesis.

I wasn’t positioned perfectly for the shock, but my portfolio was up about 3% Friday because of my large SPY short. I also have a number of individual shorts, my two biggest being SHAK and UA.

SHAK

Shack Shack is a short I’ve held ever since the borrow rate came down to reasonable levels. I think even at these prices it’s still way too expensive. I used their own forecast – 14 new shacks a year, average AUV of $2.8-3.2 million for new shacks, Shack-level operating profit margin of 18-22%, projected total of 450 shacks. Even if you use the high end of their internal forecasts, then apply a very generous 7.3% discount rate, you get a $26 share price. Keep in mind this doesn’t include execution risks, and also my projection was that average AUV would still remain very high because of the higher AUV of the New York and East Coast Shacks. Insiders have been selling since lockup and are still selling in droves. I’m still short and won’t cover til it hits $30.

UA

Under Armour is running into issues with its distribution channels, and I think its trying to cover it up. They announced a new inventory management system – I think the channels are stuffed and they can’t move the inventory. Inventories and Accounts Receivable are both rising faster than revenues – a huge red flag. Sports Authority went BK, a sign of the troubles at its distributors. It’s biggest customer is Dick’s Sporting Goods, which hasn’t run into trouble yet, but Dick’s is also launching its own athletic wear line to compete with UA. Oh yeah, and the Steph Curry’s are probably the worst reviewed shoe of all time, plus the Warriors lost.

The company has been growing revenues at 30% a year for the past 3 years, and forecasts 25% growth this year, so the market gives it a high multiple, about 70X trailing earnings. Compare this to Lululemon, which had posted an average 10% growth for 3 years, but just accelerated last quarter to 17% revenue growth, and trades at 37 times trailing earnings. UA may be worth more than Lululemon but not twice as much.

WMS

Okay, maybe I should stop shorting this thing. I read the write up by utah1009 on Value Investor’s Club, and it made a lot of sense, so I shorted. But you can’t fight a promotional management, a promotional Wall Street, AND macro tailwinds. It’s done nothing but lose money for me since I shorted $21. I think it should be worth something in the low teens eventually, but the question is how long can I wait? Luckily the position size was small, so the losses haven’t been huge. But the lesson here is pay attention to the macro – if there is a fundamental reason for this thing to do well, you shouldn’t be short.

MBLY – Mobileye

I read a really good thesis on Mobileye by Suhail Capital on Seeking Alpha, it made sense, and I shorted. The company has shown impressive revenue growth and has huge margins and little competition at the moment. But there is no patent protection, and there are a ton of companies entering the space, including the auto manufacturers themselves. I think, looking two years out, growth will have flatlined and margins will have come down, leading to 2017 earnings that are about the same as those of the last twelve months. Currently it’s trading at a P/E of 124, and if you buy the thesis, then it’s a forward P/E of about the same. I’m short a small position.

I’m still looking for great short ideas. I think Friday’s drop was just the beginning of another market rout, like January-February, like last August. Hopefully, third time’s a charm.

 

Another look at Reverse Corp

Reverse Corp (ASX: REF) came out with an announcement on the Half-Year ended Dec 31, 2015. I’ve updated my sum-of-parts analysis below.

The Cash

An interesting development in the cash picture has evolved. The company still has net cash of $5.56 million, but has also purchased shares in another Australian company, Onthehouse Holdings, an Australian real estate software company. It initially bought 1.75 million shares at an average price of 57 cents a share, then Onthehouse received a takeout offer. for 75.5 cents a share. The share price rose to 70 cents a share, and Reverse Corp bought another 1.39 million shares, betting the merger would occur. As luck would have it, Onthehouse rejected the initial takeover offer, and the buyers offered to increase the bid to 85 cents a share this morning.

Shares are currently trading at 79.5 cents a share, for a 26% gain from Reverse Corp’s buy-in price. Reverse Corp’s stake now stands at $2.50 million, from an initial investment of $1.98 million. If the deal goes through, the stake will be worth $2.67 million.

That puts cash and marketable securities at $8.06 million, or 8.6 cents per share. For reference, the whole company is trading for 11 cents per share.

Last post, I said the cash probably deserved a 10% discount, as management was looking to make acquisitions, and we have no assurance of the success of these acquisitions. The latest development seems to show that they are at least looking in the right places. I’ll keep the 10% discount, and say cash is $7.25 million or 7.8 cents a share.
OzContacts

OzContacts is positive on EBITDA, but the EBITDA is still miniscule at $35,593. This was probably because of a lower revenue this HY than the previous. It might be consumer weakness in Australia, or it might be weakness in the business. I’m not sure which is the case, and it is worth keeping an eye on. I’ll take my cue if on the next earnings announcement the inventories have built up – that would be a sign that the business has serious problems.

The company wants to make acquisitions in this business, achieve scale, and boost margins through synergies. I would normally say I don’t trust management to be do things like this, but the company has proven itself to be a shrewd capital allocator.

The company divested its loss-making divisions immediately when they stopped contributing to the bottom line, cost-cut their core business to start generating tons of cash flow, started a new business in an area they have no expertise, successfully got the business to profitability, and has been even investing in the stock market with success (more success than I have had lately). Some of these might be luck, but after enough successes in a row, I have to think management must be doing something right.

So I think it’s reasonable that management might succeed at acquiring another contact lens business and cost-cut to realize synergies.

The business is profitable and growing EBITDA (despite the decline in revenues), and probably is still worth at least 1-2 cents a share.

1-800-Reverse

The revenue at Reverse declined 16%, rather than the 50% decline in my worst case, and the 10% decline in my most likely case. So it’s doing a little worse than I thought was likely. I’m now assuming 30% yearly decline in the worst case, a 15% yearly decline in the most-likely, and 5% decline from here on in the best case.

Reverse Corp Worst CaseReverse Corp Most Likely CaseReverse Corp Best Case

Values per share

So in the worst case, I won’t lose much (in fact, might even make a little), and in the best case, I might make a lot.

There is room for additional upside. If management deploys capital in an effective way, and is able to realize synergies from a contact lens acquisition, we could see more value in the OzContacts business.

On the 1-800-Reverse side, I think the pre-paid calling business is counter-cyclical and should benefit from the current macro picture. The pre-paid cellphone business grew in the U.S. during the 2009-2010 recession. With Australia in a slump from a decline in the mining sector, and now oil and gas weakness, the pre-paid calling business ought to benefit from tailwinds of a cash-strapped consumer. There is a real possibility that revenues at Reverse Corp actually increase, rather than continue to decline, as consumers shift to pre-paid mobiles.

Finally, the strength of the 1-800-Reverse brand shouldn’t be underestimated. Though there are two competitors in the space, Reverse Corp spent years on advertising to develop recognition among consumers. It can now reap the dividends of those years of investment without need for further advertising. The collect calling industry isn’t big enough to justify large advertising budgets anymore, which essentially locks in the consumer “mind-share” at old 1990’s levels. The competitors can try to buy their way in, but they can’t afford to do the kind of advertising necessary to displace 1-800-Reverse. This mind-share ought to allow keep at least a small moat against the competitors as the industry continues to decline.

 

Disclosure: I own shares of Reverse Corp

Context matters

I was watching one of Joel Greenblatt’s MBA classes at Columbia the other day where they analyzed some investment writeups of Charlie479 on VIC. When Greenblatt asked the class for their thoughts on the write-up, many classmembers pointed out the more obvious points to the investment thesis (buying back shares, cheap on some metric, etc), however one thing that he brought up that his students were missing was the psychology of each investment – what was the difference between market perception and reality?

NVR was misunderstood – everyone thought it was a homebuilder, in a capital-intensive, cyclical business, and therefore deserved the same multiples as the other homebuilders. However, they missed its capital-light model, negative working capital, and its business practice of pre-selling.

NII Holdings was disregarded as a post-bankruptcy stock, and its earnings were difficult to compute, because the filings were so complicated. The fact that it took Charlie479 significant effort to come up with the 2.8 EV/EBITDA figure was something that stood out to Greenblatt that the students brushed over. Greenblatt realized that if it was that difficult to discern its earnings, NII Holdings must be misunderstood. (As an aside, this stock eventually went bankrupt again – a so-called “chapter 22” filing – and has again emerged from bankruptcy. It ought to be worth a look again this time.)

Finally, Sportsman’s Guide was regarded as a catalog business, however, what the market didn’t see was the potential to cut costs dramatically from internet sales. The students did concentrate on this as a salient point, but what differentiates Greenblatt’s approach is a concentration on what the market doesn’t see.

There is a plethora of new value investors on the scene (myself included) who probably spend too much time on simple metrics – EV/EBIT, ROIC, P/E, P/FCF, etc. However, what Greenblatt emphasized continually in his MBA classes is that context matters.

Current Ideas and Framework

Currently I am considering some of the following ideas:

DDD

I followed this for a while back in 2013. At that time I made money on the long side, the short side, then the long side again, by identifying a reflexive trend – using stock sales to fund acquisitions. It was a classic reflexive boom-bust, as outlined in chapter 1 of Alchemy of Finance. I lost money in the 2nd half of 2013 when I called the top of the bubble too early. I was squeezed out with a number of other shorts, and the stock chart turned parabolic until it peaked in Jan 2014. After that, it has fallen for over two years from the mid $90’s to current prices under $10. I learned some lessons –

  1.  to wait until you see the “whites of their eyes” when you are shorting – wait until the chart sets up perfectly to short, or
  2. to size appropriately in order to have staying power.

I am not the best reader of charts, so #1 seems difficult. #2 seems more within my grasp, although it involves a lot of discomfort as you “fight the market”. Whitney Tilson entered the DDD short at about the same time I did, however he had the staying power to make a lot of money on it. This demonstrates that I have a lot to learn still.

I am more interested in the long side now. I think that it’s margins could normalize  because of its cost cutting efforts (it acquired lots of unnecessary workers as part of its acquisition spree), an exit from the consumer space (which has always had lower margins), and a new metal printer (I haven’t confirmed the technical merit of this new metal printer). Such a turnaround would give it an EBIT somewhere in the neighborhood of 70-80 mm. At an 8X EV/EBIT, it would justify the current share price. That is not good enough to warrant an investment however. After a reflexive bust, the stock ought to become a true value, with an adequate margin of safety.

I have been trying to build a financial model that would allow me to test my assumptions, however it is taking me far longer than I expected. In the meantime, the stock has rallied so much that even if it was a bargain, it may not be by the time I finish. This seems to be why George Soros adopts a principle of “invest first, invesigate later”. The only problem with that approach is that you have to remember to do the investigation after you have invested and not complacency set in. This is especially difficult if the trade goes your way – you tend to do minimal work to prove the thesis without assessing the risks adequately because things are working.

AGRO

This is an idea I first read on Value Investor’s Club. I would have been better off if I’d invested then, but I decided to wait out the global turmoil, attempting to be smart and time the markets. So much for that.

The thesis is that

  1. Macri, the new president of Argentina, has eliminated export taxes on many of Adecoagro’s products, which will give it somewhere in the neighborhood of $50 mm of FCF per year.
  2. years of capex in its sugarcane business are winding down, which also ought to contribute $50-60 mm of FCF per year.
  3. a 50% devaluation in the Argentinian peso has occurred, which ought to contribute $60 mm of FCF,
  4. Export subsidies of Argentina’s competitor countries have been eliminated under the Doha round of the WTO. I am not sure what the end impact of this will be, but it will assuredly be positive. India is a big competitor in the sugar markets, however it has massively subsidized sugar cane for years. At current sugar prices, few of its domestic sugar cane operations will be profitable. Also, The E.U. is a competitor in the dairy market (an area where AGRO plans to invest its new cash flows) and it had massive dairy subsidies.
  5. An agriculture inventory that has been building for several quarters. Management of AGRO anticipated Macri’s victory and the elimination of export taxes, and waited to sell certain inventories for several quarters. This depressed cash flow for prior quarters and will increase it in future quarters.

Risks include

  1. The Brazilian real has fallen. This affects the price of ethanol that AGRO sells directly into the Brazilian market. However, the dollar has risen, and the vast majority of its revenues are in dollars. I can’t really tell if the dollar bull market is a positive or not, for reasons of #2 below:
  2. The prices of commodities have been falling. This is largely due to the dollar. So the effect of the rising dollar doesn’t really benefit AGRO as much as you’d think – though it receives revenues in dollars, it is receiving less dollars per unit of product because the price of the commodities is falling.
    So far, I’ve been chalking currency changes to a positive, because many of its costs are in the peso which devalued much faster than the dollar. However, I may be totally wrong on this – there many forced pointing in different directions and its all a little confusing. The other thing is the Fed is likely going to abandon a strategy of multiple interest rate hikes this year, which ought to weaken the dollar.
    Will this increase commodity prices? So far it looks like the answer is yes. The commodity index is up today on news that the Fed is turning dovish. Perhaps the best tack is to just keep doing a bottom up analysis of this and if the value is there, whichever of the conflicting macro forces wins out will not hurt the thesis too much.
  3. El Nino. This is another possible risk, possible benefit. The yield of sugar from sugar cane decreases with increased rainfall, and half of its cash flows come from sugar. However, other crops have increased yields with the increased rainfall. Overall, it might be a slight negative.
  4. Dollar denominated debt. The company has some dollar denominated debt, and its borrowing costs have been increasing because of the rise in the dollar. The amount of debt is $580 mm, which is 4X EBITDA before all the aforementioned increases in profitability, which will come to something like 1.5-2 X EBITDA after those changes. Furthermore, the rise in the dollar could halt or reverse, and I think the company will be able to aggressively pay this down over the next couple of years, so I don’t think this risk is all that bad.

Maybe some of the risks pull the cash flow numbers a little lower for 2016. Either way, you are still going from a situation where cash flows were flat to slightly negative for the first part of 2015, suddenly turning at least $100 mm of positive FCF and possibly as much as $200 mm of FCF in 2016. The stock has rallied by about 40%, but I think this is far too small of a rally. The EV is currently about 2 billion, so the price isn’t that low, but once the debt starts getting paid off and new investments (like the dairy investments mentioned) start working, the stock will probably seem underpriced.

Now that I’ve gone through the value argument, I think the main reason why I’m so interested is that perceptions ought to dramatically change after the company starts reporting massively profitable quarters. So the time horizon on this isn’t as long as a typical value investment – I’m looking for this to work out in the next 6 months or so or I’ve made some wrong assumptions here.

DOC

This is an idea I saw on IBD talking about how investors turn to REIT’s during times of market turmoil. What I saw that got me excited was another possible reflexive boom-bust – the company is issuing a ton of shares and using them to acquire real estate. The company did several hundred million dollars in acquisitions last year, and management states they want to do over a billion this year. They just completed a share issuance for $320 million, and the stock rallied. I haven’t done a lot of work on this, but these seems like a prime “invest first and investigate later” type of investment – the stock has a perfect technical setup, so I dont want to miss it.

The stock has an inverted head and shoulders with a neck line of $16. After breaking through, it dropped, tested $16, and the level held. This indicates that it won’t likely fall through $16 again. As such, I can pretty clearly define the risk on this trade – if it falls through $16, I’m wrong. If it doesn’t, it ought to keep rising. The one thing I don’t expect, is that the price will stay where it is for the next year.

I would have to monitor this position closely, and I really must remember not to get complacent on this – that’s how you lose tons of money on these things.

Japanese stocks

I really don’t know which ones I like yet, but I’m putting this down as a theme I’m watching for now. The BOJ seems determined to make inflation happen, in an environment where one their key metrics of inflation, oil prices, keeps falling. This puts them in the struggle of printing more and more money by buying assets. The trouble is, those assets they are buying are JGB’s, which are now incredibly scarce. So they have turned to buying stocks outright through purchasing ETFs. They want the investment banks to make a custom ETF for them with Japanese companies that investing in Japan. Who the investment banks pick remains to be determined, but Mizuho put out a list of four possible candidates recently. After scouring those companies, I could only find one that I actually liked, Colopl, a mobile phone video game developer, now investing in VR games. It was cheap (7 X EV/EBIT), but not terribly cheap for a Japanese company – there are a ton of net-nets in Japan right now.

So far I have three possible strategies:

  1. Buy up net-nets. These are proven to outperform the market over a longer time period. But if Japan is devaluing the yen, then the value of holding cash decreases, and maybe this isn’t the best environment to do net-net investing.
    On the other hand, maybe Japan isn’t successful in further devaluations. Nearly everyone in Japan thinks the yen will devalue further, so this is a very against-consensus idea, but the yen might appreciate a lot if the risk-off dynamic persists.
    So then the yen might be a buy right? Well why not buy yen at a discount? If you buy up a bunch of net-nets, you can essentially buy cash at a 50-75% discount. Then, if the yen appreciates, the true value of your holdings has appreciated. If the yen continues to depreciate the core businesses and earnings improve, and the stock ought to go up. These might be a win/win
  2. Buy companies with lots of debt. These ought to be more volatile and their borrowing costs are decreasing, so they may go up more than net-nets in this environment
  3. Buy the companies I think will be included in an Abenomics ETF. Maybe this works, maybe it doesn’t. I don’t have a lot of confidence – after analyzing the candidates Mizuho put out there, they don’t look like great values.

GPRO – GoPro

Okay, the TTM EV/EBIT is 3.6X. Okay, sure, I know trailing numbers include this huge fad trend, and Gopro might never regain that kind of popularity again. But 3.6X!

I’ve generally observed that EVERY time that I’ve ever seen a fad stock crash to this kind of crazy level, it rebounds. I’m not saying it’s never happened that a stock falls and doesn’t recover, but I think there is usually at least a “dead-cat bounce”.

I think there’s a lot of potential for upside surprise here. What if the drone product takes off? What if people have a Gopro replacement cycle every 3 years and sales start picking up? What if other countries really start digging the Gopro thing? There’s a lot of ways it could go right.

Of course there are a lot of ways it could go wrong also, but I get a feeling that its all priced in.

I still have work to do, but I just get a hunch that there is value there. The last thing that makes me bullish is this article I saw at Motley Fool. When long term bulls are throwing in the towel, it’s usually a sign of the bottom.

The way I’d play upside surprise would usually be a simple call option, but the calls are so darned expensive. I’m thinking about buying a call spread – long a call at $10 or so, short a $20 call. This ought to lock in a 300% gain to 100% risk ratio, which seems about right for the probabilities here.

 

Kearny Financial Corp – an old-fashioned thrift conversion

Here’s an interesting idea I came across on Barron’s. After I read Klarman’s Margin of Safety and re-reading some of Peter Lynch’s old books, I did a recent search for thrift conversions, and there are still a few occurring. Kearny converted earlier this year, and is already up quite a bit. However, there is probably still a lot further to go – the Equity to Assets ratio is above 25, and non-performing assets are below 1%, meaning the bank could take a ton more leverage on and boost earnings. Ultimately that will lead to a higher price to book more in line with peers (currently 1.1, peers are 1.5).

An issue with regional banks in general is knowing the regional environment. This one is mostly in New York/New Jersey area. I’m not aware of major dynamics either way (bullish or bearish) that will affect the financial sector. If stocks in general take a bath, or the fallout in bonds wreaks havoc on Wall Street, there could be implications for Kearny. Furthermore, The bank has a team that is working on getting more commercial lending done, so they are going to be taking on quite a bit more risk, but of course that will come with higher earnings in the meantime.

Disclosure: I own no KRNY, may buy shares in the reasonable future.