Investment Filter

Bon-Ton Stores

2009-04-27T22:54:00.048-05:00

I wrote an article about The Bon-Ton Stores (BONT - NASDAQ) last year (you can read the article here) after shares of the company had dropped to $5, or 90% below the 52 week-high, and I noticed it on the NASDAQ 52 week low list. At the time the retail industry was just beginning to start it's downward decline and investors were scared off by the more than $1 billion in debt that Bon-Ton had on it's books - the majority of which came from the 2006 purchase of two of Saks Fifth Avenue's subsidiaries. I won't go into the specific details of the article, but the general conclusion was that although the company was not in a stellar position it was also not in imminent danger of bankruptcy and if management could hold down the fort during this downturn, a patient investor could have a nice profit.

To my surprise, over the past several months I have received a number of e-mails from readers that were interested in discussing the article and the company, as many had differing views on whether Bon-Ton could survive this downturn. Well, since Bon-Ton just recently released it's 2008 results (year ended Jan. 31, 2009), I thought I would take this opportunity to open up the file once again and check on what, if any, progress management has made over the past year.

Unfortunately, for anyone that did invest in Bon-Ton when it was trading around $5 last year, that investment has now been almost cut in half as the company recently closed at around $3.00 (as of May 1, 2009) and traded as low as $0.80 in November, 2008. Also, recent news that Moody's has cut the company's ratings to non-investment grade has given investors another headache, as this will definitely hinder the company's chances of renegotiating it's senior secured line of credit which is due in March of 2011.

Results for 2008 were less than spectacular as revenue declined by 7% year over year, and the company had a net loss of approximately $170 million; however, it should be noted that roughly $66.5 million of this total was in relation to goodwill impairment, a store closure in West Virginia and what it calls "other impairment charges." The company also recorded over $60 million in tax expenses - due to a recent change in accounting standards - as compared to an average of $13 million from 2005 to 2007.

These numbers need to be taken in context, however, as the economy, and subsequently the retail industry, are both in an extremely dire position right now and so investors should not be as nervous about a drop in sales as they should be about the possibility of the company defaulting on it's debt. As it always has, the retail industry will eventually recover and a company such as Bon-Ton that is more than diversified enough in terms of products, will follow, but only if it can keep it's creditors at bay in the meantime.

It also appears that 2009 is going to yield similar results as both February and March have been a disappointment with the year to date numbers (up to the end of March) showing a 10.1% decrease in same store sales and a 9.3% decrease in total sales on a year over year basis.

For 2008, cash flow from operations was just over $94 million as compared to over $135 million in 2007, due mostly to the above noted decline in sales. Free cash flow, which is a very important number as it shows the amount of money a company has after it has paid out capital to either upgrade or purchase assets such as land or equipment, was only $10 million. This number is compared to $26 million in the prior year, which meant the company had less cash to put towards it's debt. Overall, the company's long term debt stayed relatively flat and on January 31, 2009 it stood at approximately $1.1 billion.

This debt (see my original article for more details), consists of the following: a senior secured line of credit with a maximum available amount of $800 million (management recently reduced it from $1 B to save $0.5 million in annual interest expense) and $320 million currently outstanding; $510 million worth of bonds; and a $260 million mortgage loan facility at a fixed rate of 6.2%. Since the mortgage facility is not due until March, 2016 and the bonds don't mature until 2014, we are mostly concerned with the line of credit which expires on March 6, 2011.

For payment of the $320 million by 2001 to be even remotely possible, management will have to aggressively cut costs while still maintaining sales; however, if February and March are any indication, it will be very difficult for them to complete the latter.

As per a recent news release (you can find it here), the company has announced that it has employed the following tactics in an attempt to alleviate debt: eliminated bonuses to senior executives; ceased contribution to employee 401K plans; cut 1,150 jobs from payroll; and will not be opening any new stores in 2009. Overall, they expect this to equate into $70 million in savings as compared to 2008, which still only accounts for 20% of the total outstanding on the line of credit.

The company has also announced it's intentions to cut inventory dramatically to help increase it's cash position, which is a very common tactic for companies in this type of situation. I wouldn't put too much faith in this strategy, however, as there was already an 11.8% drop in 2008 from the prior year and it would be no simple feat for them to be able to duplicate this success for a second consecutive year, although even a 1% drop would create another $6 million in savings.

Another possibility for the company is to cut its dividend, which is currently $0.05 per quarter and cost the company approximately $2.6 million in 2008. Generally, this is one of the first items to be cut by a company in financial distress, but I am sure that most shareholders are happy that the company has resisted as it is presently yielding a return of over 9% when compared to the share price.

So even if one is optimistic and assumes that management will save $70 million in 2009, and revenue is even with 2008 ,then Bon-Ton will still have to come up with an additional $250 million in just over one year. Needless to say, unless there is a miraculous turnaround in the economy, management is faced with having to either renegotiate the existing line of credit or will have to find other sources of credit. The latter option, however, will not be easy after the recent downgrade by Moody's, the fact that the current credit market is less than hospitable and the covenants in the company's current debt that restrict it from incurring additional debt.

It looks like many of the institutional shareholders of the company agree that the next couple of years will be difficult ones as there has been a stampede-like exit for the door as you can see here on MSN Money. I also couldn't help but notice the lack of activity when it came to insider buying, aside from quarterly 401K purchases. I can only assume that with the share price so low, if insiders are feeling optimistic about the company that they would be loading up on shares. On the other hand, there hasn't been much selling activity, either.

As always, I would love to hear other people's thoughts and/or opinions on the company. You can either e-mail me directly or leave a comment below.

Short-Term Investment Opportunities

2008-11-24T19:11:00.020-05:00

As a Value investor I have become well acquainted with the idea of having to be patient to see a return on my investments. However, like anyone else, I enjoy being able to turn a quick profit from time to time to help keep the cash flow up. Fortunately, I have been able to find a few short-term takeover/merger arbitrage deals in the past and have been quite successful overall with my largest gain coming earlier this year via NetManage, Inc.

On average I would speculate that I find between 3 and 5 potential deals each year but in fact only go through with about 1 per year. However, over the past few months I have found closer to 10 to 12 potential deals and have since narrowed it down to 2 possibilities for investment: Forsys Metals Corp. and Image Entertainment.

1. Forsys Metals Corp (FSY - TSX) is a Canadian resource company that focuses on uranium mining and has all of its operations in Namibia. Generally I wouldn't give a resource company even a second glance but the Company just recently announced that it has accepted a takeover offer from George Forrest International Afrique ("GFIA"), a subsidiary of the Forrest Group, which is based out of the Democratic Republic of Congo. The offer is for $7.00 a share ($579 million in total), which translates into a 21% return over the company's current market price of $5.78 (as of November 24th, 2008). Shares of the company initially shot up to just over $6 when the deal was announced, but quickly retreated and at one point were trading for $5.30. As is the case with most deals this one is not one hundred percent guaranteed as it is subject to both regulatory and shareholder approval, which in this case must be at least two-thirds of the vote. The Company has set mid-February of 2009 as a tentative date for the shareholder meeting.

The Officers and Directors of Forsys - along with a few shareholders of the company - which collectively represent just over 20% of the issued and outstanding, have already locked in their shares and agreed to vote in favor of the deal.

One thing to take note of is that unlike a lot of other deals this takeover bid is not subject to GFIA obtaining financing as it plans to fund the deal through cash on hand and a line of credit. This should definitely be considered a positive when you take into consideration that most deals fall apart due to a lack of financing.

For anyone that is interested, the Arrangement Agreement between the two companies can be found on Sedar. I read through the agreement myself a few days ago and didn't find anything of material consequence or out of the ordinary for deals such as this. The information circular will be mailed out to shareholders within the next month and since this deal seems to ultimately hinge on whether or not shareholders of the company will vote in favor of the takeover, I thought it would be helpful to look at whether Forsys has any large shareholders that could swing the vote one way or another.

After getting a list of mutual fund and institutional shareholders from Thomson Reuters, I found that there are no shareholders that hold more than a couple percent of the issued and outstanding, which means that it would be very difficult for any one investor to be able to stop this deal by themselves. Also, in deals such as this I like to take a look at the Company's trading history in order to see if shareholders might be offended by the purchase price. In the past I have found that shareholders tend to become psychologically hooked on previous share price highs and feel that anything below is a slap in the face. For example, if the company had recently traded well over the purchase price for an extended period of time than I would put this down as a negative, but if on the other hand it had been trading below the purchase price then I would see this as a positive. The all-time high for Forsys was just over $10, which it hit back in March, 2007, however this price did not last long and the company fell to $4 by August of the same year and has subsequently spent the remainder of the time moving between a low of $2.50 (October, 2008) and a high of $5.75 (September, 2008), which overall, I would say should be considered positive news.

Personally, I haven't yet purchased any shares as I am interested in reading the information circular before I make a decision, but as of right now I feel that this could be an excellent opportunity for investors.

2. Image Entertainment (DISK - NASDAQ) announced on November 20th that it had signed a merger agreement with Nyx Acquisitions, whereby it would sell the company for a total of approximately $100 million (which includes assumption of the company's debt), or $2.75 a share. What makes this deal intriguing is that the spread between it's current trading price of $1.66 (as of November 24th, 2008) and the offered price of $2.75 is just over 65%, which is nothing to sneeze at. In addition to this, shareholders representing approximately 38% of the issued and outstanding have agreed to vote in favour of the acquisition, (these shares are most certainly represented by insiders of the company, institutional investors, and mutual funds as they collectively account for 38.2% of the issued and outstanding) and the transaction is not subject to Nyx obtaining financing as it has already secured an equity financing committment. The remaining shareholders of the company (60.8% of the issued and outstanding) will have their chance to decide whether or not they feel this price is acceptable when the company holds a shareholder meeting in February, 2009.

To help determine whether I feel shareholders will vote for or against this deal, I once again took a quick look at what the company's share price had done in it's recent past. What I found is that it only recently dropped below the purchase price of $2.75 in January of this year but before this had spent the prior four years between $2.75 and $6.25, which it hit back in November, 2004. As I said above this could definitely be seen as a negative as shareholders may not be happy with an offer that up until January of this year would have been below the company's trading price.

Also, another detail worth noting is that the company had another takeover bid earlier this year at $4.40, which never materialized due to the purchaser having difficulty being able to actually close the deal (you can read about it here). This bid was on top of another earlier bid by Lion's Gate Entertainment which had offered $4.00 but dropped out of the picture after the subsequent $4.40 offer. Since both of these occurred so recently, there is the possibility that shareholders may feel that if they turn down this current bid than they may eventually get a $4.00 bid once again.

Either way it is hard to say how shareholders will vote in this situation. Thus, I will once again wait until the information circular is posted before I make a decision.

As always, I would be interested to know what other investors think of these deals so please feel free to leave a comment or send me an e-mail.

Value Investors Rejoice

2008-11-03T22:08:00.029-05:00

As I have said many times before, I am a big fan of Google's stock screener and will use any excuse to run my usual list of numbers* (see below) and see what companies pop up. The only problem is that I am way too optimistic with my criteria (particularly when it comes to growth and price) and more often than not my list consists of only a handful of companies, most of which are either resource based or have just declared that they are headed towards bankruptcy. Well, the times have changed in the market and besides just the usual list of clunkers, there are is an overabundance of great companies that are now showing up in my searches. Not only did my most recent search result in a list that was much longer than any previous searches, but because the list was so long, I was forced to keep narrowing the search criteria until I eventually whittled it down to a reasonable level.

Anyway, after doing an overview on the fifty or so companies that were left, I ended with a list of only six companies, all of which I believe would be a solid addition to any investor's portfolio. You can find a brief overview on the first two companies below and I will make sure to add posts on the remaining four companies over the next week.

Hansen Natural Corporation (HANS - NASDAQ), which develops and distributes juice and energy drinks, has had phenomenal growth over the past several years, with revenue growing at 71% and EPS growing at 90% per year over the past four years. The balance sheet is another wonder to behold with no long term debt and over $200 million in cash & cash equivalents, which has allowed the company to buy back $50 million worth of it's shares over the past six months. On top of all of this, the Company has recently announced that it has finalized a distribution deal with Coca-Cola Co. for it's Monster energy drink, which will replace certain existing deals the company has with other US distributors, including Pepsico, Inc and should help the Company increase it's presence in Central & South America. It's not all positive news for the company, however, as a Class Action Lawsuit was recently filed on behalf of shareholders of the Company that purchased shares between May 23, 2007 and November 8, 2007. As always it is difficult to gauge the damage that could result from this, but it is definitely something that any potential investor should take into account.

Robert Half International Inc. (RHI - NYSE) is a staffing agency that specializes in the Accounting & Financial Industry. It is currently trading at less than half of it's 2007 high of $41, mainly due to the fact that the slowdown in the US economy has meant that companies are reluctant to increase their expenses by adding to staff. The recent release of it's quarterlies (ending Sept. 30th) showed a drop in profit of 11% and a drop in revenue of 2% though international staffing, which makes up 30% of total revenue, was up 15% year over year. With only $4 million in long term debt and over $370 million in cash and cash equivalents, however, this company should have no problem waiting out the current downturn in the economy and should be poised for a big jump once it rebounds.

So that's it for now. I will do two more posts over the next week on the remaining four companies. If anyone has any other diamonds in the rough that they have come across, please send me an e-mail or leave a comment.

*Market Cap: 0 to $5B

P/E: 0 to 16
52 week price change: -99.9 to 0
5 yr. EPS growth rate: 5% to Maximum
5 yr. Revenue growth rate: 5% to Maximum

Investment Thoughts!

2008-10-14T19:45:00.031-05:00

What a crazy time in the stock markets right now. Records are being set with both gains and losses on an almost weekly basis. As is generally the case in a market that has lost such a large amount of value over such a short time period there are a lot of good bargains out there for those investors that are able to go against the crowd.

Personally, I am looking at a handful of companies including American Eagle, Abercrombie & Fitch, American Reprographics, Walgreen's, West 49 and a small cap growth company called Coastal Contacts. Since I have spoken about the first five companies in previous posts I wanted to briefly touch upon Coastal Contacts in today's Investment Thoughts:

1. I discovered Coastal Contacts (TSE - COA) a couple of weeks ago when I was out shopping for a new supply of contacts. Since I recently moved to Vancouver, I didn't have a usual place to buy from so I did a bit of shopping around to try and find the best deal and quickly realized that this wasn't going to be as easy a job as I had first suspected. The first store told me that I can't use an Ontario prescription in BC, the second said that I had to have a fitting test because I didn't have my old contacts box to prove that I had worn any in the past and the third store was about 25% higher than I am used to paying. Anyway, to cut a long story short I saw an advertisement on the back of a bus for an on-line company that did home delivery of contacts and decided to give it a try. Not only was it cheap (15% less than the next cheapest store that I found - Costco), but shipping was free and they had them sent overnight. Of course, it wasn't long before I decided to do a bit of detective work on the company, at which time I discovered that it is a Vancouver based company that went public back in April of 2004 at $1.00 per share.

Since the company went public four years ago, sales have increased in an impressive fashion of 48% per year (although the past year was a more modest 26%), but the company has had difficulty translating this into increased earnings. For the past four years (year ending Oct. 31st) the company has had earnings of -$0.03, $0.04, -$0.02 and finally $0.02 in 2007 and are currently sitting at -$0.02 through three quarters of 2008. Most of this stems from the fact that the company has had difficulty controlling operating expenses, namely their Sales, General & Administrative expenses (SG&A), which accounted for 86% of gross profit in 2007 and over 100% in 2006, which is probably why I see their advertisements everywhere.

On the balance sheet side of things the Company is in a very solid position with no debts and almost $20 million in cash in the bank, which has allowed it to re-purchase over 19% of it's issued and outstanding shares over the past year. Of course a strong balance sheet doesn't do a company much good if it isn't able to turn a profit.

Generally speaking, I don't invest in companies that don't have a history of positive earnings, but since this company is fairly new, the majority of it's expenses have been used towards growing it's company and sales growth has been above excellent, it has definitely intrigued me more than other companies in similar situations. However, with that being said, I am still going to hold off on pulling the trigger with this company and am going to wait until it has grown a bit larger and see whether it's SG&A will decline and give the company a positive bottom line. Of course, this strategy could lead to having to buy in at a higher price (it is currently trading at a Price to Sales of 0.3), but I think this trade-off is more attractive than the possibility of holding shares in a company that can't generate earnings; and

2. ATS Andlauer Income Fund (TSX - ATS.UN), a Canadian trucking company, has received an offer from it's founder and CEO, Michael Andlauer, to purchase the remaining 56% of the outstanding shares in the company he does not already own at a purchase price of $11.75. At the current market price of approximately $11.00 (as of Oct. 16th), this represents a premium of just under 7%. As always, it is difficult to say whether this deal will be accepted, but the fact that the shares have traded at $13 in the past 52 weeks makes me believe that a lot of shareholders will not be happy with this offer, although the recent downturn in the market and the fact that income funds are slowly transforming into corporations may help. If the share price drops again, than I may take another look at this offer, but at the current premium of 7%, I don't feel the risk is worth the reward.

Credit Crisis Origin

2008-09-23T16:06:00.003-05:00

I had to share this article from the New York Times that was originally printed in September 30, 1999. I know it is easy to look back and see with perfect clarity, but how did they ever think that this would not come back to bite them in the butt?

From the NY Times on September 30, 1999:

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990s by reducing down payment requirements,'' said Franklin Raines, Fannie Mae's chairman and CEO. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.'

'From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Investment Thoughts!

2008-09-09T12:30:00.031-05:00

Well, it's been a while since my last post. I don't really have any reason for the delay, besides the fact that I have been busy enjoying the last days of summer, but now that the rain has returned to Vancouver I am sure that I will have plenty more spare time.

1. Both the American and Canadian markets have been in a bit of a free fall of late. The Dow Jones is trading at the same level of August, 2006 and up here in Canada the S&P/TSX Composite has lost 18% of it's value over the past three months, with commodities leading the sell-off. As always, these drops have created buying opportunities for investors that are patient and don't mind going against the crowd. The real challenge, of course, is being able to watch your investments sink even lower after an initial purchase. For anyone that has a real difficulty with this, you might want to think about spacing your purchases so you can follow the stock down if it does drop after your first purchase, which will help minimize any potential losses. In order to do this effectively, however, you need to make sure you have a significant amount of capital to help offset the transaction costs as you don't want to be placing trades when 10% is going straight to fees.

2. A friend of mine turned my attention to Heineken N.V. (HINKY - OTC) the other day, which is the third largest beer brewer in the world and is famous for it's two signature beers Heineken and Amstel. As of close yesterday (Sept. 8th, 2008) you could buy an ADR of the company for $22.78, which gives the company a price to earnings ratio of approximately 17, which is just below it's five year average of 18.5. Generally, a discount this small would not be enough to entice me into a possible purchase, but when a company has a brand name that is as well known as Heineken than I am much more responsive to the idea of paying a little bit more than usual. After doing a quick review of the company, however, I noticed that the recent purchase of Scottish & Newcastle, which seems to be working out well for the company, has put some strain on it's balance sheet and placed it in negative working capital territory. In order to assess whether this is a serious problem, I took a look at the Company's free cash flow for the last few years to get an idea of how much cash they would have had available, after paying off capital expenditures, to put towards it's long term debt obligations. Well, after looking over the companies financial statements, I found that it had approximately $2.6 billion in free cash flow in total over the past three years, which is more than a third of the company's long term debt (after subtracting it's cash & short term investments). So, although this is a bit lower than I generally like to see, it does provide me with enough comfort to say that it's debt situation should not materially effect the Company's operations beyond a possible dividend cut in the short-term.

3. Pep Boys (PBY - NYSE), which was one of Peter Lynch's favorite companies, has run into quite a bit of trouble over the past year as the industry for automotive retail and service chains has dropped alongside the American economy. Shares are currently trading around it's 52 week low of $6.40, after a recent 25% drop, with little relief in sight. Recent quarterlies showed an increase in earnings, but it was mainly due to a tax benefit and asset sale gain. One positive note is that the company's balance sheet is fairly clean with only $340 million in long term debt and $90 million in cash, indicating that they should have no trouble riding out the downturn. Could be a good long term ride for value investors.

4. The Gap Inc. (GPS - NYSE), which has seen its shares of highs and lows in the past, is currently on a low and trading at only 15 times earnings, compared to it's five year average of just over 19 times. Recent sales figures haven't helped the cause as August sales were down 5% year over year, with Banana Republic leading the drop at -14%. This is nothing new for retail chains, of course, as shoppers are currently tightening their belts and spending less frivolously, but as I have been saying over the past several months, this current state of affairs won't last forever and in the meantime investors should be looking for retail companies with strong brand appeal and a low amount of debt. So with no long term debt, over $1 billion in cash and three of the most well known franchises in retail (Gap, Old Navy and Banana Republic) is there a better choice out there?

And as always, if anyone has any investment ideas or thoughts they want to share with me, please feel free to leave a comment or send me an e-mail.

News of Interest

2008-08-06T15:41:00.011-05:00

Here's a list of recent articles that I have come across that I thought other investors might find interesting:

For all those value investors out there that have watched their portfolio drop over the past year, you may find some solace in this article I found in the Globe & Mail. Misery loves company and in this case you can't ask for better company than Mr. Puccetti and of course Warren Buffett;
This is an article written by Lawrence H. Summers, a former Secretary of the Treasurer for the US and President of Harvard, and is his opinion of what is currently happening in America in terms of macroeconomics. I found the first section of the article particularly interesting where he goes into the reactive measures that the Government has taken to help neutralize the financial disasters that have occurred over the past year or so. Only time will tell if these changes will have a positive or negative long term effect, but personally I feel that limiting short selling in financials is something that the Government should not be allowed to do; and
As detailed in this article, Yellow Pages Income Fund (YLO.UN - TSX) has quietly been proving analysts and critics wrong as they have been steadily increasing both profits and dividends over the past couple of years. The company is currently trading at only 11 times earnings due to investors belief that it will be unable to keep sales up as people switch from print media to on-line. So far, however, Mr. Tellier has done a fantastic job of both expanding into the on-line world and maintaining the companies print media business.

And as always, if anyone has any other articles or companies of interest they want to share with me, please send me an e-mail or leave a comment below.

Investment Thoughts!

2008-07-23T15:17:00.014-05:00

A few thoughts on the current market:

The recent drop in the S&P/TSX Composite over the past month (almost 8%) has created a great opportunity for investors to jump in to the fray as there are a lot of solid investments trading at ridiculously low P/E ratios;
There are two industries in particular within North America that I feel are currently undervalued and are a good starting point for investors to look for solid investments: Financials and Retail. Although I would caution anyone that is fairly new to investing to be very careful when researching some of the larger financial companies as it can become extremely overwhelming and can lead to a great deal of headaches;
The recent share buyback announced by Bank of America (NYSE - BAC) is a good sign that management feels the companies share price is undervalued. Only time will tell if they are correct, but personally I think it is a great move;
I find it really interesting to watch the recent change in direction in both the price of oil and the subsequent analyst estimates of where it is headed. It doesn't seem like it was that long ago that analysts were predicting oil to hit $200, when it was trading around $150, but now all I read are predictions of a drop in price down to double digits; and
I just finished the book 'The Greater Fool' by Garth Turner and enjoyed it enough to recommend it to several friends. For anyone that is not familiar with the book, it is Mr. Turner's view of the current real estate market in Canada and the impending downfall that he feels is forthcoming. I would say that I agree with about 90% of what he had to say in the book, but in particular I loved how he called out both Royal LePage and ReMax for constantly trying to over inflate the real estate market with overly optimistic estimates on where prices are headed. He also asks the obvious question as to why Canada depends so heavily on the two largest real estate companies to provide direction on the real estate market. It would be like asking McDonald's and Burger King to provide estimates on whether people will be eating more or less fast food in a year. It just doesn't make any sense; and
For more interesting reading on the Canadian housing market, check out Mr. Turner's blog here. His current prediction is for an national drop of 15% in housing by this time next year. I can't say that I disagree.

Investment Thoughts!

2008-06-13T12:12:00.039-05:00

I was looking through the Nasdaq 52 week low list last week when I came across Shoe Pavilion Inc. (SHOE - NASDAQ), a discount footwear retailer. What immediately caught my eye is that it is currently trading below it's book value (i.e. assets minus liabilities) of $1.97 (compared to it's current share price of $0.56), which is generally considered a sign that it is trading at a "cheap" value. As I always do in this type of situation, I did a quick overview of the company's most recent news releases and Morningstar's ten year financial history in order to get a general understanding of the company's current situation to see whether or not this could be a permanent drop in price.

Anyway, it looks like the company's price drop of more than 80% over the past year is the result of five consecutive quarterly losses, the departure of the CFO and recent news that it's next quarter earnings will be at a loss of between $0.10 and $0.12. What really caught my eye, however, was the fact that the company has no long-term debt and only $16.6 million in short-term debt, which makes it a potential candidate for a turn-around investment play.

In order for me to even consider a company as a potential turn-around opportunity, however, there are three benchmarks that I feel must be met: (1) The recent problems have to be industry wide and not company specific, as there is much more certainty to the end of an industry downturn; (2) It must have been a solid company before the downturn began, with a good history of revenue growth and positive earnings; and (3) It can only have a reasonable (i.e. manageable) amount of debt on it's books so that it can keep itself out of bankruptcy while it waits for the industry to turn.

As I stated above, Shoe Pavilion is currently in the midst of five consecutive quarterly losses and has recently announced that it will be adding a sixth with a loss expected to be from $0.10 - $0.12. However, as I have said in recent posts, the American retail industry on a whole has seen a downturn in earnings over the past year or so, as the overall economy has slowed down and consumers are spending much less of their disposable income. So the question now is, what was the company like before the industry started to slide.

Well over the past ten years revenue growth has been quite steady at just over 10% per year, but operating income has not followed suit and was at it's highest back in 1998, when it reached $5 million, meaning that the increase in sales has not translated into increased earnings. From what I can tell, a large reason for this stems from an overzealous management group that has attempted to achieve growth by any means possible, which has eaten into the company's bottom line. However, since I am only interested in whether or not it was a solid company instead of a great company, than I would have to say that based upon the fact that revenue has been steadily growing and only one of the past ten years has seen a negative profit, that it meets this benchmark. So now the only question left to answer is whether or not the amount of debt on the company's books is manageable.

As of the company's last quarterly statements ending March 29, 2008, it had no long-term debt but had over $16.6 million in short-term debt (i.e. due in less than one year). Over the past four quarters management stopped accumulating any new inventory and has instead been selling off it's current supply - at a rate of 13% per quarter - and has used these savings to pay off this debt. So far this strategy has been quite successful and if they can keep this pace going then it may be possible for management to pay off the majority of it's debt over the next few quarters. However, this is only a short term solution and eventually the company will have to start increasing inventory. This is a potential problem that definitely needs to be considered by all potential investors.

I should also point out that since inventory makes up such a large percentage of the company's assets at almost 70%, I am no longer as optimistic about the fact that it is currently selling below it's book value. This is mainly due to my overall belief that if a company ends up in bankruptcy and is forced to liquidate, it's inventory will not sell for what it is listed at on the balance sheets.

As always, there are other considerations that will need to be taken into account before a final decision can be made, but I think the above arguments are a good starting point and if the company hadn't met even one of them, then I would have moved on to other things. And if anyone has other ideas or thoughts on this company or any other, please send me an e-mail or leave a comment.

H&M

2008-05-23T12:14:00.007-05:00

I was taken slightly aback yesterday when I went to grab some lunch and I noticed a long line of people waiting patiently outside the newest H&M (Hennes & Mauritz - OMX) store that opened up here in Vancouver yesterday. The store had only been open for about three hours but the line-up must have been about fifty metres long. As I sat down to eat my lunch I made a mental note of the last person in line and when I had finished about an hour later that same person had only moved about fifteen metres in total, which means that she may have had to wait another two hours before making it into the store. I guess the sheer popularity of this store opening should not have been too surprising to me as I had already witnessed first hand how popular it was when I lived in Toronto, but the fact that shoppers were just as frantic out here on the West Coast - where fashion is completely different from back East - just blew me out of the water. Of course, being popular is one thing, but being able to capitalize on it through proper management isn't always as easy it seems, but after doing a quick overview of the past five years of financials I am very impressed:

Sales have grown by just over 12% (compounded) per year; profit has grown at just over 9%; operating margins have increased each year from 19.1% in 2003 to 23.5% in 2007; and return on equity (my personal favorite) has increased from 32.6% to 45.4%.

With numbers like these I would have expected that the share price would be incredibly high, but it has actually been dropping over the past year and is currently at only 20 times earnings, which seems much too low. Of course, I am sure that it is not all good news for this company and I am going to have to do some more digging before I come to a final conclusion but so far I like what I have seen.

Also, if anyone down South has any insight on the popularity of the store down there, please drop me a line or leave a comment. And as always please feel free to let me know about any company or trade that you are pondering as I am always looking for new opportunities.

Investment Thoughts!

2008-05-13T16:59:00.018-05:00

I have to admit that I am loving all of this volatility in the stock market. It just makes for such interesting reading everyday as you never know which stock will be the next to be punished by investors or what new financial crisis will emerge. I think I can finally appreciate why soap operas are so popular as I feel like I'm in the middle of watching one right now and I can't seem to take my eyes off of it.

Whole Foods Market (WFMI - NASDAQ) came out with its second quarter financials today and saw it's share price drop by 8% after posting profits of $0.29 per share, which was down from a year earlier profit of $0.32. Sales, however, rose by 28% on a year over year basis, but the recent acquisition of Wild Oats weighed down on the bottom line. Personally, I have always been a big fan of this company as they have been able to maintain a consistent growth pattern in the past and have financed most of it without having to use much debt. Unfortunately, the company has always been priced at a relatively high P/E (it's five year average P/E is approximately 48), but with the recent drop it has become much more affordable, although it still has a P/E over 25. In terms of future growth I still see plenty of opportunities for the Company. Canada, in particular, could be one place that it looks to grow as it only has six stores open on this side of the border and the recent acquisition of Wild Oats included a small but very popular supermarket up here in Vancouver, Capers Community Market, that could easily expand expand outside of British Columbia. For anyone that is interested in this Company I would suggest keeping a close eye on any future price movements and if it does move down to a more reasonable valuation I would definitely recommend a purchase.
I know I am constantly talking about the retail industry, but I just can't get over how many excellent companies within this industry are currently trading at such low price to earnings. Of course, the reason for this is the current downturn in the American economy and the fact that consumers are being more conscious of their spending habits, but like any downturn this will eventually pass. The important point for investors to keep in mind when searching for a good retailer right now is to look at the companies balance sheet and ensure that it is not heavily in debt, as this can be a recipe for disaster. And, as always remember that you are better off buying a great company at a good price than you are a bad company at a great price. Personally, I am looking at the following companies, all of which I have written about previously: i) American Eagle Outfitters (AEO - NYSE) is currently trading at only 10 times earnings, has over $100 million in cash and absolutely no debt on it's books; ii) VF Corporation (VFC - NYSE) is one of my long-standing favorites (see my earlier post for more details on this company) and is trading at just over 14 times earnings. One thing that I don't like about this company is the large amount of receivables to sales that it holds on it's books which stems from the fact it is a manufacturer of clothes and not an actual retailer; and iii) The TJX Companies, Inc. (TJX - NYSE), which was mentioned on Mad Money today, is a discount retailer that owns such stores as Winners, TJ Maxx and Marshalls and saw it's share price drop by almost 5% today, even though it produced an increase in profits of almost 20%. The company currently has over $800 million in debt but has just over $700 million in cash so there is not much to worry about there.
On another note I would like to mention that I am no longer a shareholder of Netmanage Inc. (NETM - NASDAQ), as I decided not to wait for the official close of the deal but instead to take my money and run. I sold my shares last week and instantly re-invested them into American Reprographics Company (ARP - NYSE), which I wrote about previously in this post. Lucky for me I got in just before it released it's first quarter numbers and the price shot up by almost 20%. As I said before I think this company is being unfairly punished for having some exposure to the residential housing market in the States (approx. 15% of revenues) but as always only time will tell.

And please if anyone has any companies in mind that they feel are worth looking at send me an e-mail and let me know as I am always looking for new investments.

Google Finance Stock Screener

2008-05-08T17:55:00.006-05:00

I just wanted to point out Google Finance's stock screener, which I added to the sidebar, that a friend of mine just sent me, as it is by far the best screener that I have ever seen. Unfortunately it only works for NASDAQ, NYSE and AMEX Issuers but hopefully a Canadian version is forthcoming.

Now as I said in an earlier post, Yahoo! Finance has an excellent filter as it is one of the few that allows you to screen by valuation metrics (Price to Earnings, Price to Sales and Price to Book Value), but Google has taken it one step further and has added such things as 52 week high/low, margin percentages, institutional percentage held (a Peter Lynch favorite) and several varying dividend factors. Anyway, take the time to check it out for yourself and see what you think, as not every investor values a company based upon the same criteria, but I have the feeling that most people will find it much more useful than any other screener they have used in the past.

NetManage

2008-05-01T16:25:00.022-05:00

The first e-mail I received today in my inbox was from a friend of mine with the subject line 'Have you seen what happened to NetManage today?' My first thought upon reading this was that the company had been caught in an accounting scandal. My second thought was that some members of senior management had been busted for illegal insider trading. It wasn't until after this that I started to think of the possibility that another take-over offer for the company had been released - which just goes to show you how much faith I have lost in the company.

Anyway, as I am sure most people have read by now, Britain based Micro Focus International PLC has offered a price of $7.20 for shares of NetManage (NETM - Nasdaq), which equates to a total consideration of $73.3 million. This take-over comes about six months after an original offer of $7.20 was received from Rocket Software, which represented a 95% premium over the trading price at the time. I won't go into great detail about what happened after this original deal was announced, as I have already written way too much on the subject, but to summarize after about four months of delays the deal was eventually rescinded due to Rockets failure to obtain the necessary financing. A lot of shareholders, myself included, were very disappointed with the end result and I'm sure that a lot of people sold their holdings immediately after the announcement. For the rest of us, however, this newest offer will hopefully bring an end to the whole saga and wash away the feelings that were left over after the Rocket deal fell through.

As I stated in earlier posts on this company, I originally bought into NetManage with the idea of profiting off of the spread between the proposed takeover price and the shares trading price in the market. At the time I went through a whole analysis (which you can read here) of the deal and eventually came to the conclusion that this was a solid arbitrage opportunity. Of course, the deal eventually collapsed and sent the shares - and not to mention my ego - into a tail spin. After this happened I wrote an article that laid out my feelings on the situation, which eventually led me to the decision to double my holdings in the company. In hindsight its easy to look back upon this decision in a confident manner, but I would be lying if I said that I wasn't second guessing it on an almost daily basis.

Anyway, I have to admit that I am pretty happy to have this whole situation behind me, as I can't say that I really wanted to be a long-term shareholder of this company since I'm not much of a tech person and have never felt truly comfortable being an owner.

So I guess now the only decision to make is whether to wait until the deal officially closes - a proposed closing date of June was announced - and get the full $7.20, or to sell at the current price of approximately $6.95 and move on to other pastures. As for the possibility of this deal finishing the same way that the proposed Rocket takeover did, I would have to give it a slim to very slim chance as Micro Focus had over $50 million in cash (as of Oct. 31st, 2007) and profit of just under $23 million over the six months ended Oct. 31st of last year. (For anyone that is interested in seeing their latest results you can find them here).

No matter what my final decision will be, however, I have to say that this is going to be one of the most enjoyable decisions I have ever had to make.

Renting vs. Buying

2008-04-28T16:17:00.008-05:00

With the recent housing crisis in the United States and the feeling of impending doom up here in the Great White North, I thought a lot of people would find this article (from getrichslowly.org) interesting as it talks about some of the fallacies that abound concerning buying a house versus renting.

I know that up here in Vancouver, which is by far the most expensive housing market in Canada, I have a lot of friends and colleagues on both sides of this debate. Of course, the line that divides the two sides seems to be based upon the length of time the person has lived in Vancouver, as housing prices here have been on a steep incline for over ten years now and have only recently started to flatten out, which has unfortunately priced a lot of people right out of the market.

For anyone that is interested in looking at the rental vs. buying decision from a strictly financial standpoint, the New York Times has an easy to use on-line graphic calculator - that you can find here - that helps illustrate whether you are better off buying or renting. For any Canadian residents that use this calculator, make sure to take into account the fact that we do not have as many tax-breaks that home buyers in the US have, thus making buying an even more expensive option for us. Also, be sure to remember that Canada has the First Time Home Buyers Plan, whereby we can withdraw up to $20,000 tax-free (per spouse) from our registered retirement savings plan ("RRSP") to put towards the purchase of our first house, which means that anyone that doesn't at least wait until they have accumulated this much in their RRSP, is paying slightly more than they have to.

Investment Thoughts!

2008-04-24T13:26:00.006-05:00

Well, it's been almost a month since my last post. Unfortunately work, studying and sunshine have gotten in the way but I have to admit that it was definitely not due to a lack of excitement in the market. It seems like every day brings a new crisis or big story-line to follow. Who needs 'Dancing With the Stars' when you have this to watch everyday.

NetManage, Inc. (NETM - NASDAQ) - which I followed quite closely during the attempted buyout by Rocket Software earlier this year - will be announcing it's first quarter earnings on Monday. The company finished 2007 quite strong with revenues up 27% on a year over year basis and a positive earnings per share of $0.17, compared to a loss of $0.10 in the prior year. Personally, I am still invested in the company - and actually increased my holdings at $3.75 - but I have switched my investment reasoning from takeover arbitrage to pure value fundamentals, which is partly based on the fact that the company has $25 million in cash but a market cap of only $40 million. I am also very encouraged by the company's recent results (as stated above) and it looks like I am not the only that as the share price has moved from a low of approximately $3.70 after the takeover offer was rescinded, to a closing price of $4.30 on April 21st in just over one months time.

Starbucks (SBUX - NASDAQ) dropped like a stone today as it reported that second quarter earnings would be around $0.15 a share, compared to a year earlier profit of $0.19. At this price the company has a P/E of just under 19, which is nowhere near it's five year average of 47. Unfortunately, I haven't yet had a chance to go through the companies financial statements, but from a preliminary look I would say that this drop has more to do with the fact that investors had put the company at a level that was unattanaible than anything else. I don't know how many public companies I have seen that have several years of extremely high growth only to see its share price drop down to earth after having one or two quarters that don't meet the overly zealous expectations of investors. Luckily, for investors that can keep their head about them and look past the short-term, these situations can sometimes create an excellent buying opportunity.

Walgreen's

2008-03-31T12:05:00.010-05:00

Share prices of public retail companies in North America have been punished over this past year as investors worry over the economic downturn in America and the increasing value of the Canadian dollar north of the border.

Walgreen's (WAG - NYSE), on the other hand, has been relatively spared from this onslaught and is currently trading at a respectable P/E of 18.5 times after having lost approximately 24% of its market cap over the past six months. (In comparison, Walgreens had not traded at an average P/E of less than 25 times over the past ten years). When a friend of mine pointed this out to me, I was not overly surprised since Walgreens is in the drugstore business (prescription and non-prescription sales accounted for 65% and 10% of sales in 2007 respectively) and as such its products are much more immune to economic downturns than the average retail company. What I did find surprising, however, is the fact that Walgreen's has grown revenues and earnings in each of the past 33 years and it's dividend every year since 1975 and is currently on pace to do the same in 2008. These numbers are just unbelievable as even though the majority of its products are inelastic it still has to compete with other drugstores; and also since 25% of it's sales are derived from general merchandise (i.e. household items, beauty care, candy, convenience foods) you would at least expect this to hurt sales enough that when the economy hit a downturn it would not be able to keep up with prior years, but obviously this is not the case.

The first thought that came to my mind when I noticed these numbers, is that management must have been extremely successful in not only keeping costs and subsequently margins under control, but also in finding new profitable growth opportunities, which for me is one of the most important things that I am looking for when I search for new investments. As no matter how good a business is there is always the possibility that poor decisions by management, especially in terms of acquisitions, can easily derail a company (if you need a good example of this just look up the Time Warner/AOL merger).

Another solid indicator of management's effectiveness is to look at its return on equity, which indicates the return management has been able to derive from the companies net worth (i.e. assets minus liabilities). For Walgreens, the past five year average is just over 18, which is about 50% higher than the average American company.

Now this isn't to say that Walgreens doesn't have its share of problems that it will need to overcome. The retail drugstore business is getting much more competitive with each passing year as companies such as Target and Wal-Mart have entered the pharmaceutical sales business and recent comparable store sales (sales from stores that have been open more than one year) have not been as hot as they were last year and have dropped down to single digits.

With this being said, however, I would still have to say that Walgreens is in an excellent position to benefit from the eventual reversal in the retail industry. It has been growing its internet and mail delivery pharmaceutical sales service, which should help increase its margins, and its current debt outstanding is at a very manageable level in comparison to some of its competitors, which should allow it to acquire other companies during the current downturn at very attractive prices. Of course, in the end only time will tell if Walgreens can continue the torrid pace that it has set for itself, but at least shareholders can rest easy knowing that they have placed their money in the hands of a managerial group that has proven themselves to be more than capable.

Investment Thoughts!

2008-03-18T17:00:00.008-05:00

There has been a lot of talk recently about Crocs, Inc., (CROX - NASDAQ) as the once high-flying stock has been grounded as of late and has seen it's share price drop by more than 75% over the past five months, leaving it with a price that is only 8.9 times earnings - in comparison it's price was at an average of 20 times earnings in 2007 and 26 times in 2006 .

For anyone that doesn't know, Crocs makes those funky looking shoes that you can see to the left, and became a stock market darling when revenue went from just over $100 million in 2005 to over $800 million in 2007.

Recently, however, analysts have begun to wonder whether Crocs is just another one-time fad along the lines of Heely's (HLYS - NASDAQ), which derived 98% of it's revenue from kids' shoes that had a detachable wheel in the heel of the shoe. Heely's traded at a high of just under $40 in early 2007 but is now trading at just under $5 as sales have slowed considerably.

Now personally I have no idea if Crocs will meet the same fate as Heely's. Recent sales numbers don't seem to give this impression as 2007 fourth quarter revenue was twice the size of 2006, but I do agree with recent sentiment that rising inventory levels are a cause for concern as this can be an early indicator of a company that may have over forecasted sales levels. I saw this very thing occur with Spinrite Income Fund, which traded on the Toronto Stock Exchange.

Much like Crocs, Sprinrite had seen remarkable growth in terms of it's product (yarn) and in anticipation of continued growth manufactured a large supply of inventory only to see sales fall flat over the next several quarters. Unfortunately for shareholders of Spinrite the company never did recover from this as it was forced to sell-off inventory at reduced prices and took a large write-down on it's inventory, which in turn put it in violation of one of the covenants on it's bank loan. Eventually the company was bought out by Sentinel Capital Partners for $2.25 in September 2007, which was the same company that spun out the trust back in 2005. Needless to say a lot of shareholders that had been with the company from the start were not happy as the share price had dropped from a high of over $12.

Of course, Crocs could fool us all and turn out to be like neither of these companies but as always only time will tell. One insider of the company is betting on the company and recently purchased 250,000 shares, but besides this one Director there has been no other insider activity (four executives at Crocs are currently unable to purchase shares due to a company rule stating that you have to wait six months after selling shares before you can purchase anymore).

One other aspect that investors should take into consideration is the growth of sales outside of the United States, which accounted for 48% of total 2007 revenue compared to 32% in 2006 and only 8% in 2005 and has grown at a rate of over 600% per year over the past two years.

So even though Crocs cannot rely on a diversified product base it can at least say that it has a diversified country base.

Also, since the company holds almost no debt on its books, there is little to no chance that it will be heading towards bankruptcy if sales do head south. Unfortunately though, if the company does become a one hit wonder the fact that they currently have no debt will be of little comfort to shareholders that expected this company to be around for the long term.

As always, however, only time will tell the fate of this company, but in the meantime it definitely does make for good water cooler talk.

How To Do Your On-Line Research

2008-03-06T16:29:00.046-05:00

Since I don't have anything specific to talk about today I thought I would do an overview of all of the websites that I like to use when researching potential investments. And because most sites are only good for specific information I have posed a question before each to help relay what I think each particular site is best used for.

"Where can I find a list of all of a company's public disclosure documents including annual and quarterly reports?"

USA
Securities & Exchange Commission - This website, known as Edgar, is the official website of the Securities and Exchange Commission (the "SEC"), which is the regulatory body that oversees the investment markets in the United States. All public companies in the US have to file all required public documents with the SEC including quarterly and annual reports.
I have listed several of the more popular forms that investors will need and the short-forms used by the website for each:

10-K - Annual Report
10-Q - Quarterly Report
4 - Change in ownership of securities (i.e. this has to be completed when a Director, Officer
or 10% owner buys or sells shares in the company)
8-K - Indicates any material report that is deemed important to shareholders (e.g. a Director
leaves the company)

Canada
Sedar - A big difference between Canada and the United States is that Canada does not have a national regulator overseeing the investment markets, but instead each province has it's own regulatory body. Because of this there isn't a website as detailed as Edgar (see above) but instead Canada has Sedar, which is still a great website and in truth is much more user-friendly than Edgar is, but one problem is that it doesn't always have all of the news releases that a company issues. Other than this, however, you will find everything else that you need in terms of disclosure documents that a public company in Canada must release.

"What is the best site to use to get a general overview of a company and its financial statements?"

USA
Google Finance America - For me there is no better website than Google Finance to use as a starting point for a potential investment. It presents all the basic necessities an investor requires to do an overview, including: a pricing chart that goes back ten years; a five year history of the company's balance sheet, income and cash flow statements complete with an option to switch from an annual to quarterly perspective; a listing of recent news releases along with an indicator on the pricing chart as to when the news came out; and a list of several key stats & ratios.

There are some negatives, however, as it does not have a list of recent insider trading, it only gives a short list of ratios and the financial statements are not detailed enough - which is why you should always use the SEC website (see above) and download the full annual and quarterly reports - but it does, however, give access to other sites that have this information, which is very handy.

Canada
Google Finance Canada - I'm not going to go into detail about this site as it is a spitting image of the Google Finance America site I talked about above, except for the title overview of the market page, which is geared to the Canadian market. For instance the daily exchange rates will show the Canadian dollar against other major currencies and the market summary will show what is happening on the Toronto Stock Exchange instead of the New York Stock Exchange or Nasdaq.

"Where can I find the most comprehensive charts for a company?"

USA
Morningstar - Before I discovered Google Finance, Morningstar was the site that I used more than any other for my research. Nowadays I use it more sparingly and generally only when I want to see more than just a five year overview of a company's financial statements, since they go back ten years, or if I want to use their pricing chart, which is much more interactive than Google's and has a lot more options including a historical look at a company's valuation ratios such as Price to Earnings, which is very handy when you want to know how a company's current P/E measure up to it's historical. Here's an example of their ten year financial statement overview and their pricing charts, using Walgreen's as the selected company. If you have a chance, take the time to play around with all of the different charting options it has as it is amazing what you can do and the information you can get.

Canada The Canadian version of Morningstar is not nearly as good as the American version and as such their charts are not the best that you can find. Unfortunately there is no website that I have found that has as good an interactive chart as Morningstar does for American companies. Stockwatch.com is good for technical investors but they are not a free service, which is not much use to a small time investor that is very cash conscious. Personally I use Google Finance but in terms of technical analysis Stockhouse is by far the best as it allows you to enter moving averages and also has the option of adding in a Relative Strength Index (RSI) chart as well as several other technical analysis charts.

"Where is the best place to discuss with other investors a company that I am interested in?"

USA & Canada Yahoo! Finance - I have to admit that I don't really use Yahoo very much as I find it far less superior compared to either Google or Morningstar. The only time I find myself going to this site is to check out the message boards, where users post their thoughts on a number of current issues and specific companies. Just make sure that if you do go to the message boards that you take everything that is said with a grain of salt as it is meant as a discussion table only and not a reliable source of information. Also be wary of overly promotional posts that sound suspiciously like someone trying to pump up a stock.

"Where can I find a list of all the announced mergers and acquisitions?"

USA & Canada
MergerStat - As the name of the site implies, this website tracks all announced mergers in not only North America but all over the world. Unfortunately it only gives the ten most recent announcements for free and for anything more you have to pay a fee. Because of this I like to check the site daily and keep on top of all the mergers and any possible arbitrage situations. For more information on this, check out this post that I wrote back in November, 2007 about mergers & acquisitions and the possible profits that can be made when there is a spread between the announced bid price and the trading price of the target company.

"Where can I find a site that lists all of the announced share buybacks?"

USA
Streetinsider.com - As I stated before in an earlier post, this website is courtesy of streetinsider.com and details all of the recent share buybacks announced by American companies, in a very convenient and user-friendly way. I usually check this site about a once a week just so I can abreast of companies that are buying back shares as it can be an indicator of a company having a strong balance sheet. Just make sure to be wary of companies that are using debt to buy back shares as my personal feeling is that unless the shares are really under-valued, a company should not go further into debt to simply fund a buyback.

CANADA
Unfortunately I have yet to find a website that tracks all of the announced share buybacks in Canada, so the only option is to do it the old fashioned way and go through all of the major newspapers and news releases. If anyone is aware of one please let me know as it would be really useful.

"Where can I find a list of all the companies trading at their 52 week lows?"

USA
NASDAQ 52 Week High/Low - Since I consider myself to be a value investor I have been able to find a lot of potential investments by scanning the daily list of companies that are trading at their respective 52 week low. This particular site, courtesy of Nasdaq, is great as it lists all the lows for Nasdaq, NYSE and AMEX and gives a quick over of each company in terms of financials, recent news and price charts. Generally if I will take a quick look at a companies financials through this site and if it looks intriguing will shoot over to Google Finance to get a better overview. Another option is to go to Morningstar.ca, which you can read about below.

CANADA
Morningstar.ca - Unfortunately this site is not as good as Nasdaq's as it doesn't give you an overview of the company's financials, but what you can do is have two internet browsers open with one on Morningstar.ca and the other on Google Finance so that you can easily enter the symbol of the company on the 52 Week low list into Google and do a quick check of it's financials and then decide to either dig deeper or move on to the next company.

"Where can I find a list of recent insider transactions?"

USA
MSN Money - Although MSN Money advertises itself as a one-stop website for research, I have found that is not nearly as good as Google Finance or even Morningstar; however, one aspect that this website is quite good for, is listing all recent insider transactions (i.e. Form 4 on the SEC website). Click here to see an example of the recent transactions for Gap Inc.

CANADA
SEDI - Every time an Insider in a Canadian public company either purchases or sells shares in that company they must file an insider report with both Sedar (see above) and SEDI, which is a website that is exclusively dedicated to tracking insider activity. The only problem with SEDI is that some people don't feel it is very user friendly so for those people I always recommend the site Canadian Insider, which I wrote about previously in this post. Unfortunately, it will only show you the ten most recent trades of a company unless you become a paying member, but a lot of times this is more than enough. If it isn't than I suggest going to SEDI.

"Where can I find a stock screener or filter?"

USA
I won't go into detail about each respective stock screener, but take a look at the following and find out which one best suits your needs: Morningstar, AOL Money & Finance, MSN Money and Yahoo! Finance. Personally I like Yahoo's the best as it has an option to search by valuation ratios (i.e. P/E, P/B, P/S), but every investor will have their own criteria so it is important to check each and decide for yourself.

CANADA Globe & Mail - This site is the only true stock filter that I have been able to find for Canadian companies but fortunately for myself it has most of the criteria that I like to see in a stock filter so I use it quite often. There is also an option that allows you to use a more advanced filter but you will have to become a paying member to get full use of those features.

"Where can I find a dictionary of all the various finance terms?"

USA & CANADA
Investopedia.com - I find myself using this website all the time as there are so many different terms and formulas used in finance that it is almost impossible to keep them all straight in your head. The best thing about this site is that it works for both the USA and Canada as it covers specific terms such as an RRSP (i.e. Canadian version of a 401K retirement account) that only residents of that country would need to know.

Investment Thoughts!

2008-03-05T15:24:00.005-05:00

So a friend of mine told me the other day that I had stolen the blog title 'Quick Hits!' - which I had been using sporadically for certain posts that were not full articles - from Peter King of Sports Illustrated. This came as a bit of suprise to me as I thought that I had pondered over a title for a while before deciding on Quick Hits!, but it looks like I just lifted it from somebody else. Anyway, I have now changed it to 'Investment Thoughts!' but I have to say that I am not overly attached to it so if anyone has any better ideas please let me know.

Canadian Tire Corporation (CTC.A – TSE) – which is as iconic a brand name to Canadians as Tim Hortons is - isn’t getting much respect from investors these days. It recently capped off 2007 with a 15.5% increase in fourth quarter profits and subsequently raised its quarterly dividend by 13.5% to $0.21, but its share price only moved up by just under 3% leaving it with a price that is only eight times 2007 earnings. Part of this under appreciation is that investors are concerned about increased competition from Lowe’s and the recent softening in the housing and retail markets. Some of these fears are warranted, as shown from Canadian Tire’s negative same store sales in 2007 (-1.8%), but overall Canadian Tire continues to roll along as strong as ever and has grown earnings by a compounded rate of 15% over the past five years, which is a number that most companies only dream about; and
Ever since the Canadian Finance Minister Jim Flaherty announced on Halloween night 2006 that commencing January 1, 2011 income funds would have to start paying corporate taxes on all distributions, I have wondered how investors would react to a fund that is planning on switching to a corporate structure. Well I was finally able to witness it firsthand as Transforce Income Fund (TIF.UN – TSE) announced via conference call that it was considering the switch. There wasn’t an immediate drop in price as I had expected, but the price did drop over several days by approximately 13%, which is a very significant amount. For anyone that is unfamiliar with the company, Transforce is Canada’s largest trucking company but is currently dealing with very difficult conditions in the trucking industry, which has made management believe that the switch to a corporate structure would allow it to capitalize on the depressed industry by using the money it currently pays out to shareholders to acquire other trucking companies. Personally I think that this is a good idea as industry downturns are generally a good time to acquire competing companies since the price is usually lower than it would be in a healthy market. Either way I think that this will be a very interesting process to watch; and I am sure that I am not the only one who will be watching as you can bet that there are a lot of income funds out there that will be very interested to see the final outcome.

NetManage Inc. - Part 7

2008-03-03T12:30:00.007-05:00

Well I got I wished for ... an end to the uncertainty that had surrounded this proposed acquistion of NetManage Inc. (NETM - NASDAQ) by Rocket Software and the deadline extensions that came with it.

As I am sure most people have read by now, Rocket Software failed to secure the necessary financing and thus both NetManage and Rocket agreed to terminate the acquisition agreement.

The market, of course, responded very aggressively to this news and hammered NetManage's stock down by almost 20% from $4.78 to just under $4, which puts it at approximately the same price it was trading for before this acquisition was announced back in December of 2007.

A lot of arbitrageurs are probably deciding what to do now - if they haven't already - and are thinking about either cutting their losses or holding on to see what will happen with the company over the next few days or even weeks.

Personally, I am holding on to my shares and am going to wait and decide what to do once the market has cooled down a bit, as it can act very unreasonably after an event such as this occurs, as was shown this morning when investors started dumping their shares immediately after the halt on NetManage was lifted and the news of the termination was released. As it always does, this created a panic sell-off by other investors that were originally uncertain as to what to do, which subsequently sent shares of NetManage into a free fall. The resulting price, however, was somewhat expected as generally shares of a company will return to the price that they were trading at pre-announcement if a proposed merger or acquisition deal is terminated, but as I have said in earlier posts, NetManage is also not in the same position that it was back then. Since this time it has had two buyout offers - albeit one offer that was obviously not worth the paper it was printed on - and a solid fourth quarter that was well above expectations.

Now I am not saying that this company is built for the long haul and investors should change their focus on NetManage from short-term arbitrage to long-term value but at least make sure that you take the time to sit down and reasonably think about what you should do next as there are a lot of questions that an investor should consider before he/she makes their decision, such as: 'Do I need the capital right now?,' 'Are there are other investments that I would prefer to have this money in?' and most importantly 'Do I feel comfortable owning shares in NetManage now that the Rocket offer has been terminated?'

As I said above I am going to wait a while before I make a decision and see what is going to happen with NetManage over the next week or so once the market has had a chance to cool down. In the meantime I have already begun digging deeper and farther back into NetManage's financial statements and am attempting to get a better handle on it's products - although some techie friends have helped me a lot and made this much easier than it would be otherwise.

There is one thing that jumped out at me immediately, however, which I first noted back in early January, and that is that even though NetManage has $25 million in cash in the bank and no debt, it only has a market cap slightly higher than this at $37 million. Generally you will only find this type of situation in extreme cases with companies that are in very difficult situations and have been performing quite poorly, which is a category that I would not put NetManage in.

There is also the fact that there was a second bidder looking at NetManage when Rocket was originally working out the purchase price back in late 2007 and the possibility that they could return to the table. Of course, this is a very speculative argument, but it is one that should be at least taken into consideration by investors.

Either way we investors all have a decision to make and as always I am very interested to know what other people think, and if you are a shareholder in NetManage, what you are planning on doing with your shares.

Friday, Friday, Friday!

2008-02-28T19:40:00.019-05:00

So I have three sections to today's blog as there are a few things that I wanted to touch on briefly. As always please feel free to comment or send me any e-mails with your own thoughts.

1. I have heard a lot of people say that you can tell a lot more about a company by seeing how they fare during the difficult times than you can during the good times. Well if that statement is true than right now is an excellent time to see which retailers are faring the best as consumer spending in America is way down and the retail industry as a whole has been stuck in reverse for the past several months.
Personally, I have my sights set on three retail companies that I feel would be a good investment - and since I have previously written a brief post on each of them in the past I am not going to go into an analysis of them again - but for anyone that is interested here is the list:

V.F. Corporation (VF - NYSE) - This manufacturer and marketer of clothing apparel has an exceptional line of brand names that stretches across several areas of retail: jeanswear (Lee & Wrangler), outdoor clothing (The North Face & Kipling), sportswear (Majestic & Vans) and imagewear (Nautica). This should be very reassuring for investors as it means that it can sustain a downturn in the industry much better than other companies that are more highly concentrated in only one or two areas;

Columbia Sportswear Company (COLM - NASDAQ) - Management of Columbia has been forced to watch it's share price take a nosedive in 2007 as it has dropped by almost 50% from it's 52 week high and is currently trading at only eleven times earnings. Alongside it's namesake outdoor clothing line the company also owns the brand Mountain Hardware which has an excellent reputation among outdoor enthusiasts and has some excellent growth potential; and

Reitman's Limited (RET.A - TSE) - Reitman's is a Canadian company that trades on the Toronto Stock Exchange and specializes in women's specialty apparel through Smart Set, Thyme Maternity (clothing for expecting mothers), Penningtons and Addition Elle (clothing for plus size women). The company also owns RW&CO, which appeals to twenty-something shoppers and has a lot of room for growth as it currently only has 53 stores.

2. In keeping with above discussion on the retail industry I would like to discuss another well-know company in the industry, Limited Brands (LTD – NYSE) – which owns Victoria’s Secret, Bath & Body Works and La Senza - as it recently reported its fourth quarter financials on February 27th.
Investors were very disappointed with the results as quarterly revenue dropped by almost 19% on a year over year basis (although it should be noted that last year was based upon a fourteen week quarter and adjusting it to a thirteen week quarter equates to a drop of 12%). A large reason for this drop in revenue was that same store sales were down considerably, which is never a good sign for a retailer, at negative 8% for the quarter and are expected to drop even further to the negative low double digit range for the month of February.
Earnings per share, on the other hand, were up for the quarter by just under 2%, due to a share buyback program which decreased the number of outstanding shares by almost 13%, and full year EPS was up by 12.5% (or 14.5% on a weekly adjusted basis). These numbers should be taken with a grain of salt, however, as even though I believe most share buybacks are a positive occurrence for investors, you should never equate an increase in EPS due to a buyback to be the result of anything more than just that.
Now even though there is all of this bad news I still feel that this is a company that investors should take a hard long look at. The current economic conditions for a retailer are the worst that they have been in a long time, yet the company has only dropped its revenue by 12% and have still managed to have a strong enough balance sheet to complete a major share buyback and continue issuing a quarterly dividend (the current yield is 3.8%). Also, since most investors have decided to stay out of this company the potential for more losses has already been factored into the share price and is only trading at 8 times earnings; and if management is correct in expecting 2008 earnings to be in the vicinity of $1.35 to $1.55, than the worst you are looking at is buying in at 12 times earnings, which is well below the S&P 500 of 19 times.
Another thing to consider with this company is the name brands that they hold. Does anyone really think that Victoria’s Secret is going anywhere? Everybody knows the name and it has become synonymous with women’s lingerie. Bath & Body Works is not quite as strong a brand but it definitely has a good presence in the North American market and La Senza up here in Canada is a very solid name and still has plenty of room to grow, which is always a difficulty for companies of this size as it is generally not an easy task for them to keep growing at a reasonable pace.

3. So today is the now third, and hopefully final, deadline for Rocket Software to either obtain or waive the financing from Wells Fargo that it requires to purchase NetManage (you can see my earlier posts concerning this proposed acquisition by clicking on the 'NetManage' link under the heading 'Companies' on the right-hand). As per the last two deadlines I would expect not to hear anything until early Monday morning but I no longer hold out much hope that this deal will finalize. I suspect that NetManage's best hope for being acquired now lies outside of Rocket, if management still intends to pursue this strategy of course. Otherwise we arbitrageurs are left with shares of a company that we did not really want to hold in the first place, which is generally not a good position to be in. Hopefully we will at least get some more definite answers on Monday as I don't know if I could handle another extension in the deadline.

Quick Hits!

2008-02-20T17:57:00.006-05:00

I don't have too much to talk about today, as I haven't seen too many new items worth discussing, but there are two interesting stories, however, that I would like to point out and would love to hear other peoples' opinions on:

American Reprographics Company (ARP - NYSE), which I wrote about last month, has been getting kicked around by investors over the past year or so due to the housing meltdown in the States. I won't go into too much detail about the company itself, as I have already written extensively on that topic in an earlier post, but to summarise the company is in the business of providing document management services to the architectural, engineering and construction industries and because of its reliance on these industries its share price has dropped by about 50% over the past year. However, as I stated before, only about 15% of the companies revenue comes from the residential housing industry and as such it isn't nearly as exposed to the housing slowdown as investors believe. This fact became even more transparent when the company released its fourth quarter financials last week and revealed that revenue had increased by 18% and earnings by 32% year over year. The shares surged after this release by about 10% but are still only trading at around eleven times earnings, which is far too low for a company as strong as this one; and
Encysive Pharmaceuticals, Inc. (ENCY - NASDAQ) has received an offer from Pfizer Inc. (PFE - NYSE) to purchase all of its outsanding shares for $2.50 a share. Encysive was trading at $1.08 before the announcement and jumped up to $2.27 after the announcement, giving an arbitraguer a potential profit of 10%. The deal is expected to close by the second quarter of 2008 and requires shareholder approval from Encysive before it can be finalized. Unlike the NetManage and Rocket deal that I have written about over the past couple of months, this deal will not depend upon whether Pfizer can get the necessary financing, since it already has more than enough capital. Personally, I am going to wait until closer to the deadline and then make my decision, but this could be a good deal for those who believe that shareholder approval is only a formality.

If you have any thoughts on the above, or anything else for that matter, please let me know by leaving a comment or sending me an e-mail.

NetManage Inc. - Part 6

2008-02-13T23:29:00.015-05:00

"The recent uncertainty in the debt markets has resulted in unexpected delays in our ability to secure the financing for the transaction," said Andrew Youniss, CEO of Rocket Software. "We are impressed by the results of our due diligence investigation of NetManage and their strong fourth quarter 2007 results. We stand behind our offer and continue to be optimistic about obtaining financing for the acquisition of NetManage."

So these were the first words that I read early Monday morning after a restless night of uncertainty and anticipation. Was I surprised? At the time yes, but in hindsight I would have to say no. I really did expect an end to the uncertainty that had persisted in this proposed deal and I was ready to move on to bigger and better things, but the original delay in the financing deadline back in January should have at least made me realize that another delay was possible.
Either way we investors are now left with a decision to either sell our shares and move on or to stick with the company and continue riding the rollercoaster. Answering this dilemma, of course, is where the real difficulty comes in.
(Before I begin attempting to answer this question, however, I would like to point out that the line “the recent uncertainty in the debt markets has resulted in unexpected delays” is a bunch of bologna. I’m not saying that it didn’t play a part in the delays, but I see it more as the straw that broke the camels back rather than the main reason Rocket is unable to obtain the necessary financing. If Rocket had the balance sheet to secure the financing than they would have been able to do so whether or not there is uncertainty in the debt markets. Anyway, that really doesn’t matter but I felt that it should be said.)

When I decide to enter an arbitrage deal such as this one, I make the original decision to invest or not based upon my feelings of what the upside and downside of the deal is (i.e. by how much will the price drop if the deal fails to go through and by how much will I profit if it closes) and what the chances of each are. That way I can simply multiply the downside by what I believe the possibility of it occurring is, do the same with the upside, add the two together and if the final number is positive then I will invest and if it isn't than I will walk away.
So in order to make an informed decision now as to whether or not I should walk away from this deal, I feel that I should use the same line of reasoning and in doing so attempt to answer the following two questions:

1. Is there more downside risk now than there was post-announcement of the purchase offer from Rocket Software on December 12th; and
2. Is NetManage in an equally attractive position now in comparison to how I felt post-announcement?

If the answer to number one is no and the answer to number two is yes than the decision is straight forward and I will stick with the company, but if either one is switched than it becomes more complicated.
There is, of course, also the question of opportunity cost, as an investor may feel that the capital they currently have invested in NetManage would be better put to use elsewhere, but since that is a question that only each investor can answer themselves, I have left it out of my analysis.

Question #1

In order to answer this question properly, it is necessary to try and quantify the downside in price of when I originally invested and what I feel it is now so that I can compare the two side by side.
Before the December 12th announcement the shares of NetManage were trading at $3.69 - with a prior six month average closing price of approximately $4 - after which the shares jumped to $6.60. Based upon this I feel that it is fair to say that if the deal had been cancelled at the time of the original financing deadline of January 18th, then the shares would have moved back down to their original position of between $3.69 and $4.00 (since no new material news surfaced during this time) which gives an investor a downside risk – depending on their exact purchase price – of approximately 40%. Now, however, since NetManage has released its fourth quarter financials, the potential price drop is not nearly as clear.
As I am sure most people have read by now, NetManage’s fourth quarter numbers were much better than anticipated, as they finished with positive earnings of $0.17 a share after increasing revenues 26% over both the prior quarter and year over year. Now as I stated in my last post it is very difficult to say whether this level of earnings is sustainable, as the exact details of the numbers have yet to be released, but after listening to the conference call it was very reassuring to note that no one customer accounted for more than 25% of the increased revenue, which makes it much more plausible that this revenue increase will not be a one time event.
Regardless of this, however, I think it would be very naïve to simply state that future quarters will be as strong as the most recent numbers were without at least doing a very thorough analysis, but since the question we are trying to answer is whether or not there is more downside risk now than there was after the original deal announcement, than this type of analysis would be more than what is necessary for our purposes.
Simply stated NetManage has become a more attractive company than it was in December and the recent movements of the share price in the market has indicated that investors agree with this theory. After the initial release of the financials on February 4th, the price of the stock jumped nearly 22% and even after the release on Monday that the deadline was being delayed for a second time, the price of the shares initally dropped by about 2% but rebounded to finish the day with an 8% gain. Even as recent as yesterday the shares closed at $5.60, which is a 23% gain over Monday's closing price.
So the answer to the first question is actually quite straight forward: There is less downside risk now for an investor than there was back in January.

Question #2

The answer to this question does not seem to be one that will be as easily decided as the one above. At first glance you would have to say that NetManage is nowhere near as well positioned as it was after the original announcement of the deal, as we have now gone past two deadlines for Rocket to obtain the financing and it is becoming clear that the chances of this deal actually closing are much slimmer than they originally seemed. On the other hand, however, after taking into account what we were discussing above, with specific reference to NetManage’s fourth quarter financials, I would have to say that the answer isn’t quite as obvious as that.
When the deal was originally announced in December, NetManage had been on a downward spiral in terms of share price. The shares hit a high of just over $11 back in March of 2004 but saw a fairly quick descent down to $5 over the next five months. After this the shares hovered between $7 and $4 for the next few years until the announcement of the proposed acquisition in December of 2007 when the shares shot up to $6.60.
Revenue meanwhile, was following the same path, as it declined from a high of $104 million in 2000 to a low of $36 million in 2007, which equates to an average compounded drop of 14% per year.
Now, however, NetManage seems to be better poised than it has been over the past few years. Earnings for the quarter ending December 2007 were $0.17, the company has over $25 million in cash and cash equivalents and has recently had two offers to purchase all of the outstanding shares (the other offer is discussed on page 20 of the Form 14A) of the company.
I should state, though, that this does not mean that it is better off than it was post-announcement of the Rocket offer, but I do feel that NetManage is well positioned to either receive takeover offers from other companies or else revive its stock price to a higher average level than it has been trading at over the past several years. The only problem with all of this is that it is highly speculative, whereas my initial reasoning for buying in to NetManage was because the proposed purchase by Rocket was a publicly announced deal that had a set price, approval of both sets of Boards and a tentative deadline - although looking back now it obviously was not as definite as it seemed.
So even though I don’t feel that NetManage is as badly positioned as it was pre-announcement of the deal, I would have to concede that it also isn’t in as good a position as it was post-announcement, which gives us the answer to the second question.

Unfortunately, with the two answers being somewhat divergent, the final question of whether or not to hold onto the shares of NetManage is not straight forward. Of course, as always, it is up to each individual investor to decide whether they should hold on to the shares or whether they should move on but as for me I think I am going to stick with it. Overall I feel that even though the upside is not as certain as it was and the possibility of this specific deal occurring has declined significantly, the downside is not nearly as risky as it was originally, which in a way puts me much more at ease. Also, even though I generally shy away from speculating on companies being bought out, I feel that NetManage is in a great position for another offer as not just one, but two companies have recently offered to purchase it; and since I have always been an investor that likes to follow his gut for better or for worse, I feel that I should do the same in this instance and stick with the company.

NetManage Inc. - Part 5

2008-02-07T18:22:00.000-05:00

Well tomorrow is a big day for us shareholders of NetManage, as it is the new deadline for Rocket Software to either obtain or waive the financing aspect of the deal from Wells Fargo, since the original deadline of January 18th was delayed to tomorrows date of February 8th. I wrote about the original delay in financing and my beliefs as to why it was postponed in my last post about NetManage (which you can find on the right hand side under the heading 'Companies') so I won't go into any of that again, but there has been one new occurrence that I would like to discuss as NetManage released its fourth quarter financials on February 4th.
Of course, as an investor in NetManage that is purely playing the arbitrage angle, I am really not as interested in the companies financials as I am with my other holdings. However, since the delay in the financing deadline occurred a few weeks ago I have started to realize that this acquisition is far from final and felt it would be wise to at least read over the financials and listen to the conference call.
Prior to reading these quarterly numbers I was vaguely aware of NetManage's past performance and the fact that they had slowly been getting worse over the past five years or so. This thought had been worrying me over the past few weeks, as the prospect of owning shares in a company that was steadily declining is never a nice feeling.
Anyway, I was quite surprised when I did pull up the numbers and saw that management had increased net revenue by 27% over the prior year and net income had gone from a loss of $916,000 in the fourth quarter of 2006 to $1.7 million in 2007. On top of this, cash and cash equivalents stayed flat at $25 million, which is a good sign for Rocket as this amount should help in its negotiations with Wells Fargo. I won't go into too much more detail about the numbers as you can pull up the numbers for yourself on the SEC website, EDGAR, but also because I don't want to start getting too involved in the company itself since I don't plan on being a shareholder for too much longer.
The conference call was not very interesting as management is not allowed to comment on the Rocket acquisition beyond what is already public, but one of the questions that was asked at the end of the call brought up an interesting point. If the recent increases in revenue and net income are sustainable - which management believes to be true - than isn't the current price of $7.20 lower than what the company is worth?
The answer from the President Zvi Alon was, of course, very vague and never seemed to come close to providing a direct response, but it is true that if the current EPS of $0.17 is sustained over the next three quarters than the purchase price of $7.20 would only be 10.6 times the prior twelve months of earnings, which is not an attractive premium. Now I am not suggesting that management should quash this deal and search for another, as who knows whether this level of EPS is sustainable, but it is nice to know that us arbitrageurs have another foothold to stand on in case this deal does not go through, as NetManage has now become a much more attractive takeover target than it was even six months ago.
Anyway, I am very excited to see what will happen with this deal either tomorrow or Monday, as I feel that I have spent way too much time anaylzing it from every possible angle and would like to move on one way or another, but as I have stated before I am still very confident that it will get done.
Does anyone else have any thoughts?

The Retail Industry

2008-01-29T16:00:00.000-05:00

As any Investor knows, the end of year holiday season is an important time for retailers, as it is at this time that they make most of their annual profits. Unfortunately, however, this can be a bad thing for the companies themselves, as investors tend to put a lot, if not too much, faith into the holiday shopping numbers; and because 2007 had a weaker than expected season, a lot of good public retail companies are trading at some very attractive prices.
The three main things that I am looking for when searching for companies in the retail industry are ones that have several solid brand names, a good history of revenue growth and a low amount of debt on its balance sheet. This way I know that during any Industry downturn I won’t have to worry about the company heading towards bankruptcy since the company should be more than well prepared to survive until the Industry picks up again.
Anyway, enough of that. Check out the two companies that I have listed below. I feel strongly about both of them and think that either would be a solid pick for anyone:

1. V.F. Coporation (VFC – NYSE), which is a manufacturer and marketer of clothing apparel, is somewhat of a powerhouse when it comes to retailers, as it holds the rights too many household brand names including Nautica, Lee, Wrangler, Vans, Kipling, The North Face and Majestic, which supplies all of the Major League Baseball and Football uniforms. The stock is currently trading at around 16 times earnings, which is close to its’ five year average, but is still below the S&P 500, which is at approximately 19 times earnings. What I really like about this company is that it has solid brand name appeal in several separate areas of retail: jeanswear (Lee & Wrangler), outdoor clothing (The North Face & Kipling), sportswear (Majestic & Vans) and imagewear (Nautica), which helps the company to keep earnings growing during difficult times. In terms of debt, the company currently has $1.2 billion outstanding but as this equates to a debt to equity ratio of 0.51, I don’t feel that the company has over extended itself. Another positive is that Management seems to be very shareholder oriented as they have consistently increased the dividend over the past twenty years (from $0.09 per quarter in 1987 to the current distribution of $0.58 per quarter) and the stock has a current dividend yield of just over 3%.
One problem, however, that can confront a company as big as this, is that can become very difficult for management to keep growing the business at a consistently high pace (the company has a compounded growth in net income of 12% per year over the past three years). So in an attempt to at least delay this, the company purchased the jeanswear brand ‘Seven For All Mankind,’ in August 2007; and after consulting with my girlfriend and brother - both avid shoppers – I have found out that it is an excellent brand name that sells for three times the price of the average pair of jeans, and when you have that kind of pricing power you can ensure that you will have great margins; and

2. Reitmans Limited (RET.A – TSE), a Canadian women’s special apparel retailer, is currently trading at only 12 times its last twelve months of earnings, as Investors have punished the stock for poor same store sales (-4.5% year over year in December). The company hit a 52 week high of $27.15 back in June, 2007 but is currently trading at $16 (as of January 29, 2008), which equates to a drop of approximately 40%. The company, however, has more than enough brand name appeal to weather this Industry downturn with such stores as Smart Set, Thyme Maternity (clothing for expecting mothers), Penningtons, Addition Elle (clothing for plus size women) and RW&CO (a newer brand that appeals to twenty-something shoppers and currently only has 53 stores open) and since each of these stores has its own distinct market, they don’t have to rely on just one set of shopper. Also, because the company has over $170 million in cash and only $14 million in long-term debt it should survive almost any length of downturn. Couple this with the fact that its five year growth in revenue is almost 13% - although it should be noted that the past three years have slowed down to 7% - and you have the makings of a solid company at a great price.

NetManage Inc. - Part 4

2008-01-25T16:58:00.000-05:00

Well another day of trading has ended with no news and no updates pertaining to this deal (Check under the NetManage heading on the right-hand side for background information), but once again the price of NetManage (NETM - NASDAQ) has dropped considerably today, at one point hitting a low of $4.70. The stock eventually closed at $5.03, which equates to an arbitrage profit of 43% based upon the current purchase price of $7.20 a share, but all this drop in price has done is make me wonder if I have missed something that the sellers from today have seen.

The one thing I like to do in situations like this, where there is no news releases or company disclosures of any kind, is to check the daily trading volume to see if the price drop was the result of a large majority of sellers - which can indicate a news leak - or if it was just a select few investors selling, which in my mind is much less worrying. After looking at the volume today, which ended at 51,682 shares or less than 1% of the issued and outstanding, I realized that although it was higher than the daily average over the past month, it is still far from what I consider to be excessive. So based upon this I would have to say that this drop in price was probably more likely a panic sell-off by a select few investors that have decided, for one reason or another, that this deal isn't going to finalize, rather than a major development in Rocket's negotiations with Wells Fargo that we should all be aware of.

There also doesn't seem to have been any insider selling, as there has been no disclosure to this affect, which would have definitely given me cause for concern.

Either way today's sell-off doesn't seem to be much cause for concern but as always I am very interested to see where this deal will lead. I am also very interested to hear other people's point of view, as there isn't a whole lot of conversation happening on any of the message boards. Does anyone have anything to add, or any questions/comments?

NetManage Inc. - Part 3

2008-01-22T16:25:00.000-05:00

Well the deadline for Rocket Software to obtain the necessary financing to purchase NetManage Inc. has come and gone, with still nothing set in stone (you can read about the entire acquisition in this news release or you can check out my two earlier posts on the right hand side under the heading 'NetManage'). It was reported today that both companies have decided to postpone the deadline to February 8th from its original date of January 18th. It is, of course, difficult to draw any definitive conclusions from this delay, but nonetheless I am going to do my best.

As I stated in my earlier posts, Rocket was attempting to obtain the financing to acquire NetManage from Wells Fargo, which had already consented to the deal, but had to ensure that it would stay within the covenants (i.e. restrictions) set out in the credit facility before Wells Fargo would release the funds. Now that the deadline has been delayed by both parties it makes you wonder if Rocket has placed themselves on the wrong side of one or more of the covenants. This does not mean, however, that Wells Fargo will simply deny it the funding, as many times banks will re-negotiate the restrictions to something more workable, but it does seem to indicate that the financing aspect of this acquisition is not as certain as once believed.

One theory floating around in cyberspace, is that Rocket was waiting for the Feds to cut the interest rate, which they did this morning, so that they could obtain a better rate with Wells Fargo. Personally, I feel that this idea is a bit much to swallow as today's cut was a surprise move to almost all investors, however, this theory does have one aspect that holds some logic to it.

If you read the terms of the deal carefully you will see that the exact wording of the agreement between the two companies states that Rocket had until January 18th to secure the financing with Wells Fargo "on terms acceptable to Eastern" (a subsidiary of Rocket Software created solely for this acquisition). So based upon this statement we have to also entertain the idea that the management of Rocket may have decided that the present terms of the credit facility are not the best that they can get from Wells Fargo and as such have delayed the deadline to further negotiations. Of course, it is difficult to ascertain for sure if this is the real reason behind the delay, but it does have some credibility to it, and if this is the truth than it means that investors should not be overly concerned, since the company must have been able to meet the covenants Wells Fargo set out.

One thing that I do truly believe, however, is that since Rocket has decided to delay the deadline instead of walking away from the acquisition, management must feel that they will eventually obtain acceptable terms with Wells Fargo and subsequently finalize the acquisition of NetManage. If management of Rocket did honestly believe that the financing was not going to occur than I would have expected them to cut their losses sooner rather than later and move on to other things.

Either way, however, we investors are once again left in the dark for a couple of more weeks of waiting and wondering. For those of you that have not lost faith in this deal finalizing than all this delay has done is create another buying opportunity, as shares dropped down to a low of $5.38 today; but for anyone else that has started to doubt this deal will finalize than perhaps this has created the opposite, an opportunity to get out before things get worse.

NetManage Inc. - Part 2

2008-01-17T12:52:00.000-05:00

Seeing as tomorrow is the cut-off date for Rocket Software to obtain the necessary financing to acquire NetManage Inc., I thought I would do a quick update and re-confirm a few details of the deal; and since I wrote a fairly detailed post about this acquisition on December 19th, I will try not to repeat any of the information I spoke about at that time. Before I get started, however, I would like to point out that the price of NetManage hasn’t moved much over the past month and its shares closed at $6.02 yesterday, which leaves an arbitrage profit of 19.6% based upon the reported acquisition price of $7.20.

One significant new piece of information that has recently been released is the form 14A, which NetManage issued on Edgar on January 14th and will be sent out to shareholders shortly. This form is a standard for mergers & acquisitions and lays out all the details that shareholders need to be aware of. As per usual it is extremely lengthy and filled with a lot of useless information that investors have to wade through. I went through it in great detail last night and found the following paragraph, which details the financing aspect of the deal and which I feel is the most important aspect of this acquisition being finalized:

"A portion of the funds required to pay the Merger Consideration are being obtained by Rocket pursuant to a credit facility with [Wells Fargo Foothill] (“WFF”). Although WFF has consented to the Merger, Rocket’s ability to draw the funds necessary to fund the Merger Consideration will be subject to its compliance with the covenants and other terms of the loan documents governing the credit facility with WFF. If Rocket is unable to obtain the funds necessary to pay the Merger Consideration, either pursuant to the credit facility with WFF or otherwise, Rocket will be in breach of the Merger Agreement"

So based upon the above paragraph it looks like Wells Fargo has already consented to the merger but must ensure that Rocket will continue to meet the covenants (i.e. restrictions) of the credit facility before it will allow them to withdraw the necessary funds. Unfortunately it makes no mention of what the covenants are and whether or not they believe Rocket will be able to meet them. I guess that would just make it way too easy for us investors.

I also found a few other tidbits of information in the 14A which I feel are important for an investor to take note of, and have made reference to the page that you can find the information on:

Page 14 - Directors & Executive Officers of NetManage collectively hold 21% of the outstanding shares and since the Board has already unanimously approved the deal I feel it is safe to say that the majority, if not all, of these shares will vote in favor of the deal;

Page 15 - A contact number for Morrow & Co, LLC (Proxy Solicitors) is given for shareholders that have any questions about the merger;

Page 49 - More details on the financing aspect of the deal are given under the heading ‘Agreement for financing.' It also makes mention of this condition being waived if prior to January 18th Rocket does not inform NetManage that it has not obtained the financing; and

Page A-29 - Section 5.3 (f) to (h) has more details on that conditions that must be met for the merger to be finalized, although the deadline for point (h) has already passed. Don't be confused by mention of Eastern Software Corporation as it is simply a subsidiary of Rocket that was created solely for this acquisition.

So after reviewing the 14A and taking special note of the above items, I still believe that this deal will come down to whether or not Rocket can obtain the necessary financing, which is in turn contingent on them meeting the covenants of the credit facility. My own personal belief, which I am basing upon Rocket's past history of obtaining financing for acquistions (see my December 19th post for detailed information on these deals), is that it is more likely than not that it will be successful; and since tomorrow is the cut-off date I won't have to wait much longer to see if I am correct.

The Bon-Ton Stores

2008-01-03T18:02:00.005-05:00

I have started to realize that over the past month or so I have spent way too much time following what the big investment firms and home builders are doing South of the Border and have lost sight of everything else in the investment world. So my New Years resolution is to get back to the basics and look for some good value investments outside of the credit crunch bubble. So here goes:

The Bon-Ton Stores (BONT - NASDAQ), an operator of department stores focusing on women's apparel, recently came to my attention when it landed on the NASDAQ 52 week low list. I recognized the name immediately as it is one of the largest department stores in the United States and also because it had been a bit of a high flier this year in the stock market. Recently, however, the tides have turned for the company and just yesterday it closed at $5.12 (as of January 14, 2008), which equates to a drop of 90% from its 52 week high of $56.54 on March 3, 2007. In my own short experience, when a companies stock drops as much as this is because the company has hit some very difficult times and is headed for at worst Chapter 11 and at a minimum a long road full of directional changes and cost cutting which may or may not work; but of course the only way to find out for sure is to start digging through the financial statements.

One interesting side note about the company, before I get into the nitty gritty, is that even though Bon-Ton has not had one year of negative earnings over the past ten years, it generally only has a positive fourth quarter. So each year it has three quarters of negative earnings followed by an excellent fourth quarter that keeps it in the black. Now I understand that retail companies will almost exclusively have their best quarter at the end of the calendar year because of holiday shopping, but the difference between the quarters is not usually as drastic as it is for Bon-Ton. For instance in 2006 (negative numbers are in parentheses) they had first quarter earnings of ($0.67), second quarter earnings of ($1.20), third quarter earnings of ($0.66) and fourth quarter earnings of $5.31, which put them at $2.78 for the full year. The current year also looks like it will follow a similar pattern (1st: ($1.78), 2nd: ($0.91) and 3rd: ($1.17)) as analysts expect full year earnings of $0.99, which translates into fourth quarter earnings of $4.85. If this estimate is true than the company would be trading at only five times earnings which puts it at a very cheap level in comparison to the rest of the department store industry, which is currently trading at twelve times. Now I am not entirely sure why I am so fascinated with this revelation of the earnings discrepancy, but it just honestly jumped right out at me when I was looking at the financial statements and made me wonder what will happen to its stock when it releases its fourth quarter earnings later this month. Anyway, I am getting off topic so I am going to move on as the real question at hand is whether or not Bon-Ton is a good investment.

The first thing I noticed when I began my research was Bon-Ton's share price as compared to its net worth (i.e. assets minus liabilities), which is a very useful number to note as it reveals what is left over once all of the companies liabilities are taken care of.

Looking at the most recent quarterly statements of Bon-Ton (Nov. 3, 2007) I can see from the balance sheet that it currently has a total equity (i.e. net worth) of $285 million and approximately 17.5 million shares outstanding, which translates into a book value per share of $16.28. So just to put this into perspective, this means that if the company paid off all of their outstanding liabilities they would still have $16.28 per share left over; theoretically a company should never trade for less than its book value, but of course this is not always the case. As of the last closing price Bon-Ton was trading at $5.12 or 31% of it's book value. Now one thing that I always take note of when performing this calculation is how much of the book value inventory accounts for. The reason for this is that if a company goes bankrupt, their book value should deteriorate since inventory will generally not sell for as much as the company has it valued for on its books (this is especially true for a company such as Bon-Ton whose inventory is made up of apparel). So for a company that is trading below book value I like to say that they have a 'margin of safety' (a term that I have borrowed from Benjamin Graham) when it comes to its inventory value, as the price of inventory can drop down to the point where book value will equal the shares trading price before it starts taking away value from the shareholder. In Bon-Tons case it's inventory can drop by $169 million or 17% of its current value, which is very comforting to know. Of course, just because a company is trading for less than its book value does not mean that it is a good investment. All this says is that it is currently trading at a great price, but if you are like me and prefer holding onto your securities over a long time period you will generally not purchase a company unless you feel it is a superior company with long-term value. So with this in mind I did a quick and dirty analysis of Bon-Ton so that I could get a better overall picture of the company. After reviewing various financial and historical background information I came out with two issues that really stood out to me and gave me cause for concern. The first was the amount of debt it has on its books and the second is the recent news of a large drop in same-store sales. Either one of these is a cause for concern so I made sure to do as much research into both of these issues and try to make an informed decision afterwards.

Debt

A high debt level can be a very worrying prospect as it can easily turn a company into a candidate for bankruptcy. For Bon-Ton total long-term debt, as of Nov 3, 2007, was $1.3 billion, which is a substantial amount of money for any company. The majority of this debt was taken on in early 2006 to facilitate the purchase of two subsidiaries of Saks Incorporated (SAK - NYSE) which cost just over one billion dollars. Now when I look at long-term debt there are three main aspects that I want to know about: what kind of debt is it, when is it due and what, if any, covenants (i.e. restrictions) have been placed on the debt. Luckily all of this information is easily obtainable in the notes to the annual financial statements, which are located at the back of the statements. For Bon-Ton looking at its year end 2006 statements under Note ten I was able to find the following:

Due Date: $25 million of the outstanding debt is due by the end of 2010, $350 million is due by the end of 2011 and the remaining $925 million is due in 2012 or after. This is a positive sign as the company should have little to no problem keeping up with debt payments over the next couple of years.

Type of Debt: In order to facilitate the purchase of the two subsidiaries of Saks, Bon-Ton opened up a credit facility (i.e. a line of credit) with the Bank of America and entered into an indenture with the Bank of New York. Since these two represent approximately 75% of the debt outstanding I have concentrated my efforts into simplifying them below.

Credit Facility - The total facility allows for up to $1 billion in loans, has an expiry date of March 6, 2011 and is secured by substantially all of the assets of Bon-Ton. As of February 3, 2007 $342 million of this amount had been withdrawn.

Now as I have said in earlier posts, bank debt is much more worrying for an investor than any other type of debt, as the bank can very easily demand repayment of the whole loan at anytime and in doing so force the company into bankruptcy. Banks of course generally don't want to force a company into bankruptcy since it will probably mean that they won't recover 100% of what it is owed, but if a company hits hard times and is having trouble keeping up with interest payments then this may be the only solution. In this case, however, since Bon-Ton has only taken out $342 million of the total $1 billion, it should have no trouble keeping up with interest and ultimately principal repayments, so I am not overly worried about the possibility of bankruptcy, but it is always good to take note of it.

There are also two covenants (i.e. restrictions) on this loan that an investor should be aware of. The first places a maximum on the amount of dividends Bon-Ton is allowed to pay and the other puts a limit on the amount it can spend on capital expenditures. The dividend restrictions states that the company cannot pay out more than $15 million over the life of the agreement or over $4 million in any one year (presently Bon-Ton is paying out $0.05 per quarter for a yield of just over 3%, which is a better than average pay-out). This should not be a problem as the company hasn't paid out more than $1.7 million over the past three years but it is good to note that there is a ceiling. The second covenant restricts the company to $125 million per year in capital expenditures with a one year carryover for any unused amounts. Once again I don't feel this will be a problem as the most the company has ever spent in one year is $100 million.

Indenture - An indenture is a technical word for a contract between a bond issuer (i.e. Bon-Ton) and the holder of the bond (i.e. Bank of New York) that states the time period, amount of interest and any other covenants or terms of the bond. This particular indenture was signed on March 6, 2006, for $510 million at 10.25% (payable every six months), with a maturity date of March 15, 2014 and a stipulation that they cannot be redeemed prior to March 15, 2010. One positive note for Bon-Ton is that they may redeem up to 35% of the Notes prior to March 15, 2009 through the proceeds of an equity offering (i.e. selling more shares). There are also several covenants on this indenture but the financials do not provide the exact details so the company must not feel that they are material. It only states that there are restrictions on dividend payments, additional debt, making certain investments, using assets as security in other transactions (this one is standard in most secured loans), and selling assets or merging into other companies. Overall I would consider this debt to be much more positive than the bank debt as the bondholders are not capable of demanding full payment of the debt until March 15, 2010.

The one aspect that you have to be worried about with bonds is whether or not the company will be able to meet the interest payments. If the company defaults on even one payment than the bondholders can demand full payment of the notes. So to ensure that the company will not run into this problem I like to look at its coverage ratio. Anything below 1.5 makes me worry and anything below 1 makes me run for the hills. For this calculation I like to look at it on an annual basis so that I get a clearer picture of the companies position. Going back the last twelve reported months for Bon-Ton I found that it had a total interest payment of $110 million, which when compared to their EBIT of $145 million gives it a coverage ratio of 1.32 placing it in the higher than average risk category. It is not, however, a definite sign that you should stay away from this company, but if the retail industry heads south and Bon-Ton's sales follow suit then it could have difficulty keeping up with interest payments. On the other hand, however, the interest payments on the indenture alone will be just over $26 million every six months. In this case the company should have no problem paying out the semi-annual payments even if it does hit rough times and sales decline significantly.

Same Store Sales

Every month sales, including same store sales figures, for all public retail companies are reported and nicely condensed into an easy to read news release by CNNMoney (here is a link to the December results).

Every investor that has an interest in the retail industry should take careful note of this release and make sure to pay special attention to the same store sales figures. As I have said in earlier posts, same store sales is a key figure for a retail company as it indicates whether or not a company is increasing their sales from existing stores. In the recent December report, Bon-Ton had one of the worst same store sales when it had a decrease of 11.3% compared to the prior year. This number on its own is a very worrying figure, however, what I like to do is compile a month by month breakdown as I personally don't feel that you can get a clear picture of a companies position based on only one month.

After doing a bit of data collection I came out with the following same store sales figures for Bon-Ton in 2007 with negative figures in parentheses: January 2.2%; February 9.8%; March 0.6%; April (13.4%); May 1.2%; June (8.0%); July (7.6%); August 1.3%; September (7.1%); October (1.4%); November 8.6%; and December (11.3%).

If you add up all the numbers you get a total decline of 25.1%, which is a very concerning number, but when I look at the monthly numbers on an individual basis I see a slightly different picture. For the beginning of the year they had some solid numbers with an almost 10% increase in February. After this the company had several poor months, including a horrible April, with a couple of small positive growth numbers in between. At the end of the year they had both ends of the spectrum with a solid November and subsequent poor December. In my own short history of experience with retail companies I have noticed that the ones that ended up completely losing the publics interest had consistent monthly results of poor same store sales. Bon-Ton on the other hand has a somewhat inconsistent past year that to me doesn't completely indicate a company headed towards the garbage dump. On the other hand, I also don't feel that it is completely in the clear and would hope that management are very concerned with the figures, which of course could have been why it decided on adding to their base of stores and ultimately purchased the two subsidiaries from Saks.

So after taking into account all of the above information, I would have to conclude that Bon-Ton doesn't seem to fit into the usual profile of a company that has dropped so much in price over such a short amount of time, as the company doesn't seem to be heading for imminent bankruptcy and it doesn't look as if management is going to have to drastically change the direction that the company is headed. On the other hand, I also don't believe that this is a great company, but instead would categorize it as a solid company that is currently trading at a cheap price. The only problem with this is that I am not sure if I would know when to sell the shares. Generally I hold on to my investments for as long as I can and don't sell them unless I feel they are wildly overvalued. For Bon-Ton though, I feel that I would have a very difficult time knowing when this would be. I know they are worth a lot more than they are trading at now but since I don't feel that they are a great company I am not sure I will ever know what its true value is. In this case I think I would have to use a set measuring stick, such as waiting for the price to double, before I sold. Either way I am not sure that I will be a shareholder anytime soon as my financial resources are currently tied up so all of this may be a moot point anyway; but if anyone out there has some spare cash sitting around and likes this company more than I do for the long run than this is a great time to buy.

Quick Hits!

2007-12-31T17:10:00.000-05:00

A few notes and observations from recent news and events:

1. Red Robin Gourmet Burgers Inc. (RRGB – NASDAQ) has hit a 52 week low price of $31.99 (December 31, 2007) after dropping almost 20% over the past month. The current price puts it at just over 18 times earnings, which is much lower than their five year average of 28 times earnings. The financial results of Red Robin though are still very impressive and every time I visit this restaurant for supper there is hardly an open table. It seems to me that the company is being punished by overzealous investors who gave them a price of 37 times earnings back in 2004, when revenue growth was over 20%, since it appears that full year 2007 EPS will be the same as 2006 due to a second quarter earnings drop of 19%. Sounds like a receipe for a solid investment: a great company at a fair price;

2. Shares of West49 Inc. (WXX – TSX) have shot up by over 40% over the past two weeks due to a share purchase by Michael Gold, a private investor who is famous for the turnaround of Bluenotes in 2004 as well as Stitches and Suzy Shier. I had never heard of him before this purchase but apparently he is very well known in the retail investment world. Personally I own a large holding in West49, with a buying range between $0.68 and $1.30. My most recent and largest purchase was last month at $0.68 a share and which time I felt that the company was trading a price that was just too cheap to ignore. I never expected that the price would move as much or as quickly as it did however; and I definitely did not expect it to be because of one investor. As I have heard many times though it is always better to be lucky than good; and

3. The Canadian General Sales Tax (“GST”) is being lowered at midnight tonight to 5% from 6%. The GST was originally created back in the days of Brian Mulroney at 7%, and over the past two years the Conservative government, led by Stephen Harper, have cut the it twice. Personally I could care less about the cut but I know of a lot of shoppers that are holding off on some purchases until tomorrow. I can’t really understand this reasoning as a one percent drop in the retail price of a product would probably not elicit much of a response, but I suppose the drop in the GST has more of a psychological effect than anything.

Anyway, that’s it for now and Happy New Year!

Am I Missing Something?

2007-12-19T17:07:00.000-05:00

I once read that Warren Buffett made a better percentage return on short-term arbitrage opportunities from Mergers & Acquisitions, than he ever did investing in companies for the long-term. Ever since I read that, I have been very mindful of announced mergers. The idea of course is that there will be a price spread between the agreed upon merger price and the price that the target is trading for in the market. Unfortunately, most times there isn't much of a spread, with the majority coming in at an average of 2 - 5%. Also many times they don't announce a tentative closing date, which makes it much more difficult to estimate a possible return.

Fortunately, every now and then your patience is rewarded, and you find an announced deal that has been agreed upon by both Boards and has a closing deadline for the deal, which is what brings me to NetManage, Inc. (NETM - NASDAQ).

It was reported on December 12, 2007 that NetManage has agreed to be acquired by Rocket Software, a privately held company, for $69 million (although NetManage currently has $25 million in cash and cash equivalents so the real price of the transaction is closer to $44 million), or $7.20 a share, with a target closing date of late February (after which either party can walk away). Prior to the announcement NetManage was trading at $3.69, which equates into a very respectable premium of 95%. Directly after the announcement the shares shot up to $6.70, which still gives an arbitrageur a healthy return of 7.5% over approximately three months. Since this time, however, the shares have dropped even further, and as of the close of markets today (Dec. 21, 2007) are trading at $5.97, which equates into a return of just over 20%. Nothing has changed over the past week to warrant this drop in price, however, as no news releases have been posted about the acquisition. In addition there doesn't even seem to be any articles about the deal, which makes the drop in price that much more confusing; as why would the shares drop so drastically when no new public information has been released?

Obviously for some reason the market feels that the acquisition is not a 100% done deal. Yet the only detail that I can see stopping this acquisition is if Rocket Software is unable to secure the necessary financing, which must be either satisfied or waived by Rocket prior to or on January 18th. Unfortunately since Rocket is a privately held company, I can't go into their financial statements and see how much cash they have on hand, what their current debt situation is or if they currently have access to any debt; but what I can do is a search on Google News to see if Rocket has bought any other companies recently and whether or not they had any difficulty in securing financing.

After a quick search and a lot of reading I discovered that Rocket has made three other acquisitions during 2007:

In February Rocket signed a letter of intent to purchase software maker 'Seagull Software,' for $51.5 million, at which time it stated that it already had access to the necessary funds;

In March Rocket agreed to acquire software maker CorVu Corp. (OTC - CRVU) in an all cash deal worth $19.8 million, which closed two months later; and

In October Rocket acquired the assets of privately held software developer SmartDB Corp., for an undisclosed amount.

Unfortunately two of these deals were with privately held companies, so the exact details, including the timing of each deal, have not been released; but it is a very positive sign that Rocket has been active in purchasing businesses and has been able to secure the financing for each of them.

Now if you are still worried about Rocket not being able to get the necessary financing, one option to consider is to wait until after the deadline of the 18th has passed to ensure that the financing aspect won't stop the acquistion. Of course, you would be taking the risk of missing out on some of the profits as the share price of NetManage may jump considerably after the deadline has passed, but at least you won't have to worry about the deal falling through.

Another piece of news that I came across, and should be taken into consideration, is that Rocket is currently being sued by a management software company CA, Inc. (NYSE - CA) for $200 million. Now obviously this is not an easy variable to measure as nobody knows what the end result will be, or even when the lawsuit will be settled. From what I know of lawsuits of this size, however, it generally takes a couple of years for them to be settled, which if true means that it should have no impact on this sale closing. Another good sign is that this lawsuit was revealed in August of 2007, which was four months before Rocket announced its intentions to acquire NetManage, meaning that the Board of both Rocket and NetManage must not have felt it would interfere.

Overall I would have to say that this is a very promising opportunity. The acquiring company, Rocket Software, has been very active in terms of acquisitions over the past year, the Board of the target company, NetManage, have given their approval for the acquisition and a tentative closing date for the deal, end of February, has been announced. So really considering all of this there isn't much guesswork for the investor to have to do. Now all I have to do is convince myself that I have seen something that the rest of the market hasn't, and not the other way around, which is never an easy task.

Update (Jan. 7, 2007): I finally found one other person out there that has decided to write about this deal and why he thinks there is such a large discrepancy between the offering and market price. You can check it out here.

I have to say that it is somewhat relieving to know that I am not the only one who has taken note of this deal. I know that it shouldn't be necessary to have another person confirm your beliefs, but I was really starting to wonder why nobody else had even written one small article on it. Anyway check out the article and hopefully it will help you decide on whether or not you will invest in this deal.

Sub-Prime Meltdown

2007-12-12T18:17:00.000-05:00

I will be the first to admit that the sub-prime and subsequent housing meltdown in America has left me more than a little confused as to what the exact end results will be; but I do know enough to realize that there are a lot of good companies out there that have only a small exposure to the residential mortgage market and have been unfairly driven down to new lows.

American Reprographics Company (NYSE - ARP), which I wrote about in another post, is one such example, as is Moody's Corporation (NYSE - MCO), a company that I feel so strongly about that I invested a quarter of my net worth in them. However the company that I want to speak about in this post is United Pan Am Financial Corporation (NASDAQ - UPFC) which, strangely enough, was the subject of my very first post.

I won't go into too much detail about UPFC as I have already done that before, but basically the company lends money to automobile buyers with a below average credit history, at much higher rates of interest than they would get at a traditional financier such as a bank. Much like mortgage lending companies do, UPFC than bundles these loans and sells them as ABS' or Asset Backed Securities; the asset of course is the car.

The major difference between Automobile ABS' and MBS' (Mortgage Backed Securities) is that there is a much lower risk of default with the ABS, as the original loan and subsequent monthly interest payments are so much lower for a car than they are for a house. This is a very important difference as the current problems in America are due to the high default rates of sub-prime residential mortgages, which are the basis of what an MBS is and as such a lot of companies that have dealt in the MBS market (such as Citigroup and Merrill Lynch) are incurring huge losses.

Over the past six months however (which is approximately when the sub-prime meltdown was publicly revealed) UPFC's share price dropped from a high of $16.13 on June 15th, to a low of $5.28 on November 7th. This translates into a 67% drop in price and is much more than either Citigroup (NYSE - C) (45%) or Merrill Lynch (NYSE - MER)(43%) dropped during that same time period.

Anyway, after I noticed this difference I thought it would be interesting to compare the three companies from the point of view of an Investor and try to decide on which would be the better choice. So I put some numbers together below for each company, along with my own analysis of each respective category and used a very crude scoring system (two points for the winner of each category, one point for second place and zero for the loser) to help decide.

Of course you have to take into account a lot more than just these numbers when deciding on which is the better investment, but it is a great starting point. Unfortunately I haven't figured out yet how to copy and past excel tables into blogger so I had to improvise a little.

Company - Citigroup Merrill Lynch United Pan Am

Chg. in Revenue* 19% -19% 17.50%

Chg. in NI* -60% Over 100% -43%

Chg. in Price* -45% -43% -67%

P/E** 8.46 (-35%) 12.75 (34%) 7.5 (59%)

P/B** 1.23 (-43%) 1.30 (58%) 0.54 (-68%)

Yield 6.9% 2.4% N/A

Equity/Assets 5.4% 3.5% 16%

*Calculated on a year-over-year basis
**Based on the high and low price of past 6 months as of Dec. 12, 2007

Change in Revenue

The importance of this number should be obvious. It is based on a year over year basis and indicates whether or not company sales have actually been hurt during this current downturn. I was very surprised by the numbers as I expected that all three would have significant drops but only Merrill Lynch was down from last year. Citi and UPFC both did quite well considering everything and were able to post double digit gains, which is a great achievement in any market. Score: Citi - 2, UPFC - 1, Merrill - 0

Change in Net Income

Revenue and Net Income are of course interrelated, but growth in revenue does not necessarily translate into growth in net income. For these companies the credit crunch has resulted in more defaults in loans and mortgages, which doesn't affect revenue but will show up in a lower net income. Once again Merrill is on the losing end as net income dropped more than 100% and put them into the red. It wasn't much better for UPFC or Citi but they were both able to keep their heads above water with a positive bottom line.
Score: UPFC - 2, Citi - 1, Merill - 0

Change in Price

Price is one thing that you can't blame on Management; well not directly anyway. The stock market is extremely fickle and won't always punish, or reward, a company as a rational investor would expect.

As opposed to change in revenue or net income, a larger drop in price is a good thing for an investor right now. The more the price has dropped, the cheaper it is. All three companies had very similar drops in price, but UPFC, who had the smallest drop in net income, dropped the most, with a 67% decline.
Score: UPFC - 2, Citi - 1, Merill - 0

Current P/E

I added the Price to Earnings category because I think it is important to put the change in price of each companies stock into proper perspective.

A change in price of two companies isn't as directly comparable as you would think. If one company was over-valued to begin with then its drop in price would probably be higher and it would seem that it was cheaper, which isn't necessarily true. So to counter this problem you have to look at the current P/E.

To have a larger 'margin of safety' when investing, it is good to see a P/E that is at least below the average of the stock market as a whole, which, over the life of the market, has been around 15 times. So all of three of the companies are below this but UPFC has a slight edge over the other two.
Score: UPFC - 2, Citi - 1, Merrill - 0

Current P/B

Price to book value is another valuation ratio and tells you what the company is trading at as compared to their net worth (a.k.a. book value). I find this ratio to be particularly important when it comes to financial companies as they make their money from loans, which make up the majority of their Assets.

In this case UPFC is actually selling below their book value, which would give any follower of Benjamin Graham an excellent reason to invest in the company as this was one of his favorite valuation scenarios. The idea being of course that if the company is selling below book value then they are worth more dead than alive and the investor can prosper from this discrepancy. Score: UPFC - 2, Citi - 1, Merrill - 0

Dividend Yield

This stat indicates the current income that you will receive from the company in the form of dividends. Citigroup easily wins this match with a 6.9% yield. Of course this yield makes the assumption that the dividend won't be cut anytime soon, which is a very unsure thing in this type of market.
Score: Citi - 2, Merrill - 1, UPFC - 0

Equity/Assets

This ratio is a good measure of financial stability. It can help an investor stay away from companies that have over-extended themselves and have too many loans outstanding. For this ratio I like to use a cut-off of 5%, which in this case would leave Merrill out in the dark.
Score: UPFC - 2, Citi - 1, Merrill - 0

Total Score:

UPFC - 12
Citigroup - 9
Merrill Lynch - 1

Now based upon the numbers above UPFC is the winner in terms of investment potential, which is what I had originally expected. It had a positive increase in revenue in the third quarter, its net income dropped the least, its share price dropped the most, it is selling below book value and in terms of Equity/Assets they are leading by more than a wide margin. Of course as I said above this is just the tip of the iceberg. UPFC obviously doesn't have the name brand that either Merrill or Citigroup has, nor does it have as strong a balance sheet, but in terms of past growth and profitability it is a definite competitor with either company.

Another positive for UPFC is the fact that they are still able to sell the ABS' that they continually use to fund their business. On November 8th they sold $250 million worth to investors, which shows you that there is still confidence in the market with respect to UPFC's ability to repay the principal.

So if I had to choose between the three I would have to go with UPFC. Not only are they in a business that seems less risky right now, but their situation isn't nearly as confusing to me as either Citigroup and Merill are; and that will help ensure that I don't have any sleepless nights worrying about my investment.

American Reprographics Company

2007-12-11T01:21:00.000-05:00

I received an e-mail from my friend Angus the other day telling me that he had just purchased American Reprographics Company (NYSE - ARP). He said that he had read a couple of articles about the company and thought that it was a solid company for him to use as his starting point into the world of small-cap investing. Well so far so good as the stock price went up 10% the day after he bought it.

The first thing that I thought of when he told me about the company was "what on earth is reprographics?" A quick trip to an on-line dictionary helped fill me in on the meaning and a second trip to the Morningstar 'Company Profile' filled in the blanks of the exact service ARP provides. It turns out that ARP re-produces complicated documentation, such as architectural and construction prints for companies; and it looks like they are the McDonald's of the industry as they have been purchasing a lot of the smaller competition over the past several years and now have over 280 branches in North America.

Up until around May of last year they had been giving a great return to their shareholders; the following year however the share price didn't know what to do and didn't move much one way or another until around July of this year when it started a nose-dive down to its current price of $16.75 (Dec. 10/07), or approximately 50% of July's value. A big reason for this drop was investor's fears over the sub-prime meltdown as ARP has some of its revenue tied into the home building industry. The ridiculous aspect of this argument however is that only 15% of ARPs 2006 revenues can be traced back to the residential home-building industry; while 65% is tied to commercial construction which hasn't felt much impact from the sub-prime meltdown.

Recent third quarter financials backed this up as revenue increased 16% year over year, while net income grew by 1%, due mainly to a lower gross margin and higher operating expenses from recent acquisitions. These numbers aren't what I would call mind-blowing but they are far from devastating. Maybe my math is wrong but I don't really see how a 1% growth in net income can translate into a 50% drop in share price. Even considering the fact that the company was over-valued at the time (P/E of 35 times) a 50% drop is just ridiculous as the current price is only 12 times earnings, while the S&P 500 is currently trading at 21 times. Now if ARP was not what I would consider a great company or even above average than I could understand the low P/E, but this is not the case at all. A quick analysis of its Income Statement and Balance Sheet shows that the company has given investors a solid average growth of 9% per year in revenue and 25% in net come over the past 5 years, while currently carrying an amount of debt that is only 5 times net income.

Now as of today I haven't decided whether or not I will be investing in ARP, but I can guarantee that over the next week or so I will be learning a lot more about the reprographics industry as so far this just looks too good to be true.

Moody's Corporation

2007-11-29T18:17:00.000-05:00

Do you know that feeling you get when you find a great deal on something that you’ve wanted for a long time but haven’t been able to afford?

For my girlfriend that feeling usually comes whenever a pair of shoes that she can’t stop talking about is on sale. The only problem is that by the time she buys it, it has gone out of fashion and thus the reason for the price drop. The great thing about her though is that she doesn’t care if nobody else wants it; she knows what she likes and a few months or even a year or two doesn’t change that; and since she is so stubborn it doesn’t matter what anyone else thinks about them.
Well that’s the view that I like to take when it comes to investing. If there is a company that I liked a year or two ago there isn’t much outside of a major change in direction or management that will change that feeling; and that is exactly how I felt when I recently saw Moody’s Corporation (MCO – NYSE) on the 52 week low list.

After taking a quick look at their price chart, I noticed that its share price had dropped around 50% over the past year, from a high of $73 in February, down to the most recent closing price of $35.39 (November 28th), with the majority of the drop coming over the past 6 months.
I have always thought that Moody’s was the epitome of what I was looking for in a company. They have a solid brand name that even your average person on the street would recognize; they have a solid history of earnings (ten straight years of growth) and their cash flow is among the best in the industry. The only problem was that they have had an average price of 28 times earnings over the past 5 years, which to me was just way too high.

As I have stated in earlier blogs I have noticed that a lot of great companies with a history of earnings growth (although sometimes it is a short history) have been priced at a ridiculously high multiples to earnings, have had one year (or even one quarter) of flat or declining earnings and have seen their prices drop almost immediately to ridiculously low levels. So needless to say I tend to avoid these companies until after they have dropped; and this is exactly what I think has happened with Moody’s.

The most recent quarter end of Sept. 30th showed an earnings drop of 13% from the prior year (which was a record third quarter at the time) and the recent problems in the capital markets in the States has people thinking that Moody’s won’t be able to match its previous years of glory but personally I think this is much too overblown. Revenue for the quarter was actually up 6% from the prior year, which shows that even during these tumultuous times Moody’s is still able to generate sales.

Another issue that has plagued Moody’s is a subpoena that it received from the Connecticut attorney general, along with S&P and Fitch, concerning possible anti-competitive practices. It doesn’t appear that this will have much of a negative affect on earnings but it is a slight cause for concern as the ethics of management of any company you invest in should be a major issue for every investor.

The current trailing twelve months price to earnings ratio is at 11 times and if Moody’s is able to produce even half of last year’s fourth quarter earnings then at today’s current price you will be able to buy them at only 13 times earnings; and with the average S&P 500 company trading at 20 times earnings you will have a nice margin of safety of 35%.

Note: I have put a brief overview of Moody's below and have categorized it according to the three major sections of the financial statements.

Income Statement:

Revenue and net income have increased each year over the past ten years with revenue growing at an average rate of 18% per year and net income at 26%
- Both have grown at this rate over the past five years which shows that the
growth has been steady and not just within a two or three year period

Both net and operating margin have improved each of the past five years
- Operating margin in 2006 was 61.8% compared to 50% in 2001
- Net margin was 37% in 2006 compared to 27% in 2001
- This shows that management is conscious of costs during good and bad times

Balance Sheet:

Currently the company has $421 million in cash
Long term debt is at $600 million but is not due until 2015 and 2017
- This is also a good sign as it shows that Moody’s has room to increase its debt if
times worsen and revenue falls significantly
The current ratio (current assets/current liabilities) is at .8 which is generally lower than you would like to see it but with Moody’s ability to generate so much cash this is not as worrying as it would be for a weaker company

Cash Flow:

Presently the company pays out $0.32 per year in dividends, giving it a yield of 0.9%
- A very positive sign is that the company has increased the dividend each of the
past four years
The company has authorized a $2 billion share repurchase program as of June 5, 2006
- Now is an excellent time for the company to be buying back shares as the price
is so low
Capital expenditures is only 19% of CFO giving it a great free cash flow

Crazy Times in the Market

2007-11-23T18:11:00.000-05:00

The stock market is a crazy place to be right now. I don’t think that anyone really understands what is going on or just how much more of this up and down movement is ahead. Just take a look at some of the major activities that have taken place over the past several months:

Citigroup (C - NYSE) and Merrill Lynch (MER - NYSE), two of America’s largest companies, have been hit hard recently by write downs on their sub-prime credit exposure. Things at Citigroup are getting so bad that there have actually been cries from investors to bring back the once disgraced ex-CEO Sandy Weill. Is it just me or do Investors tend to forgive and forget more easily when the times are tough;
Housing giants D.R. Horton (DHI - NYSE) and Toll Brothers (TOL - NYSE) are trading at prices that they haven’t seen since 2003, as both companies take major write-offs to their inventory after America enters one of it’s worst housing slumps;
The retail industry watches as their share prices are knocked lower and lower over the past several months only to see double digit gains in one single day because it just happens to be the yearly Black Friday shopping spree in America. Circuit City (CC - NYSE) in particular has seen a substantial jump in their share price with a 20% gain in one day; and
Pseudo-Governmental mortgage agencies, Freddie Mac (FRE - NYSE) and Fannie Mae (FNM - NYSE), find out that even they aren’t safe from the long reach of the sub-prime meltdown as both companies see their shares hit 10 year lows.

A lot of these events are of course inter-related. As one industry goes down investors start to get worried about the economy as a whole and begin selling off a majority of their holdings in other industries, which in turn creates a domino effect. This is especially true when a country as powerful as America is going through difficult times like it is right now. Investors start getting nervous and decide that they are safer off keeping their money out of equities. Other investors however take the opposite approach and see this as a good buying opportunity. Several senior officers at Fannie Mae didn’t even wait for the dust to settle before they began buying more shares in the market.

Personally I see a lot of good buying opportunities in the market right now. As I stated in an earlier blog I like several of the housing companies as a solid turnaround play and I honestly can’t see either Fannie Mae or Freddie Mac becoming insolvent and feel that they too will be able to weather the storm; but like always turnaround plays can take a long time to materialize, but if you have the patience this could be one of those times when you look back and realize just how happy you are that you didn’t follow the crowd. Because as everyone knows the stock market tends to have a real problem with short-term memory.

Share Buybacks

2007-11-15T20:56:00.001-05:00

I was going through the website for streetinsider.com and found a page that details all of the recent share buybacks announced by American public companies (unfortunately it doesn't include Canadian companies except for the ones listed on an American exchange). You can check out the page here.

This is great find for investors like me as it provides a convenient way to keep pace with all the announcements. Before this I relied on news sites for updates but that was always so tedious and of course you can't hear about every buyback this way.

If you check out the site today you will see that Bob Evans Farms Inc. (BOBE - NASDAQ) has announced that it will be repurchasing 2 million shares, which is in addition to the 3 million shares approved by the board earlier in the year (2 million of those shares have already been purchased). The share buyback will be completed by the end of the current fiscal year end, which is April 25 2008, and represents approximately 8.5% of the issued and outstanding.

This announcement jumped out at me because I have been following Bob Evans ever since I noticed that the share price had dropped from just under $30 to a 52 week low of $24.58. The reason for the drop was an announcement from the company that October same store sales were down 1.8% from the prior year. This was the first time all year however that same store sales had dropped and the company has a great history of revenue and net earnings growth so it seemed to me that it was just another case of investors doing a panic sell-off. Of course only a short week later shares rose by 15% in one day after the company announced growth in second quarter earnings ($.43 compared to $.36 in the same quarter 2006); and now with the share buyback annoucement there was another rise in price.

This just goes to show you that you can never predict what will happen with a share price over the short term. There are just too many emotional investors involved to make any sense of it.

Mergers & Acquisitions

2007-11-12T14:55:00.000-05:00

I just added a link on the right hand side to a website called Merger Stat, which tracks mergers and acquisitions ("M&A"). It is a pay website but you can get a list of recent M&A activity free of charge from the home page. Just look under the 'Deal Alerts' headline at the top of the home page and you will see a link for 'See More Deal Alerts.' This will bring you to a page with details of the past 2 or 3 days M&A activity.

What I am using this site for is to see if there are any price spreads between the announced purchase price and the price that the target company is trading for in the market. A lot of time there will be a small spread from 5 - 10% between these prices.

Of course this doesn't mean that you are guaranteed this return. What you have to do is try and piece together an understanding of whether the deal will be accepted by the target company and what a general timeline for the purchase is. A 10% premium on the trading price is good if you can get it within six months, as this would transalate into a 20% annualized return; but if the deal takes two years to finalize then it goes down to a 5% annualized return which isn't nearly as attractive. So you have to try to understand what kind of a timeline you are looking at. Depending on the complexity of the deal this can be a very difficult or simple thing to do.

Right now I am looking at a couple of proposed deals. The first one is Cagle's Inc. (CGL.A - AMEX), which recently had an offer from some of it's senior management to purchase all the outstanding shares at a price of US$9, which translates into a 5% premium over it's current trading price of US$8.55. In this case Board approval is more probable as the parties attempting to acquire the company are not only senior management, but are also part of the founding Cagle family and should have a good relationship with the Board. So the big question here is when will the Board approval be sought. Personally I would be looking for a maximum turnaround of 4 months as this translates into a minimum annualized return of 15%. Remember however that even with Board approval this deal could be rejected by the shareholders.

The second transaction that I have been looking at is Resurgance Health Group's offer of US$7.50 per share for SunLink Health Systems Inc. (SSY - AMEX), which translates into a 24% increase over SunLink's current trading price of US$6.05. This transaction seems much riskier than the deal with Cagle's Inc. as SunLink rejected a superior proposal from North Atlantic Value LLP that was made back in 2006. Details of that offer can be found in this news release. Also, the Board of Directors didn't make a decision on that offer for quite some time so there is a chance that they could drag their feet on this offer as well.

So remember that M&A deals are constantly occurring so don't feel pressured to jump in on any deal that has a positive spread as a less risky and/or more rewarding deal could come by any time.

A Downtrodden Industry - Time to Pick Through the Wreckage

2007-11-09T15:48:00.000-05:00

The decline in the home building industry has recently been plastered all over the front pages of the business sections. New home sales in September were down 23% compared with the same period a year ago, the credit crunch has made it so that mortgages for new home buyers are not as easy to find as they were a year ago and on top of all of this Moody’s and Standard & Poor have downgraded a majority of the home builders debt to junk or non-investment grade status.

So the question now is when will the home building industry hit bottom and start to rebound; and the only answer I have to this is that I have absolutely no idea. All I know is that the industry will come back from this mess and if history teaches us anything it will come back even stronger than it was, as the weaker companies are either bought out by their larger rivals or pushed into bankruptcy.

To make sure I know which side of this a company will be on, I like to take an extra long look at the following measures:

1. Cash flow – If a company can maintain a positive cash flow during this downturn than it is an excellent sign that they can keep their heads afloat while the industry is struggling. This is also a good place to see where their money is being spent. Now that the share prices are so low you would think that management might consider doing share buybacks. Also, be aware of a company that has a negative cash flow but has spent their money on debt repayment, asset purchases or share buybacks as these can all be another good sign. It’s not always necessary for a company to simply stockpile their cash;

2. Debt – The amount of debt a company has on their Balance sheet is extremely important in deciding on whether or not they will survive to see another day. Check to see if the company has been re-paying the debt recently (as I stated in the first point now is a great time for a company to pay down debt as inventory levels should be decreasing and providing an influx of cash) and how much of the debt is due within the next 2 – 3 years. If a company has a lot of debt but it doesn’t come due for the next 10 years than it isn’t as big a worry as a company that has most of their debt due within the next couple of years. This information can be found in the notes to the audited financial statements;

3. Revenue Decrease – Don’t get too worried about large drops in revenue from the prior year as that is expected during a downturn as severe as this, but instead use this statistic as a comparison between each company. If one company has seen a 50% drop in revenue while another has seen only a 20% drop it could be indicative of a company’s ability to sell houses during bad times as well as good. Make sure to note however, whether last year’s revenue was much higher than their usual growth as it isn’t fair to punish a company for being unable to keep up with records years; and

4. Number of contracts signed – Each home builder will report the number of new contracts that they have signed during the quarter and how much revenue is expected to be forthcoming from the contracts. This is a good number to help an investor estimate future revenues and also to compare the number of contracts to prior quarters to see which way sales are heading and by how much contracts have been increasing or decreasing.

Of course this is not an exhaustive list of what to look for in each of the home builders, but it highlights some of the more important features that an investor should be aware of when looking at a downtrodden industry with one home building specific point.

I began my research last night and will post my results of several homebuilders within the next few days.

Notes

Here are some links to some recent news releases that you should be aware of: Toll Brothers sees lower home-building revenue, Homebuilders' Hell, Credit Ratings Cut to Junk for Top 3 Home Builders, NVR Chairman Buys 118, 708 Shares.

Income Trust Anniversary

2007-10-31T18:40:00.000-05:00

I just read a great article in The Globe and Mail regarding Income Trusts and last year’s surprise announcement from the Finance Minister, Jim Flaherty, that beginning in 2011 they will be taxed like any Corporation. You can check it out here.
The basic premise of the article is that while Income Trusts are still down by over 10% since the announcement, there are a lot of good companies behind the Trusts and if an investor uses some common sense, they can find themselves a good investment.
Personally, I can't agree more with this article. I wrote about my feelings on Income Trusts on November 9th of last year, just after the Halloween announcement, and my views on the situation haven’t changed.

Anyway, enough of that, here are a few companies that I’m currently looking at:

1. Columbia Sports Company (COLM – NASDAQ) – This is a very well known company for outdoor enthusiasts as they are makers of outerwear brands including their leading lines of skiwear and rugged footwear. They are also the owner of a brand name called ‘Mountain Hardwear,’ which is considered the Wayne Gretzky of mountain wear and outdoor equipment by a lot of mountaineering enthusiasts.
Over the past three months Columbia’s share price has dropped from a high of $70.93 down to a low of $46.79 (as of October 31st the price was at $48.73). During this time the only significant news was that that company had a record third quarter in terms of revenue and profit. In my opinion this is just another case of a great company that was over-valued and then came plummeting down over a short span of time;

2. Heartland Express Inc. (HTLD – NASDAQ) – I had never heard of this company until I saw them on the 52 week low list earlier this month. After I took a quick look at the financials I realized that it was a company that I wanted to know more about. Turns out that they are a trucking company based out of Iowa and because of the recent problems in the housing market in the USA, a lot of investors are trying to unload their stock sending the shares into a downward spiral.
What makes this company so attractive is the lack of debt and history of good earnings growth. Two necessities that every company needs to survive downturns in their respective markets. Look for this company to weather the storm and come out even stronger; and

3. TJX Companies (TJX – NYSE) – TJX is a company that has been very successful by sticking to one of the five principals outlined in the book ‘Good To Great.’ They have concentrated on one industry (off-price retailing of brand-name apparel) and have put all of their resources and knowledge into becoming the leader within that industry. Some of the most well-known discount shops in America are part of TJX including: TJ Maxx, Marshalls and Winners. Of course this company is no secret to the investing public so the P/E isn’t necessarily low (approximately 19 times), but you can’t always get a discount on a company, especially when the company is a leader in its industry.

MicroPlace

2007-10-24T14:28:00.000-05:00

Feel like you want to make a difference with your investment dollars but don’t know how? Check out MicroPlace, an eBay owned Investment Company that specializes in sending capital to the world’s working poor while giving the investor a return on his money.

The basic premise behind MicroPlace works like this:

1. The investor purchases investments through MicroPlace from security issuers;
2. The security issuer sends the money to lending organizations;
3. The lending organizations provides loans to borrowers who live in some of the poorest regions in the world;
4. The borrowers use the loans to start or expand small businesses, using the profits to repay the loans; and
5. The security issuer sends all interest and principal re-payments back to the original investor.

The average interest rate on an investment is 2 – 3% with a maturity date of 2 – 3 years. Each investor can choose which country and lending organization they want their money to go too as long as it is part of the MicroPlace community.

Now since this is an investment and not a donation the money is not tax deductible (at least in Canada it isn’t); and although the interest rate is lower than what the average investor can get from other investment vehicles, there are no fees to the investor, which in general can eat up to 1 – 2% of profits.

The best part of this whole process though is that it is can become very cyclical. If an investor decides to not remove their interest and principal re-payments they can compound their returns and in turn provide even more capital to a new business or entrepreneur. This in turn can then give the investor a combination that is very rarely seen: a positive social impact on the world and a positive return on investment.

Black Monday - Part 2?

2007-10-19T16:15:00.000-05:00

Well it's been 20 years since Black Monday occurred and we're still seeing signs of it today, albeit on a much smaller scale. The S&P/TSX composite index fell 2.3% today and the NYSE composite dropped approximately 2.5%, which of course don't really compare with the infamous day of October 19, 1987 when the Dow fell 23% and the Canadian counterpart dropped 11%.

So it might not be considered a second Black Monday, but it does provide more fuel for the theory that investing is more about understanding human psychology than it is about picking the best stocks.

Anyway, here's a quick list of some companies that I have been following as of late:

1. Monro Muffler, Brake Inc. (MNRO - Nasdaq) - They have spent the past couple of week on the 52 week low list with a new low occurring almost everyday. They have a great history of earnings growth and a minimal amount of debt. It also doesn't hurt that they are one of the more recognizable brands in North America.

2. Sharper Image (SHRP - Nasdaq) - Sharper Image used to be one of my favorite stores when I was younger, as they always had some new and exciting gadgets that you couldn't find anywhere else. Unfortunately though, it seems that those days are in the past as it recently had a 39% drop in sales, which of course has hurt their share price over the past few months; and to make matters worse a recent ruling regarding a lawsuit against the company has gone against them. Could be a good turnaround investment, but as always with this kind of investment be wary of any increasing debt or upcoming loan payments which could make it that much more difficult for them to withstand these tough times.

3. Rent-A-Center (RCII - Nasdaq) - Another case of a good company that traded at a ridiculously high price to earnings and then saw their price drop substantially after they reported some bad news. In this case it was a lower 2007 forecast in earnings than they had previously announced. The strange thing about this is the fact that it somehow overshadowed the 4% increase in net earnings and 24% increase in revenue on a quarterly year over year basis that was reported on the same day.

Well that's it for now. Make sure you keep your eyes open and your ears closed to all the pessimism in the news and you should be able to find a few more diamonds in the rough out there.

On-Line Brokers

2007-10-09T16:31:00.000-05:00

Any small investor that has his/her own on-line brokerage account can tell you the frustration of paying the high fees associated with buying and selling in the market. Unless you have a high amount of assets invested or are considered a day-trader you are forced to pay a substantial amount for each trade in comparison to the amount of money you are investing. For myself, the fees cost an average of 1 - 3 % of my total investment, which means that I have take that percentage off of my total return. Unfortunately there isn’t much we can do about paying the fees but because of the ever growing number of on-line brokers, we can at least choose the best from what’s available.
To help make this decision that much easier, The Globe & Mail puts out an annual ranking of all the Canadian on-line brokers and breaks it down from fees to customer service to research tools. Personally I focus on the fees that each broker charges, but for investors looking for a little more this article will really come in handy. Also, the writer Rob Carrick is one of my personal favorites and since he focuses on the on-line brokers he has become somewhat of an expert on this topic. Check it out here and help yourself maximize your return.

Quick Hits!

2007-10-01T12:39:00.000-05:00

Here are my thoughts and reflections of the past week:

1. I think it’s a good time to be looking at the American currency for Canadian investors right now. Canada isn’t really gaining ground on the other major currencies in the world (i.e. the Euro or the Pound) and as such I don’t see the Canadian dollar staying at par with the States forever.

2. Check out this link for a listing of all the stock exchanges worldwide. For anyone looking to diversify out of North America, this could be a good starting point. Make sure to check out the daily volume of trading on each exchange before deciding so that you don’t get stuck holding onto something that you don’t want.

3. I think that Coldwater Creek (CWTR - NASDAQ) could be a good bargain. They have no debt and have shown good growth over the past few years. I have also heard through the female grapevine that this store is very much on the active shopper’s radar.

4. Ruth’s Chris Steakhouse (RUTH - NASDAQ) was an interesting find last week. They are an upper-class steakhouse that is only found in major cities in North America and from what I can tell they always have a line-up out the door, but for one reason or another have seen their share price drop over the past couple of months. It might be the poor current ratio that they have.

5. The US stock markets hit an all-time high today (October 1st, 2007), which is going against the overall thought that the American economy is in the doldrums. Makes you wonder what really pushes the markets up during these bull runs.

Well that's it for now. Keep searching and as always don't get caught up in the crowd mentality.

Quick Hits!

2007-09-20T13:41:00.001-05:00

Here’s a list of some companies I’m currently looking at:

1) Shoe Carnival (SCVL – Nasdaq) – A good retailer that has a solid customer base but has seen a drop in earnings and profit over the past few quarters. It has almost no debt however and a good long history of earnings growth and is trading at a low P/E.

2) Spanish Broadcasting System (SBSA – Nasdaq) – The thing I like about this company is that it has no true competition. They own the majority of the Spanish speaking radio stations in the United States, with 70% of its revenues coming from New York, Los Angeles and Miami. What I don’t like about it is its lack of consistent positive net income, although it does generally have positive free cash flow.

3) Cheesecake Factory (CAKE – Nasdaq) – I’ve been watching Cheesecake Factory for a couple of years now as I was a big fan of the restaurant and its financial statements. The only problem was that so was everyone else. Well its recent P/E is around 23 times, which is much more reasonable than it was in the past when it hovered closer to 40 times.

4) Sears Holdings Corporation (SHLD – Nasdaq) – This is more of a gut feeling than anything to do with the financials. I work very close to a Sears department store and tend to walk through it quite a bit on my way to lunch or to pick something up for myself and have noticed that the traffic has increased significantly over the past 6 months. I have also taken note of the fact that many women I have talked to are starting to think of Sears as the Canadian version of Target or Marshall’s in the States. It will be interesting to see their next quarterly statements.

5) Circuit City (CC – NYSE) – This one-time darling of the stock market and secondary focus of the bestselling book ‘From Good to Great’ has gone from a 52 week high of approximately $29 to a recent low of around $9. The earnings are down, the profit is in negative territory and comp sales are diving. It isn’t easy to say if this is a temporary or permanent drop in earnings but an early release from the company indicates that the fourth quarter earnings will be positive and as far as I can tell the stores are still seen as top of the line by customers. Could be a good time to buy.

Quick Hits!

2007-09-07T15:40:00.000-05:00

The markets are falling, the markets are falling …. At least that’s what I read this morning at the Globe and Mail website. And what was it that sparked the drop this time? Maybe a speech by George Bush or maybe a new video from Al Qaeda has surfaced or perhaps it has become known that the Easter Bunny isn’t actually real. Alas, it was none of these things; instead the panicked sell-off came from a report stating that US employers cut their payrolls for the first time in four years.

I’m surprised people aren’t selling everything else they own alongside their stocks. Why not get rid of the new big-screen HD TV or BMW sitting in the driveway? If the economy goes down like everyone is thinking and companies’ earnings go down the toilet then everything could conceivably be worth less than it is now.

And just in case there is a reader out there that isn’t either related to me or a good friend of mine, you should probably know that I’m really sarcastic.

Anyway, on with the show:

1. I know I have spent way too much time talking about Contrans Income Fund (CSS.UN – TSX) but I can’t help but share the news that their CEO Stanley Dunford added to his position in the company by purchasing another $340,000 worth of stock last week after the shares hit a 52 week low. It definitely makes me feel a bit better about having Contrans as my largest personal holding.

2. General Motors (GM – NYSE) recently had some good news after it came out that August sales at the car manufacturer had risen 6% year over year, while both Toyota and Ford saw their sales go south. For GM it was a much needed bit of good news as every other piece that has come out over past couple of years has been quite dismal. I’m not saying that I would rush out and buy the stock as I believe that car manufacturers have too many factors that are out of their control (i.e. unionized workers, fuel prices, constant R&D and marketing spending each year) but it is good to see that they are trying to get back on track after so much bankruptcy speculation.

3. Urban Outfitters (URBN – NYSE) has been one of my favorite companies over the past year or so since my girlfriend first introduced me to the store. They recently had a bit of a downfall in their share price when they went down from a high of just under $26 to a low of approximately $19.50, although they have recently traded in the $22 range, giving them a still high P/E ratio of approximately 28 times. The thing that I really like about Urban Outfitters besides their lack of debt and the rave reviews from the customers that I have spoken with is the growth they have seen in their direct to consumer sales (i.e. on-line shopping), which was first pointed out to me by a friend of mine. Take a look at their 2007 Q2 earnings release which shows a 24% increase in year over year direct to consumer sales during the six month period from January to June. In comparison, sales for the company overall were up 16%. More importantly however is that on-line sales now contribute 13% of total sales which is up from 11.7% during the same period last year. The reason that this is so important is that on-line sales tend to have much higher margins than retail stores as you don’t have as much expenses (i.e. staff, rent, logistics), which of course means more profit per dollar of sales, which is a great way to grow net earnings without having to increase sales.

4. If anyone is looking for a good read on investing by one of the greatest investors ever, check out this link, which will take you to the home page of Berkshire Hathaway, Warren Buffett’s company and scroll down to his Annual and Interim Reports section. They are a work of art and should be mandatory reading for stock analysts and senior officers of public companies on how to be completely transparent and straight forward when reporting results.

5. Check out this list of the 101 Dumbest Moments in Business of the year, it's hilarious and pay particular attention to number 32. It really made me wonder why I even bother.

Anyway, that’s it for now. Keep your eyes open and your back turned to the crowd and don’t let these panic sell-offs sweep you away.

Quick Hits!

2007-08-29T17:54:00.000-05:00

Today is turning out to be a great day. The sun is shining, my stocks are up and the Toronto Blue Jays just hit two home runs in the ninth inning to tie up the ball game.
So with all that being said I don’t think there is a better time for some Quick Hits:

The housing market in the States is taking a beating and subsequently the housing builders are moving in the same direction, although they did re-gain some ground in today’s trading (courtesy of bargain hunters I’m sure). So the task at hand now is take a look at the companies in the industry and find the ones that will weather this storm and live to fight another day. Pay particular attention to the amount of each company’s debt and inventory. Either one being too high is not a good sign and can mean that the company may not survive this downturn. I recommend paying particular attention to D.R. Horton and Toll Brothers. If not for an inventory write down (a non-cash charge) D.R. Horton would have posted a profit in its third quarter and of course they were able to keep a positive cash flow for the quarter, which is a very good sign for a Company in an ailing industry..

Gateway Inc. (GTW – NYSE) is being bought out by Taiwanese PC giant Acer Inc. for $710 million or $1.90 per share. After the announcement shares of Gateway moved up nearly 50% to $1.81, which was still 5% under the target price. So presumably if you had noticed this difference, which lasted for two days, you could have gone into the market bought shares of Gateway and made a risk free return of 5% before fees. The deal is expected to close in December, which would give an approximate annualized return of 15%, which is nothing to sneeze at.

Movie Gallery (MOVI – NYSE) has been heading closer and closer to bankruptcy over the past few months. The share price has hovered around $0.30 and doesn’t seem to want to move one way or the other. Companies like NetFlix, which rents movies through a home delivery service via the Web, have decimated its market share and is making it seem like the old way of renting videos from stores is on the way out. Movie Gallery terrifies me as there is a definite possibility of losing your entire investment, but if they do survive bankruptcy, or are bought out, it could be a huge turnaround as it really doesn’t take much movement for a company at $0.30 to gain 100 or 200%.
So if you are able to stomach the risk, take a look at Movie Gallery’s financials, the amount of short and long term debt owing, the structure of the debt (bank debt is bad, bond debt not as bad) and pay particular attention to any covenants they have in regards to the bank debt. If they aren’t able to meet even one of the covenants then the bank may come calling, which is never a good thing.

I received an e-mail from my mom the other day concerning a store that is coming to her Cleveland suburb. Apparently some of her fellow shoppers love the store and have described it as an ‘up market Winners.’ The name of the store is Stein Mart (SMRT – NYSE) and they sell brand-name apparel, accessories and home goods at 25–60% below department store prices. Keep an eye on them as a growth/value candidate as they were recently trading at its 52 week low.

Well that’s it for now and oh yeah, just so you know, the Blue Jays just lost the game in the 11th inning. The day is now officially not nearly as good as it was an hour ago.

Quick Hits!

2007-08-21T17:57:00.000-05:00

I've realized a couple of things while doing my blog over the past 6 months. The first thing is that I don't like writing long articles and the second thing is that I can't write. So to combat these problems I've decided to try a new format that I'm going to call "Quick Hits!"

Basically I'm going to copy a few of my favorite sports writers formats and do a bullet point synapses of everything and anything to do with investing. So here goes.

1) American Eagle Outfitters (AEO - NYSE), which happens to be where 90% of my clothes come from, is currently selling at only 13 times earnings. This doesn't make any sense to me as they are an excellent growth company with no debt and a solid history of being one of the leaders of fashion and to back this up I would like to point out that my girlfriend, who knows a lot about fashion, whole-heartedly supports my addiction to this store. Could be a good buy. Abercrombie & Fitch (ANF - NYSE) is another solid retail company worth taking a look at, though they are trading at approximately 16 times earnings.

2) If I had to pick only one company that I was allowed to invest in and I was forced to keep this company for the next twenty years I would take a seriously long look at Manulife Financial (MFC - TSX). I used to work in the John Hancock division of Manulife and I can tell you personally that not only was business booming but the training room for new hires was busier than any other room that I was aware of. And the rumor is that since it is having so much trouble keeping up with the constant need for more staff, Manulife has begun outsourcing a lot of the work to Manila, which should help cut costs.

3) Home Depot (HD - NYSE) has recently announced a Dutch Auction tender offer of up to 250 million of their shares, representing approximately 12% of the issued and outstanding. The original price range was $39 - $44 but has since been revised down to $37 - $42 as the share price for HD has dropped from $41 to approximately $34 as of this writing (Aug. 20). I'm not sure why the share price hasn't reacted more appropriately to this offer, but I know that I will be participating. If under a worst case scenario, I am not able to tender any of my shares then I will be left holding a piece of a company that I have been a great fan of for quite some time. Of course with the housing market in the States going down the tubes and the company issuing earnings warnings there is a good chance that the shares will fall further, but once the housing market resumes Home Depot will come out of it even stronger as the weaker competition has either been bought out or gone into bankruptcy. And in the meantime, I will have received a 12% increase in my holdings from the offering.

4) I found a small growth retail company on the NASDAQ 52 week high/low today called Citi Trends (CTRN - NASDAQ) which specializes in discount clothing stores situated mainly in the Southern States and caters to African American women. They are very typical of a small growth company with great growth in both earnings and revenue but unlike other companies of similar stature they have no debt and are only trading at about 15 times earnings. Currently they have 295 stores (as of the end of its second quarter) and are looking to open up to 30 more by the end of fiscal 2007 with 90% of the new stores located in exisiting states. This company is definitely worth a second look.

The World of Investing

2007-08-20T18:08:00.000-05:00

Some quick thoughts on the current World of Investment:

1) The 'market meltdown' that happened last week wasn't as much a meltdown as it was more just a one day panic sell-off, making it difficult to capitalize on the irrational price drops as most shares went back up to their original price over the next couple of days;

2) There are a lot of good companies that have been unfairly hurt by the sub-prime lending induced market drop in the States, including a lot of well-run Savings & Loans that don't have any sub-prime lending on their books;

3) Rona Inc. (RON - TSX), Canada's number one housing products supplier, is currently trading at about 13 times earnings as fears of a long housing slump in the States has made investors weary of bulding suppliers (Home Depot suffered a recent 16% drop in year over year second quarter earnings). The only difference is that Rona derives 100% of its sales from Canada and the Canadian Real Estate Association has just issued a news release revising its full year home sales growth target to 523,100 units, which would be an 8.1 percent increase over 2006, which was at the time a new annual record. Seems to me that the price of Rona's share should be going up, not down;

4) Contrans Income Fund (CSS.UN - TSX), which is one my biggest holdings, saw its price drop from $12.35 on July 20th to its most recent closing price of $9.00 on August 20th. Meanwhile the CEO, Stanley Dunford, has been buying shares on the open market, with the most recent purchase happening on August 17th when he spent approximately $34,000. Makes you wonder if he knows something that the sellers don't;

5) Dell Inc. (DELL - NYSE) is restating the last four years of its financial statements. The shares didn't really take much of a hit though since the restatement will apparently be immaterial on its revenue and net earnings. I've always been a big fan of Dell, but restating earnings to me is a really, really bad sign of a company, whether the change is material or not. Especially when the reason given for the errors was that management wanted to make sure they hit their quarterly numbers. All I can say is that Dell shareholders must be relieved that the founder Michael Dell is back at the reins; and

6) Netease.com Inc. (NTES - NYSE) is an interesting Company. They derive 90% of their revenue from an on-line game called Westward Journey that has done very well for the Company, allowing them to grow revenues 79% and earnings 197% per year over the past four years and of course since they are an internet based company they have great margins, great cash flow and zero debt. The only problem is that this game is now 4 years old, its newest game Tianxin was not well received during the first round of testing and the launch has been pushed back to early 2008. Investors meanwhile have punished the Company by sending its shares down to approximately 12 times earnings, which is very low for a growth Company such as this. I of course, have no idea if its new game will do well or fall flat on its face, but after talking to some gamers it doesn't sound like the four year old Westward Journey game is going anywhere anytime soon. And with an expansion pack coming out shortly for the game I have a feeling that this Company could be a good buy if bundled with several other stocks.

Travelzoo Inc. - (TZOO - NASDAQ)

2007-08-01T16:35:00.000-05:00

One of the first things I learned about investing is that when you invest in a company you invest in the industry, and all industries follow the same life cycle of which it is crucial for an investor to be able to identify.

The first stage for an industry is the pioneer stage (the riskiest stage for investing and one which I believe should be avoided) after which it moves into a growth stage (the most profitable time to be invested in a company) and then a mature stage (e.g. televisions) and finally into the decline stage (e.g. newspapers). Each of these stages can last from as little as a few weeks up to several decades, with some industries overlapping in two stages at a certain point time, making identification that much more difficult. The real trick however, is to identify industries that are just about to leave the pioneer stage and move into the growth stage, as this is when an investor can make a lot of money.

The problems with this strategy is that it can take a long time before an industry is able to move out of the pioneer stage (if at all) and it is anything but simple to be able to identify when this will occur. There is however one other way to capitalize on the returns from industries such as this (which happens much less frequently but is much easier to identify) and involves finding a company within a growth stage industry that has seen its share price drop from the usual ridiculously high P/E to a more reasonable level because of some superficial or temporary reason, which brings me to the subject of this article, Travelzoo Inc. (TZOO – Nasdaq).
Travelzoo Inc. is in the on-line discount travel business (first represented by Priceline.com, which came public during the late nineties dot com faze) which is an industry that is still fighting for market share and has, in my opinion, left the pioneer stage and is well entrenched in the growth stage.

In December of 2004 Travelzoo Inc. had a share price as high as $95 (with a P/E over 200) only to have seen it recently close at $20.66 on July 31st, 2007 (the 52 week high was $40.68 on April 17th, 2007), which isn’t to say that the Company is trading at a “cheap” price as its P/E is still at a moderate valuation of approximately 20 times, but it is no longer at a ridiculously high valuation (the S&P 500 is currently trading at 20 times earnings while the ‘Online services’ industry as a whole is trading at 55 times earnings).

The question is though, is this a great company at an okay price or a bad company at a bad price? Well, I guess it is pretty obvious that I wouldn’t be writing about it if I didn’t think it was a good company but here is a sampling of its past performance so that you can decide on your own:

Revenue – Has grown at 62% compounded since 2001when it came public, with the last two fiscal years growing at a compounded rate of 44%;1
EPS – 119% compounded rate since 2001;
LT Debt – Zero, Zilch, Nada, Nil;
Current Ratio – 6.3 times;
Free Cash Flow - $17.2 million in 2006 on $17.3 million from CFO (as an Internet based company they don’t have many capital expenditures, which means they can spend their cash on other things such as company growth, dividend issuances or share buybacks);
ROE – 40% in 2006 (Average of 44% over last 5 years);
Gross Margin – 98.5% in 2006 (another positive for internet based companies is that they don’t generally have a high cost of sales);
Profit Margin – 24% in 2006 compared to 6.5% in 2001 (the Company has been very diligent about increasing the profit margin which is a good sign that management cuts costs even during the days of big growth);
Valuation – Currently has a 20 times P/E, 7.7 times P/B and 4.8 times P/S; and
Share Buyback – The Company repurchased 1,000,000 shares or approximately 5% in 2006.
So now the question is what happened to the Company that made the stock price drop so significantly?

Within the past 6 months the largest drop in price came near the end of April when it lost almost 20% of its value which, not surprisingly, occurred at the same time as its first quarter earnings release. So after searching through old news releases, I found that the reason for this drop was because it had missed the Analyst’s consensus estimate EPS for the second consecutive quarter, which I feel is a ridiculous reason for an investor to sell his/her shares. Basically how it works is that Analysts put up a consensus estimate range of what they think the EPS will be and then if the earnings don’t hit within that range it is considered a disappointment and generally the share price will drop.

Needless to say I don’t believe that a company missing the Analysts estimate of earnings is a material issue. I am much more concerned with how the numbers measure up year over year or to the prior quarter or even to what the industry as a whole did.

So for Travelzoo the two latest fiscal quarters (June 30th and March 31st 2007) had diluted EPS of $0.17 and $0.25 based on revenue of $20,100,000 (an increase of 16% from the prior year and also the 32nd straight quarter of revenue growth) and $19,740,000 respectively. The prior year quarters in comparison, had $17,358,000 and $16,928,000 in revenue and EPS of $0.25 and $0.24 respectively. A big reason for this drop in EPS is that the Company is currently growing its operations in Europe (subscribers increased 102% in 2007 and 135% in 2006), Asia and Canada (Asia, Canada and Europe are all currently operating at a loss), which has significantly increased the Companies sales and marketing expense and of course its payroll. So the next question is what do I think the future holds for Travelzoo and will the growth continue?
Well first of all, I believe that this is another example of a fast growing company in a relatively new industry, which becomes way too overvalued and then falls back down to earth once the ridiculously unsustainable growth rate slows down. It isn’t that I believe that the growth rate will keep skyrocketing, but I also don’t believe that the Company is past the growth stage.
Generally I don’t like to put a number on things like this but I expect them to be in the 20 – 30% range when it comes to revenue growth (which is still an excellent number), with EPS catching up next year once the restructuring charges from the expansion plans have been taken care of.

I am also a big fan of how Management runs the company. They don’t like debt, prefer to buy back shares than issue dividends, they have clients signed to contracts to cut down on new competition threatening their market share (which is very important for an internet based company as the barriers to entry are relatively thin) and they stick to what they know, which is on-line discount travel, without messing around in any other sectors.

However, because of the recent news release from management that the next few quarters will be hurt by restructuring charges, I am going to change my usual course of action and wait for at least the next two quarters to see how the share price does with the belief that it will drop lower once earnings are released. Hopefully this will allow me to jump in just before the EPS recovers from the one-time charges and I will maximize my profit.

Of course the downfall to this plan would be that I have to pay much more than the current share price, which is why I am constantly telling people to buy as soon as they believe a company is a good purchase and not try to guess the bottom.

But I guess it is just like the saying goes, “Do what I say, not what I do.”

Savings & Loans

2007-07-25T14:28:00.000-05:00

Well, it has been a long time since my last blog (three months to be exact) and yet for some reason I have not received a single e-mail asking me why. Is it because my devoted fans think that I have spent this whole time writing and will present them with an article that is so great that it will make the three month gap feel more like three minutes? Or is it because I have no devoted fans? It is hard to say which is true but I think I’m going to stick with the former. Of course this means that I have to deliver with a great article which sounds like a lot of hard work. So maybe it is just better to come back to reality and realize that I haven’t received any e-mails because I only have two readers and one of them is my mom who stopped reading after the second post. Oh well, what can you do?
Anyway, I’m going to move past this depressing revelation and get straight to the reason for this post … Savings & Loans (aka Regional Banks) (“S&L”) in the good ole USA.
Share prices for S&Ls have been dropping like a fat kid on a smartie over the past couple of weeks. It started with the Sub-Prime lending meltdown about two months ago and has now moved on to S&L outfits that dot the American landscape.
Ever since I read Peter Lynch’s book “Beating The Street,” where he goes into great detail about buying S&L’s, I have been fascinated by them, but always found them to be overvalued. Well, the time has now come when they are selling at bargain basement prices. So all that is left to do is sift through the wreckage and find the best pieces. Of course it would be a lot easier if I could get my hands on The Thrift Digest which details each and every S&L in America, but the book costs an arm and a leg and unfortunately libraries in Canada don’t hold a copy. So it is back to the basics, digging through financial statements and gathering information. If only people read my blog then maybe I could afford to hire a secretary, or I could just hire somebody that owned the Thrift Digest. Oh well, what can you do?
Anyway, the first step when searching for Companies within an Industry is to write down the criteria that you plan on ranking them by. In this instance I basically just cheated and wrote down the criteria that Peter Lynch detailed in his book and then added a couple of my own. The first eight, including the comments, were taken straight from his book and the remaining are my own choices.
I should point out however that before you use any of the following you should take a long look at each and decide whether or not you feel they are important. Feel free to mix and match or even just completely ignore my additions and focus on the ones that were given by Peter Lynch, who is arguably the greatest mutual fund manager ever. Or you can just use my criteria, done by arguably the greatest investor in my household. The choice is yours.

"1. Current Price

2. Initial Offering Price – When an S&L is selling below the price at which it came public, it’s a sign that the stock may be undervalued. Other factors, of course, must be considered.

3. Equity to Assets Ratio – The most important number of all. Measures financial strength and “survivability.” The higher the E/A, the better. E/As have an incredible range, from as low as 1 or 2 (candidates for the scrap heap) to as high as 20. An E/A of 5.5 to 6 is average, but below 5, you’re in the danger zone of ailing thrifts.
Before I invest in any S&L, I like to see that its E/A ratio is at least 7.5. This is not only for disaster protection, but also because an S&L with a high E/A ratio makes an attractive takeover candidate. This excess equity gives it excess lending capacity that a larger bank or S&L might want to put to use.

4. Dividend – Many S&Ls pay better-than-average dividends. When one of them meets all the other criteria and also has a high yield, it’s a plus.

5. Book Value – Most of the assets of a bank or an S&L are in its loans. Once you assure yourself that an S&L has avoided high-risk lending (see below), you can begin to have confidence that its book value, as reported in the financial statements, is an accurate reflection of the institution’s real worth.

6. Price-Earnings Ratio – As with any stock, the lower this number, the better. Some S&Ls with annual growth rates of 15 percent a year have p/e ratios of 7 or 8, based on the prior 12 months’ earnings.

7. 90-Day Nonperforming Assets – These are the loans that have already defaulted. What you want to see here is a very low number, preferably less than 2 percent of the S&L’s total assets. Also, you’d like this number to be falling and not rising. An extra couple of percentage points’ worth of bad loans can wipe out an S&L’s entire equity.

8. Real Estate Owned – This is property on which the S&L has already foreclosed. The REO category, as it’s called, is an index of yesterday’s problems, because whatever shows up here has been written off as a loss on the books.
Since this financial “hit” has already been taken, a high percentage of real estate owned isn’t as worrisome as a high percentage of nonperforming assets. But it’s worrisome when REO is on the rise. S&L’s aren’t in the real-estate business, and the last they want is to repossess more condos or office parks that are expensive to maintain and hard to sell. In fact, where there’s a lot of REO, you have to assume that the S&L is having trouble getting rid of it."

9. 5 Year Growth Rate of EPS – As I have stated before when I buy a Company for reasons other than hidden asset values or turnarounds, I need to seem some growth in EPS. Otherwise what is the point?

10. Sales Region – One of the best things about S&Ls is their loyal customer base. Unlike Canada where people change banks every time they get a new haircut, S&Ls are able to create a bond with their customers and thus don’t have to worry about customer turnover nearly as much. For this reason I like to see the Region that the S&L is situated in and check the recent population and economic growth, since the bank will tend to follow the same pattern.

11. Share Buybacks – A Company that buys back it shares (especially now since the share prices are down) is a good Company.

12. Commercial Loans – For an S&L commercial loans are the risky kind of loans because of the problems explained above in number 9. So I like to check and see what percentage of loans outstanding is commercial and ensure that it is below at least 10%.

So there you go a complete Do It Yourself list for buying S&L’s. I am currently working on my own list of Companies so that I can pick up one or two of what I feel are the better of the bunch, and once I have done this I will post my results, but in the meantime check out the 52 Week High/Low website or go to one of the stock filters I have listed in the sidebar and do a search for banks and find your own S&Ls to invest in. Better yet why doesn’t everyone do up their own list and then send me the results. That way I don’t have to do anything and you know what they say … stick with what you’re good at.

Canadian Insider

2007-04-26T15:19:00.000-05:00

I just wanted to point out the new link 'Canadian Insider' (Owned by INK Research) that I added under the 'Canadian Stock Research Sites' heading on the right hand side. Its a website that allows you to search for insider activity within a company so you can see if any insiders have been recently buying or selling stock in the market.
As I have mentioned in earlier posts an insider buying stock (don't confuse buying with being awarded) can be a good sign for things to come. Who better than management of a company to know whether it is under or overvalued or whether a it is headed for good times.
On the other hand however, insider sales are more of a grey area. Personally I tend not to put too much emphasis on insider sales (unless it seems as though several insiders are selling at the exact same time) as more often than not the sales are nothing more than someone needing an infusion of cash, perhaps to take their family on vacation, buy a new car or whatever the reason may be.
Anyway, to do a quick example, I checked up on a company that I have recently been purchasing in the market, Contrans Income Fund (CSS.UN - TSX).
After punching in the symbol a list of the most recent insider activity was displayed, highlighted by none other than the CEO himself, Stanley Dunford. Over the past month and a half Mr. Dunford has been very active in the market buying 5,289 shares within a price range of $9.94 - $10.74 (Unfortunately my purchase price was closer to $11.00). The actual amount of money that Mr. Dunford spent on the shares comes out to $54,155.66, which compared to his 2006 salary of $1,257,287 ($497,920 base salary, $626,965 in bonuses and $132,402 in "other compensation" which includes car payments and club memberships) does not seem like a large amount, it still represents a significant increase in his own personal stake in the company that should not go unnoticed.

So if you're like me and you interpret insider buying as a positive sign for investing than take a look at the Canadian Insider website as so far it is the best site that I have found for Canadian companies (Morningstar.com does a good job for American companies). Of course don't take insider buying to be a sign that you should go ahead and purchase the company, it is just one indicator that should help you to create an overall picture to help with your decision.

Sun-Rype Products (SRF - TSX)

2007-04-17T15:11:00.000-05:00

A consistently profitable company with a great product is hard to find these days. A lot of companies shoot to the top with a rapid ascension only to find that they can’t sustain the momentum. More often than not the management for these companies simply over expands its resources and the company fizzles out when the rapid growth of its product or service slows down and their cash flow goes south.
Sun-Rype Products (SRF - TSX), on the other hand, has been one of those rare growth companies that you don’t have to worry about making a wrong move. They concentrate on what they know, which is 100% juice and snack products, return a consistent profit year over year and are constantly looking for ways to improve the bottom line without the use of debt. Take a look at the highlights of their Financial Statements from the past 5 years, they're a work of art. Pay particular attention to the Earnings and Cash Flow per share, Current Ratio and Return on Average Equity. These four things alone can tell you a lot. What I see with Sun-Rype is that EPS has been growing steadily (7.9% over the past 5 years), they have a strong cash flow that has been growing along with EPS (a good sign that EPS hasn't been inflated by management), they are more than capable of paying off their expenses over the next year (a current ratio of over 2.0 shows us this) and management has been successful in growing the company with intelligent decision making (the Return on Equity is a good indicator of management performance as it tells us what kind of a return management has gotten from the company).
Of course the best part about Sun-Rype is its line of products. Personally, I can’t get enough of their juice. There is really nothing like it around and with a wide range of 100% juice products and only a handful of direct competition it is hard to see any reason why it wouldn’t be able to sustain its current growth. In fact with the expansion of their fruit snack line and the fact that presently their juice products are only sold in the Western part of Canada, it’s easy to see that there is a lot of untapped potential within this company.

Energy Partners Limited - (EPL - NYSE)

2007-04-04T17:22:00.000-05:00

I thought this was interesting: “Energy Partners’ Limited (“EPL”) has recently announced a tender offer for their shares, where they will be purchasing $200 million worth of shares at a price of $23.00 (EPL was trading at about $17.50 before the announcement), representing approximately 22% of their issued and outstanding shares.” Pursuant to this offer, EPL will further be repurchasing another 5% (based on pre-tender offer shares outstanding) of their shares in the open market.
Now the confusion begins when you look up the current share price for EPL and notice that they haven’t gone far above $18 since the announcement.
Of course this seems way too good to be true. Anyone can go into the market, where there is a large daily trading volume, buy as many shares as they can afford and then turn around and tender them to EPL for a maximum gain of 30% over a two week period.
So just to make sure I went through several questions and/or concerns that I had about this offer that may be holding the share price down, and attempted to get some kind of an answer to each.

Is there a Record of Holder date?
If you had to be an owner of the stock as of a certain date, such as the date of the news release, than this could partially explain why the price hasn’t moved. However after speaking with the Information Officer at MacKenzie Partners, who are running the deal, he assured me that there is no cut-off date.

Is there a minimum subscription number?
In other words if they don’t have a certain amount of shareholders tender their shares will the offer be rebuked? The answer to this was a flat out no.
However, on the other end of this, if the offer is over subscribed then the shares will be tendered on a pro-rata format, so there is an almost definite possibility that a shareholder won’t be able to tender 100% of their shares, which is in my opinion the biggest reason for a lack of movement in the share price.
A worst case scenario for this is that 100% of the issued and outstanding shares are tendered and each investor is only allowed to tender 22% of their shares, which translates into an overall gain of approximately 7% over a two week period.

How is the offer being financed?
Since EPL doesn’t currently have a large amount of cash on hand, I was interested in knowing how it will be financed. Also, since EPL is planning on refinancing its revolving credit facility and refinancing its 8¾ % Senior Notes due 2010 through a debt tender offer alongside this deal, there is a definite necessity for some immediate funds.
Well, it looks like Bank of America is going to help out in this respect, with a $300 million senior secured revolving credit facility. Also, EPL is planning on issuing $450 million in notes and/or convertible notes, or if this doesn’t work, $450 million in senior unsecured bridge loans. According to the pro forma statements that EPL put in the Offer Sheet, this will increase long term debt from $317 million to $538 million and would have changed 2006 diluted EPS from -$1.32 to -$2.47, due to an increase in amortization rates of the new borrowings.
So even though there isn’t that usual increase in EPS when a company buys back shares, there are still positives for those shareholders that decide not to tender their offer and hold onto their shares. For instance, as I stated earlier, after this tender offer EPL will be buying back another $50 million in shares in the open market, which is approximately 5% of the outstanding shares before the tender offer.

So all in all, I feel that this could be a great arbitrage opportunity that investors should take a serious look at. The maximum possible gain that I can see is approximately 30% and the minimum is around 7% (both over a two-week period), which will occur if 100% of the issued and outstanding are tendered.
Of course another downside to this offer being over-subscribed is that you will be left with some shares of the company, which you may not want to be holding, as there is a very real possibility that the share price will tank after the offer. However, this is not what I predict will happen as once the company re-purchases it's shares, you should be this much better off than you were before the repurchase. As I’ve said in several earlier blogs share repurchases are a fantastic way for management to reward their shareholders as it gives the remaining shareholders that much more ownership without having to pay any money. Also, since EPL has a strong cash flow, the debt that will be on their books after this offer shouldn’t last for too long and the remaining shareholders will be in an even more enviable position.

Note: Here's a link to the Offer Sheet that goes into much more detail such as how you go about tendering your shares.

Contrans Income Fund - (CSS.UN - TSX)

2007-03-20T17:06:00.000-05:00

What if you had the opportunity to buy a stock with a dividend yield of 11%, held little to no debt, has not had negative earnings in over thirteen years, has grown revenue at a compounded rate of 14.15% and EPS at 18.6% over the past three years and has a TTM P/E of 8.2. Would you be interested? I know I would. At least interested enough to take a closer look at the company and check out the finer details. Well, this just happens to be the case with Contrans Income Fund (CSS.UN), a company that I mentioned briefly in my Income Trust meltdown post.
Contrans Corporation is a trucking company that has been in business since 1985, when it purchased the Eastern Trucking division of Laidlaw Transportation Limited. Since this time Contrans has grown to become one of Canada’s leading providers of freight transportation services, mainly through acquisitions which it has steadily done over the past 20 years.
What I like best about Contrans is their CEO, Stan G. Dunford, who has been at Contrans since 1988. Not only does he understand the trucking business inside and out, but he is an extremely intelligent and careful manager. This is quite evident by the careful choice in acquisitions and by the lack of debt that the company keeps on its balance sheet (as of 2006 year end LT debt was only two times their Net Income). Also, I’m a big believer that managers should be ranked upon their ability to use the company’s equity to improve the bottom line. In other words I like to turn to the ROE of the company and compare it to the industry as a whole.
For the past four years Contrans has steadily increased its ROE starting with a return of 17% in 2003, 18% in 2004, 22% in 2005 and 26% in the most recent fiscal year of 2006. Meanwhile the overall trucking industry has averaged 17% over the same time period.
Now as I have said earlier I think that an ROE over 12% is great, so not only does this show that Contrans has been doing well, but it seems as though the industry as a whole has followed suit. So if you do decide to take a look at Contrans than you might also want to turn your attention to the rest of the trucking industry or more specifically to their competitor Transforce Income Fund (TIF.UN), which may also be a solid addition to any investor’s portfolio.

Safety Insurance Group (SAFT - Nasdaq)

2007-03-07T15:46:00.000-05:00

Can somebody please explain to me why Safety Insurance Group ("Safety") is trading for only 6 times its earnings and why it has recently hit a 52 week low for a share price of approximately $40. I realize that its fourth quarter earnings of $1.42 per diluted share were a drop from the prior year when they earned $1.69 but a P/E of 6 times for Safety Insurance seems ridiculously low to me.
Of course, Safety could just be one of those companies that will never garner the P/E that it deserves. Unfortunately we can’t use the Gordon Growth Model, as the dividend growth rate is constantly changing, for estimating what their P/E should be, but another good method is to find similar companies (all in the same industry – Property Insurance) and see what they trade at (the Property Insurance industry as a whole is trading at 14 times earnings).
So in order to find a good comparison, I thought it was best to use the following statistics: Market Capitalization, Sales, Profit Margin and Dividend Yield. Then based on these values I assigned a weighting to each company, which I would apply to their P/E (I would have liked to add in 5 year EPS growth, but unfortunately it wasn’t part of any of the stock screeners that I use and it would have taken too much time to do manually).
The first thing I did was to compile a list of the three companies that were the closest to Safety in each of the 4 previous mentioned stats. Once I assembled these sets of companies, I found the average P/E* of each set and assigned a weighting to each category based upon my belief of their relative importance to the P/E ratio. Market Capitalization and Sales each got a 35% weighting while Profit Margin and Dividend Yield got 15% each. Once I tallied the results I came out with the following P/E averages for each category: Market Capitalization – 14.98, Sales – 12.00, Profit Margin – 9.29 and Dividend Yield – 9.34, thus giving us a final weighted average P/E of 12.24.
Now I know that this is not a perfect comparison, but it does make for interesting conversation considering that Safety is currently trading at approximately 6 times its TTM earnings and hasn’t gone over 11.5 over the past four years. Maybe it’s because of the somewhat small market cap of Safety that keeps its P/E down (although as noted earlier similar market cap companies were trading at 15 times earnings), or maybe it’s because of the relatively few institutional funds that have purchased their stock. To tell you the truth it could really be any or no reason at all as to why it trades so low.
However, to continue with our experiment, if we assign the P/E of 12.24 that we calculated to be fair, Safety Insurance Group would currently be trading at a price of $85.56, which is at a premium of 115% over its current price. Even if we went the pessimistic route and took Safety’s most recent quarterly results of $1.42, which was their lowest quarter over the previous 7 quarters, and say that they will only be able to earn that over the next four quarters then we come out with a future price of $69.52, which is still a 75% premium over the current price.
Unfortunately one of the things that you can’t control is the P/E that is assigned to stocks, but I have to say that at its present valuation Safety Insurance Group seems extremely undervalued and it doesn’t look like I’m the only one that thinks so. A lot of the directors and management of Safety Insurance have been increasing their interest in the company over the past couple of months.

Note: If you would like the detailed calculations and list of companies I used for the P/E comparison just send me an e-mail and I’ll happily send it along.

* Based on March 6, 2007 closing price and 2006 full year diluted earnings

Treasure Hunting

2007-03-05T15:29:00.000-05:00

A lot of good companies out there at great prices thanks to the recent “China syndrome” meltdown.
Take a look at Capital Corp of The West (CCOW – NASDAQ), a holding for County Bank which provides commercial banking services, or Center Financial (CLFC – NASDAQ), which focuses on the Korean-American market in California with 17 banking offices and 7 loan offices. Both companies have a good history of revenue and earnings growth as well as an excellent ROA, which is a key indicator for the financial industry.
Or if you’re looking for some Canadian content take a look at a couple of my personal favorites which I’ve written about before, West49 (WXX – TSX) and the North West Company Fund (NWF.UN – TSX). West49 is a great growth prospect as a retailer of young women’s fashion and North West Company is one of my favorite stalwarts that has an unbelievable barrier to entry in that it operates in the remote Northern parts of Canada and Alaska and has been doing so for over 300 years. Two places that are logistical nightmares for companies.

S&P 500 Annual Guide

2007-03-02T18:18:00.000-05:00

I’m a big fan of the S&P 500 annual Stock Guide, which I have now purchased for the past two years. It’s cheap, convenient, reader friendly and highlights most of the major financial and company background that I like to know. All in all I just find that it’s a great tool for the beginning step of uncovering companies that I will want to research in more depth.

One interesting aspect of the guide, which I used to overlook, is the Analyst rating at the top of each company’s page, which ranges from Strong Sell to Strong Buy, with Sell, Hold and Buy in between. Well, I thought it would be interesting to see how well an investor would do by simply following the Analyst’s ratings and buying shares in the company that they list as a Strong Buy. With all of the fees and commissions involved in having a personal broker or the extra loads and commissions associated with investing in Mutual Funds, this might be a great alternative for investors that don’t want to put the time or effort into doing their own research but also want something a bit more exciting than just investing in an index fund. Plus with a retail value of $39.95 for the guide you don’t have to spend much money.

So I went through the 2005 guide, picked out all of their Strong Buy recommendations and did a year over year share price comparison, assumed equal investment in each company and came out with the overall portfolio return. Before I detail the returns however, I should throw in a couple of points that need to be taken into account with this.

Firstly, this is only a one year time horizon, and as every good investor should know, the average life of your investments will change with each and every security that you own.
Secondly, I have not added in dividends paid by the company, as frankly it would have taken much too long. So instead I’ve taken the S&P 500 average yield of 1.7% and upped it to 2.0% (just to be safe), which I’ve added on to the final return. It’s not perfect, but I think for interest’s sake its good enough.

Thirdly, two companies, MBNA Corporation and Scientific-Atlanta Inc. were bought out by another company during the year and thus the closing price is based on what was paid to each shareholder.

Anyway, after compiling the full list of Strong Buy’s, I came out with a portfolio of 54 companies with Energy, Consumer Staples, Information Technology, Consumer Discretionary, Health Care, Industrials, Utilities and Telecommunication Services all being represented. As the guide’s price is based on the closing price of November 4th, 2005 I ended the portfolio one year later on November 6th, 2006 and came out with a total return of 11.47% (including the 2% increase for dividends), compared to a 13.08% overall return for the overall S&P 500.

So what exactly does this prove? Well it does show us that you would have been better off simply buying an index fund that follows the S&P 500 as a whole (plus you would have paid a lot less in commission), but other than that not much. But it does make for interesting conversation.

P.S. If you would like to see the complete list just e-mail me and I'll send it along.

Selective Insurance Group - (SIGI - NASDAQ)

2007-02-21T14:42:00.000-05:00

If you’re looking for a good insurance company to invest in, take a look at Selective Insurance Group, Inc. (SIGI), based out of New Jersey. They deal mostly with commercial insurance (80% of their business) through a network of independent insurance agents and have been quite successful over the last ten years. Recently they did a 2 for 1 stock split, which doesn’t really mean much except that management must think they have been doing quite well as of late. They are also trading at a very low P/E of approximately ten times their trailing twelve months of earnings, compared to their average 13 times.

A couple of negative points are that several key members of management have been selling shares recently and they tend to award too many options to the executives. But other than that they seem to be a solid company with a strong history and good outlook on the future. Of course I’m not an expert in insurance companies so you will want to dig a bit deeper before taking the plunge on this company.

ING Canada - (IIC - TSX)

2007-02-16T17:34:00.000-05:00

ING Canada just released their fourth quarter and full year 2006 results. They ended the year with a 44% drop in fourth quarter net income year over year and a 15.8% drop in full year results from their record year of 2005. The market in turn reacted with a very modest drop in price of only 1.3%. So how does ING respond to this down year? By announcing that they are going to buy back $500 million in shares through a dutch auction process and increase their quarterly dividend from $0.25 a month to $0.27.
Most companies are lucky to have this kind of spare cash flow in a record year, let alone after such a difficult quarter. If this isn’t a sign of a strong company I don’t what is.

Now it’s very difficult, or even impossible, to figure out how many shares this buyback translates into, but simplifying the process and using their current share price gives us roughly 10 million shares, or 7.5% of the current outstanding shares, which in turn means an instant increase in EPS of 7.5%. Couple this with their current dividend yield of approximately 6% (using their closing price of $51.51 on Feb. 16th) and you have an instant return of 13.5%. Not a bad return considering all you have to do is buy the shares before the buyback occurs.

Of course a valid argument would be that their shares should now be valued according to their 2006 or even fourth quarter 2006 results, which were of course quite a bit lower than previous years. So to see just what kind of price you can expect let’s be overly cautious and say that INGs quarterly earnings will not, at least for the next 12 months, go above their fourth quarter results of $0.82 a share. Over a full year this becomes $3.28 and at a reasonable P/E of 15 you end up with a share price of $49.20 or 4.5% lower than their current price. Subtract this 4.5% from the 13.5% that you’ve earned from the share buyback and dividend yield and you come out with a 9% return on a company that is having one of their worst financial years. Now that is a scenario that most investors would jump at.

Nicholas Financial Inc. - (NICK - Nasdaq)

2007-02-05T15:01:00.000-05:00

I found a great company today on the Nasdaq 52 week high/low known as Nicholas Financial Inc. (NICK - Nasdaq). It's an automobile loan company that caters to customers that have a poor credit history and have trouble getting financing at the usual places. It's a competitor of an earlier company that I wrote about, UPFC. It also designs industry specific computer application software for small businesses, but this only accounts for a small percentage of their revenue.

Anyways, it passes all the usual tests with flying colors. It has had at least ten straight years of income growth, has recently been buying back shares, a solid history of positive EPS over the past ten years, has been increasing the amount of loans each year (good sign of growth for a loan company), has been increasing it's profit margin each year and has a spectacular ROA, which as of 2006 was at 7.81%. On top of this it's currently selling at a 52 week low of $10.97, as of Feb. 5th, 2007, giving it a P/E of 9.97, which compared to it's 5 year average of approximately 12.5 gives the stock a built-in 25% reduction in price.

This company is one of those cases where you start to think, "why is it selling for so cheap? Does every other investor know something that I don't?" Yet when I do a search on any news articles for the company I don't find anything negative. In fact I only seem to find good news. I know that currently the automobile market in the United States is in a bit of a trough, but it doesn't show in NICK's financials. It's quite the opposite actually as it is currently posting record earnings. So the only thing that seems to make sense is that this is just another case of a good company having it's shares beaten down for no solid financial reason. Now all I have to do is convince myself of that.

West49 - WXX (TSX)

2006-12-12T14:03:00.000-05:00

As people that have had to listen to my rants about investing know, I love retail or fast food outlets that are successful in one area of the country and have plans to expand to the rest. West49 is the most recent company that I have found that fits this profile.

West49 is a Burlington, Ontario based specialty retailer of clothes, shoes and accessories that focus on snowboarding, skateboarding and surfing. Their target group is teenagers but they have recently opened two stores that focus on the adult male (Duke's Northstore).

West49 originally retailed under their namesake banners West49 and Billabong, but over the past year and a half it has made three significant purchases: 10 Vanouver based women's retailers called Off the Wall; 24 Quebec based banners known as D-Tox and Amnesia/Arsenic; and an on-line retailer at www.boardzone.com. These acquisitions along with 20 store openings in fiscal 2007 have given West49 a solid presence in western and eastern Canada, along with their original stores in Ontario.

I first discovered West49 in the Globe and Mail 52 week high/low about six months ago. At first it didn't really impress me much, since I've never been a big fan of a company that doesn't have a history of positive earnings (I've always had a hard time understanding why people invest in companies that have yet to make money but are full of supposed 'possibilities').

Anyway, I put West49 in the back of my mind and didn't think twice about it until a conversation I had with my sister-in-law Josie, who is a grade school teacher. She was telling me that the kids in her class can't get enough of the West49 brand. She went on to say that they were all making the trip up to Burlington, Ontario from Niagara Falls, Ontario just so they could visit the store. This, of course made me much more curious about the company. I mean if the teenagers at one school were all making an hour drive just to go to its store then there's a good chance that other teenagers were doing the same thing.

So I went back to the drawing board and jotted down a few things that about the company. The first thing that I noticed was the price of the stock. At a price of $.90 it was selling for about 13 times it's past four quarters of earnings, which is a positive considering that the TSX is currently trading at about 17 times earnings. On top of this West49 was about to open 20 new stores and was just beginning to reap the benefits of their earlier acquisitions.

Of course I've never liked having to guess about a companies chances of succeeding in new markets, which is why I always wait a quarter or two after the openings so that I have a better understanding as to whether the expansion will work. The downside to this strategy is the fact that you can miss out on a significant price gain in the stock once the new earnings are released, but on the other hand you can also miss out on a drop in price if the expansion doesn't fair well. Either way, I prefer to wait a bit and ensure that the expansion is going to work before I invest. It wasn't until the most recent quarter end of October 28th, 2006 that I decided West49 was a good solid company with great growth prospects.

During the previous year West49 had expanded from 63 West49 stores, 3 Billabong stores and 11 Off the Wall stores to 69 West49, 6 Billabong, 14 Off The Wall, 18 Amnesia/Arsenic, 16 D-Tox and 2 Duke's Northshore, giving an overall growth of 48 stores. The financial results that came along with this growth in stores were very impressive. Sales were up 49.2% over 3rd quarter 2005 and same store sales growth was 5.8% (a good sign that sales growth wasn't just due to the acquisitions). On top of this West49 posted EPS of $.06, which was a 20% growth over 3rd quarter 2005 EPS of $.05.

Overall I was really impressed with West49's results, especially their Balance Sheet and Cash Flow which showed me that West49 has been paying off their debt and has a good supply of cash to fund it's operations. Also, management's plan to now focus on the existing stores and slow their growth considerably is a good sign that West49 won't become another Krispy Kreme that grows too quickly and doesn't have enough money to keep going.

NOTE: As of March 9th, I became a shareholder of West49 purchasing 1000 shares.

D.R. Horton & Yellow Pages Income Fund

2006-11-22T14:29:00.000-05:00

I just thought I should send out a quick note on two companies that I am presently researching, both of which are in current "turmoil:" D.R. Horton (DHI - NYSE) and the Yellow Pages Income Fund (YLO - TSX).

D.R. Horton Inc. (DHI)

DHI's share price has recently taken a hit due to the slowdown in sales across the entire home building industry. What makes DHI different than most of the other home builders however is their ability to earn consistent revenue and EPS year over year and their strong balance sheet.

Currently, DHI is in their eleventh year of revenue growth (averaging 40.8% per year - 8.6% growth in 2006) and just saw their ten years of straight EPS growth (averaging 36.9% per year) end when their 2006 EPS was 15.6% lower than 2005. For most companies, this kind of growth would warrant a nice high P/E, but because of the slowdown in the industry, the market has dropped DHIs P/E ratio to 6.4, compared to its average P/E of 10 over the past ten years. So basically the market has priced DHI with the expectation that it's earnings will fall to $2.50, which translates into a drop of 36%. Couple this with the fact that DHI's current dividend yield is 2% and you have a 'margin of safety' of 38%. Considering the fact that during 2006, which was considered a bad year for the home building industry, DHI was able to increase revenue 8.6% while seeing a drop of only 15.6% in EPS, I have to say that I like its chances of staying above this margin of safety. Even with this reassurance however, it's still nice to see that the company isn't too heavily in debt and that's why the balance sheet is so important.

As of September 30th, 2006 DHI had $4886.9 million in long term debt, giving it a debt to equity ratio of .75 (compare this to the industry average of 1.0). On top of this, if you take a look at the details of the debt on their most recent quarterly report, you can see that its made up entirely of senior notes (basically a bond with priority over other debt securities) which aren't due until at least 2010, and unlike a loan taken from a financial institution, these debt holders can't decide at anytime to send DHI into bankruptcy if it looks like they aren't going to be able to meet their payments. On top of this, there is a callable feature on the notes that give DHI the right to redeem them at any time prior to maturity at a price equal to the greater of either 100% of the principal amount (i.e. what the debt holder originally paid for the note) or the present value of the remaining scheduled interest payments. So if interest rates drop, which they have been doing, then it will be in DHIs best interest to redeem the notes and issue new ones at a lower interest rate, which they have been doing, saving them money in the amount of interest they have to pay out and still generating cash flow from the new notes to operate their business.

Yellow Pages Income Fund (YLO.UN)

With the recent changes in tax law on income trusts in Canada, a lot of the prior high flying income fund companies have seen a large drop in their share prices, which I detailed in my previous post, and YLO was not an exception. Prior to the announcement, YLO traded at just over $15.00 and one day after the announcement, it dropped to just over $12.00 and a P/E of 18, translating into a drop in share price of 20% (compare this to the average income fund drop of 12%), giving YLO a dividend yield of approximately 12%. So even if the share price doesn't move an inch, you can still expect a 12% return on your investment. What makes YLO such a great investment however, besides the high yield, is its underlying businesses and the strong brand names that go along with them.

YLO owns 96% of the Yellow Pages Group, which in turn owns the Yellow Pages and Trader Media Corporation. The Yellow Pages by themselves, are an amazing asset, but when you add in Trader Media which owns, among other publications, AutoTrader and the Buy & Sell, you have a company that runs several publications with monopolistic qualities.

The yellow pages have been around since 1908 and are the leading Canadian directory publisher (both on-line and in print). Also, since YLO has the exclusive rights to Bell Canada and Telus' directories, along with several other companies, it would be extremely difficult for a legitimate competitor to get started. Thus, if any business wants to advertise via the phone book, they have to go to YLO and since directory advertising tends to have the best return on advertising dollars spent, it's not likely that businesses are going to stop advertising with the yellow pages anytime soon.

Companies such as this are hard to come by, but it does happen more often than you would think. It's very similar to Warren Buffetts love of companies that own the only newspaper in town. With no competition for advertising dollars, the company is free to raise their rates along with inflation and don't have to worry about a slow down in sales since there is no alternative to their paper, much like YLO with their yellow pages.

The second exciting aspect of the Yellow Pages Group is their recent acquisition of Trader Media, which runs dozens of publications that advertise products ranging from used cars to condos and is currently dominating the Ontario market and are looking to do the same in the rest of Canada. This is a very exciting concept since Trader Media can now use Yellow Pages Group's strong balance sheet and existing media base to integrate their businesses together and become more cost efficient. Also, as many of my friends have pointed out, Trader Media has a stranglehold on the used car publication industry in Ontario. With 9000 outlets across the province and an extremely loyal customer group (I know several people that spend half their day on autotrader.ca) it would be extremely difficult for anyone to compete and steal away market share.

So if you're like me and you like owning companies that you can easily understand and have a monopoly like grip on their industry than take a closer look at the Yellow Pages Group, I know I am.

Shopping Might Have Its Advantages

2006-11-16T12:46:00.000-05:00

I'm currently reading a book called "One Up On Wall Street," which is written by one of the greatest investors of anytime, Peter Lynch. Mr. Lynch is one of the few people in this world that is able to make investing very uncomplicated and user friendly and gives a lot of tips that people can begin using immediately.

My personal favorite part of this book is how he describes all of the investments that he has discovered by going shopping with his wife and daughters. As they are off running around the mall spending money, he's looking for ways to make money. He checks out which shops have the longest line-ups and traffic and then goes home and finds out whether any of them are public. If they are then he will of course start his investigaton into whether or not the company is worth investing in.

I know that my own girlfriend has been able to tell me about a lot of great companies before they became household names on Wall Street, or even Bay Street for that matter. One good example is H&M, which she has been talking about for quite some time. Unfortunately I didn't pay it much heed until recently and have missed out on a stock that has spent the better part of the last five years going straight up. Of course this doesn't mean that I still can't get in on this stock and enjoy some success, it just won't be as much as I could have had.

The overall idea of what Mr. Lynch is trying to say though is what is important. It doesn't have to be only at the malls that you can find good investments, but it can be at anytime and any place. You don't have to be a CEO of a company or the Head of Sales to see that a company is doing well. Recently, I have been buying as many shares as I can get my hands on from the company that I work for since I have seen firsthand a large increase in the amount of hirings and I'm in a customer service role.

So keep your eyes and ears open at all time for any new companies that are doing well. And once you find a company that has a growing customer base and is expanding, go home and find out if it's publicly traded, because it might just be the next GAP.

Income Trust Meltdown

2006-11-09T11:41:00.000-05:00

The recent income trust meltdown in Canada was one of the more interesting and exciting events that I have been fortunate enough to witness over my short investing career. When I first heard Jim Flaherty, the Finance Minister, on television announcing that our government was going to change the current tax laws (starting in 2011) on income trusts my mind began to race with the anticipation of a large sell-off over the next couple of days. Of course I wasn't 100% sure as to what this meant for the income trusts. Were they going to switch back to the more formal corporate style public company, were earnings going to be dropping like crazy once the tax laws were enforced and would anyone invest in income funds again.

After I took a few moments to collect myself and think about the situation rationally and ignore the fact that I personally had 25% of my investments in trusts, I was able to come out with some reasonable answers to these three questions. Firstly, if companies decided to revert back to the corporate form it would, in the long run, be a good move for a lot of the stronger growth oriented companies. When a company is an income trust, it has to pay out most of it's earnings in the form of dividends to it's shareholders. This in turn cuts down on the taxes paid by the company but means less money for it to grow via either acquisitions or enhancement of it's current sales or capital operations. So somewhere out there are companies that have the potential to grow their operations substantially but have been hindered in the past by lack of available funds due to the large dividend payments. The key is to find which companies fit this profile.

As for the second question of how this will affect earnings I realized that it was a pretty straightforward calculation. Once the new tax laws come into effect in four years, the dividends that were being paid out will now be taxed. So, for example, if a company made $2 million in earnings and paid out $1 million, it's taxes would increase by $333,333 (assuming a 33% tax rate), thus decreasing earnings to $1.67 million. Of course many income trust investors were more worried about the dividend yield that the company has, but this isn't what they should be thinking about. The high yields of income trusts are no longer a reality with the new tax laws and the individual investor has to realize that the potential growth of the company and the subsequent growth in dividends (if the company decides to either stay an income trust or to keep paying dividends) is the new measuring stick. In other words they should be valued with the same methods used to value dividend paying corporations.

Finally, to answer the question of whether anyone will invest in income trusts anymore, I was only able to come up with one definite answer: "I have no idea." In fact I don't think anyone knows. If you take the reaction the day after the announcement where the Toronto Stock Exchange (TSX) lost approximately 3% and the income trust sector lost 12%, the you would think that income trusts are a dying breed that no one will ever touch again. However if you had waited a few days and waited until cooler heads had prevailed you would have noticed that the TSX had already began to make back some of the ground it had lost. In particular some of the stronger companies that I had found, such as NWF.UN, CSS.UN and LIQ.UN had already made back of most of what they had lost. So once again people's emotions had taken the better of them and a lot of people had overreacted and sold their shares as soon as they could. To me it seems strange to sell your shares when the prices are going down and buy when they go up, but if it wasn't for this reasoning then I wouldn't have been able to find the bargains that I did. There were several companies that were selling for a ridiculously low price. Contras Income Fund (CSS.UN - TSX) went down to about 9.5 X the trailing twelve months of it's earnings, even though they had four straight years of sales and income growth, 40% growth in income over the past thre years, an ROE of 21% and almost no short-term debt.

To finish off all I can say to the individual investor is to not panic and use some common sense when valuing the trusts. Look for companies that have been well managed, have a solid history of earnings, have a strong balance sheet with little or no debt and a good amount of cash and an underlying product or service that they understand. If the investor can do this and they stop worrying about the current drop in prices and only the companies financials, they will find that the price will eventually reflect the true value of the underlying company and their patience and rational thinking will be rewarded.

North West Company Income Fund - (NWF.UN TSX)

2006-10-11T09:08:00.000-05:00

An Income Fund With Growth

Snapshot

The North West Company Fund (NWF.UN - TSX) is an open-ended Mutual Fund based out of Winnipeg, Manitoba that invests solely in it's wholly owned subsidiary The North West Company (NWC). Basically what this means is that the mutual fund is a way for NWC to distribute it's earnings to shareholders via a monthly dividend. So the real question is what does NWC do to earn this money that it pays out to its shareholders?
NWC operates retail outlets and food distribution centers in rural communities and urban neighborhoods across Northern Canada and Alaska and has operated in these communities, through predeccesors, for more than 300 years. NWC has found a niche in that it mainly services remote Northern locations and Aboriginal communities that many large retail stores have ignored due to the inherent logistic problems. NWC has several different store banners in which they operate, including their flagship Northern Store, which as of year end 2005 operated 131 stores in remote Northern communities. Along with this banner NWC has 12 Quickstop convenience stores , 18 Giant Tiger discount family stores operating under a master franchise agreement and 5 NorthMart stores that target larger Northern regional markets. Along with these banners are two separate food distributors, one in Alaska (Frontier Expeditors) and one in Canada (Crescent Multi-Foods), 3 North West Company Native handicraft stores, Canada's largest Inuit art distributor (Inuit Art Marketing Service), a catalogue (Selections) that reaches over 250,000 in Northern Canada and 27 AC Value Center stores that operate throughout Alaska.

Sales & Earnings

One of the first things that I look for in a company is evidence of a steady increase in both sales and earnings over the past several years. This is a good indicator of the proficiency of management to create ways to expand the business. It also reflects whether the underlying product or service has a solid customer base.
For NWC there has been a consistent increase in both sales and earnings for the past 7 years, and 2005 sales were at a 21% increase over 2001. This is strong evidence that NWC is one of the few large retail businesses that remains unaffected by the growth of retail giant Wal-Mart.
Profit margin, which is earnings divided by sales, is another great way for investors to gauge management's performance. For NWC, the profit margin has increased each of the last five years from 4.1% in 2001 to 5.1% 2005, which indicates that management has been looking for ways to cut costs and become more efficient even when sales are increasing. More often than not, in many public companies, management is only concerned with cutting costs when things are turning sour and will spend more recklessly when sales are good. NWC on the otherhand has been increasing both profit and gross margin ((sales - cost of goods sold)/sales), which is an excellent sign.
For retail stores one of the most important indicators of prosperity is same store sales growth which tracks the yearly growth of stores that have been operating for more than one year. This ratio is important as many companies have difficulty keeping the sales in existing stores growing, while new store openings tend to make up the majority of sales growth, which can distort the true picture. In contrast, NWC had same store sales of 5.4% in 2005, placing this company near the top of the retail industry.

Dividends

When researching an Income Fund, the dividend payment is a key point of interest. NWC's last four quarters of dividend payments equalled $.72 per unit (changed to reflect a 3:1 stock split), which divided by the share price of $17.86 (as of October 24th, 2006) gives a dividend yield of 4.0%, which isn't bad considering that it's trading close to it's 52 week high of $18.10.
It is also worth noting that management has been increasing the dividend over the past several quarters and is set to continue if earnings keep rising. Combine this statistic with the fact that NWC's earnings have been growing at an average rate of 8% over the past five years and you have a stock that is paying a 4% dividend and is growing at an extremely healthy rate.

Cash Flow & Balance Sheet

There is nothing more harmful to a company than carrying a large amount of debt on it's books. Not only does this limit management's options as to how it can spend its earnings, but if there is a drop in sales or an increase in expenses (which inevitably will happen to any business or industry), a company with a large amount of debt will have much more difficulty surviving. To illustrate with an example, let us consider a lawyer who is just starting out in his career. We'll call him Joe Law and say that he earns $60,000 a year, has $40,000 a year in expenses and a large amount of school debt. Now say that the law business starts to slow down and Joe finds himself out of work. If Joe is lucky and he still has his $20,000 in profit from the previous year, then he might be able to scrape by for half a year. If Joe is able to cut down his expenses then he'll be able to go even longer. However there will be a point where Joe will no longer be able to meet the minimum payments on his debt. This is when the bank comes calling and Joe may find himself in the unattractive position of delcaring bankruptcy. Meanwhile, another entry level lawyer in the same position but with no debt should be able to weather the downturn in business and will have a much better chance of coming out of the slowdown with his credit rating intact. Of course this example is a very basic one, but it serves the purpose of illustrating my point that a company deep in debt is one to be avoided.
In NWC's case, it currently has total debt of approximately $111,000,000, which are only 2.6 times their 2005 earnings. So even if NWC doesn't see any increase in earnings over the next three years, they will still be able to pay off all of their debt and have some left over cash to spare. This ratio makes me much more at ease for NWC's chances of surviving any downturns in their industry. Also, if the saying that only the strong survive is true than NWC should be well positioned to not only survive a downturn in the industry but come out of it in a much stronger position with less competition.
As for the more immediate future of paying the expenses to keep the business afloat, NWC currently has around $21,000,000 in cash, which by itself covers the current portion (due in less than one year) of the long term debt. Also, with a current ratio (current assets/current liabilities) of 1.94 and a cash ratio (cash & cash equivalents/current liabilities) of .18, they shouldn't have any problem covering their short-term expenses.

Management

When you're looking at investing in a company, there is nothing more important than management. Even the best management can't save a sinking ship and the worst management can destroy even the strongest business. However, gauging management's efforts and results isn't as easy as you would think. One of the best indicators that I have found is to look at the return on equity (ROE) of the company. The ROE is the net income divided by the company's equity, or net worth (assets minus liabilities). So basically it tells you how much the company has been able to make in earnings with everything they have at their disposal. NWC's 2005 ROE was 18% and has increased for each of the past five years when it was 14.9% in 2001. Compare this to the fact that the average for all public companies is 12%.
Another good gauge for management's performance is to take a look at how they spend the profit of the company at the end of each quarter. Generally management will have a few choices to choose from including: paying down debt, growing their business either through acquisitions or expansion, paying a dividend or repurchasing shares. It's an extremely important decision to make and it could potentially make or break a company in the long run. Over the past few years NWC has of course been paying out a large percentage in the form of dividends, as it is an income fund, but it has also been paying off a large portion of its debt. This in turn has decreased the interest expense that the company incurs each year which has helped to increase the earnings and strengthen their balance sheet, all of which are good for the shareholder. One thing that I would like to see in the future is for management to start a share repurchase program, which as I stated in my first post, is an excellent way to increase each shareholders piece of the pie, without asking for anything in return.

Looking Ahead

Now that we've taken a look at the past, it's time to see what we can look forward to in the future of NWC. For 2006 one of management's key strategies was continued expansion of the Giant Tiger banner. With 16 stores at the end of 2005, their plan was to have 20 by the end of 2006. As of July they were right on track with two store openings, one in Calgary, Alberta and another in Medicine Hat, Alberta. These openings are especially significant since Giant Tiger has been one of NWC's best performers over the past few years. Also on the table is to grow their Alaskan operations, in particular their Frontier Expeditors warehousing operation, which is only one of two food distributors in Alaska with a local warehouse facility. This becomes even more interesting when you consider that Alaska has been growing at an average growth of 1.2% over the past five years, compared to 1.0% for the entire USA. Along the same lines, it's nice to see that Northern Canada has been growing at a healthy rate with the Yukon leading the pack with a 3.5% increase in population in 2005.

Conclusion

NWC is the type of company that I love to own. It has a long operating history (over 300 years through it's predecessors), strong growth in both sales and earnings, a return on equity that has increased each of the past five years, a niche market that many companies would find difficult to penetrate and very little debt compared to earnings. Yet, this doesn't always translate into a sure buy, you always have to ask yourself, "does the price at which it's currently selling make sense, or is it overvalued?"
As of October 24th, 2006 NWC was selling for $17.86, which puts it at 18 times the last 12 months of reported earnings. Compare this to the overall Toronto Stock Exchange average of approximately 15 times earnings and you can see that it is selling above what the average company is going for, relative to earnings. Generally, I like to purchase companies that I see as being undervalued (who doesn't love a good bargain) so that there is a "margin of safety" as Benjamin Graham likes to say, but every now and then I make an exception to this rule and NWC is one of those exceptions. They are one of those rare Income Funds that have been able to grow both their dividend AND earnings, neither of which is an easy task. So if you're looking for some current income, but don't want to sacrifice future growth potential than NWC could be just the thing you're looking for.

United PanAm Financial (UPFC - Nasdaq)

2006-09-27T15:15:00.000-05:00

United PanAm Financial (UPFC) is a listed stock on NASDAQ that provides financing (through subsidiaries) for automobiles and insurance premiums for individuals that have poor credit and have difficulty securing financing elsewere as a result. It operates through a national network of branches that are conveniently located near automobolie dealers and purchases automobile contracts using a warehouse line of credit or periodic securitizations that generally last for about six months. This means that UPFC must maintain an excellent credit rating in order to secure cash to fund their operations.
UPFC originally came to my attention when I noticed it on the Nasdaq 52 week high/low a couple of weeks ago. I took a quick look at their earnings, as I do for all companies on this list, and noticed that they had four consecutive years of steady Revenue and Net Income growth, a great reason to dig a bit deeper.
My next stop was to the valuation ratios, in particular the Price to Earnings ratio, which showed that you could currently buy UPFC for only 10 X the most recent 12 months of earnings. Not a bad ratio at all. Of course this makes me wonder why it's selling at such a low ratio. Perhaps there was a poor management decision that was brought to the public's attention or maybe a forecast of doom and gloom for one reason or another. In order to find out for sure I always look to Morningstar and search in their news section for the company. When I took a look at UPFC the only relevant was a positive synapses of their second quarter operations.
The next stop for me is always to the most recent Quarterly Statement and Annual Report, both of which can be found on the SEC website or the company's own webpage. Personally I prefer going to the company's website and seeing how much time and effort they put into the look of their site. I prefer an extremely plain and uncomplicated website along with an annual report that looks like it was done on a black and white typewriter. I find that the less time a company puts into making their website and reports look glamorous, generally means the company is more worried about keeping costs down and focusing more on the numbers than the colors that go into their site. UPFC is the best example that I have found to date of a company that doesn't waste time or money on their site.
The first thing I noticed in the Annual Report was that UPFC serves a niche that banks and financers shy away from: the individual car buyer with bad credit (Avg. yield on each loan is 28.5%). Of course there is a good reason why most financial institutions stay away from these individuals as they don't want to be burdened with a high volume of loans that they will be forced to write off. In order to keep its loan losses down, UPFC bases most of their branch manager's bonuses on the amount of bad loans that they incur. Also, since all of their branch managers have at least 12 years experience in the auto finance industry, mostly with large finance companies (e.g. GMAC, Toyota, Ford & Chrylser Credit), they are more likely to possess the experience necessary to spot a good or bad loan application. On average UPFC approves 1 in 9 loan applications and have seen their net loan write offs as a % of their average net loans go from 5.67% in 2003 to 5.24% in 2004 and 4.51% in 2005.
The next thing I noticed was that UPFC had recently approved a 500,000 share repurchase program, representing approximately 3% of all its outstanding shares. Share repurchase programs are one of the easiest ways for management to reward their shareholders. Basically it gives each shareholder a larger piece of the pie without them having to invest more money. Of course, if you don't believe me about the virtues of share repurchases, you might want to read Robert G. Hagstroms' excellent book, The Warren Buffett Way, which first turned me onto this simple, yet extremely effective program.
Share repurchases are also an indicator that the company believes the stock to be trading at a low to what it perceives to be it's true value. I also took note of the fact that upper management had been buying shares for themselves in August. It's always nice to know that management has a monetary interest in the company.
Another great indicator of solid business performance is the ROE, which will show you whether management has been able to grow the company at a reasonable rate year after year. UPFC had been averaging approximately 17% over the previous three years as compared to an average of 12% for companies in the NYSE.
Of course as I've read many times, if a company's future performance is based solely on its past than librarians and historians would dominate the Forbes 400. So what I started to look for was what they were doing to increase future earnings. I'm not really interested in a company that is content bringing in the exact same earnings year after year. When it comes to your holdings you should always ask 'what have you done for me lately.'
To answer this question, I went straight to the 'Business Strategy' section of their Annual Report. In it UPFC details its plans to pursue a controlled year over year growth strategy. At the end of 2005, UPFC operated in 31 states, leaving 19 states untapped. In 2005 it opened 20 new branches, bringing the total to 110 with plans on opening 24 each year starting in 2006. As of June 30th it was right on track in meeting this target.
After taking a closer look at their sales by branch, it becomes evident that their branches hit the peak of their profitability in the third or fourth year of existence. Currently, less than half of UPFC's branches have been open under theree years. This represents a great possibility for an increase in Net Income over the next couple of years.
Of course no company is all good news and slaps on the back and UPFC has some information on page 28 of their 2005 Annual Report that are a cause for concern. It states that due to an error in the company's accounting software and a mistake in the accounting of interest income, management decided to restate the Dec. 31st statements for 2001, 2002 & 2003. Although this did not have a large impact on the statements, it could indicate that further problems may arise with future statements and since UPFC is so dependent on funding from outside financial institutions it could potentially mean an increase in the interest that it would have to pay, which would significantly cut into profits.
Even with this negative aspect however, I still feel that UPFC is a solid growth company that is currently undervalued. It has had good growth in both Revenue and EPS, has seen it's net loan charge offs drop over the past few years and still has a large part of the country to grow into. Of course don't just rely on my research, do a bit of your own and see if you come out with the same conclusion.