Entries categorized as ‘Value Investing’

The Best Company in America

January 5, 2010 · 5 Comments

We typically post investment ideas that we like enough to add to our portfolio. However, we have not been able to find a lot of bargains out there lately, so we’ll start posting ideas that are close to meeting our requirements.

A Valuehuntr near miss is Church & Dwight Co. Inc. (CHD). CHD is one of those boring companies we would love to own. It also happens to be the largest producer of sodium bicarbonate (baking soda) in the world, and likely one of the best run companies in America.  The company was founded in 1846, and (as Coca Cola) it still uses the original company formula today.

The company develops, manufactures, and markets a range of household, personal care, and specialty products under various brand names in the United States and internationally.  Its top brands include ARM & HAMMER, TROJAN, and OXICLEAN.  The company meets a lot of the characteristics we look for when searching for good businesses, such as wide barriers to entry and great management, but the stock seems overvalued, which is the reason why it has not been added to the Valuehuntr Portfolio. Although CHD is not being added to our portfolio, we will like to highlight the company anyway.

THE BUSINESS

The company operates in three segments: Consumer Domestic, Consumer International, and Specialty Products.

The Consumer Domestic segment offers household products for deodorizing, such as ARM & HAMMER baking soda, cat litter products, laundry/cleaning products, and consumer care products such as TROJAN condoms and ARM & HAMMER deodorants and toothpaste.  The Consumer International segment sells the personal care products highlighted above in international markets, including France, the United Kingdom, Canada, Mexico, Australia, Brazil, and China. Finally, the Specialty Products segment produces sodium bicarbonate, which it sells together with other specialty inorganic chemicals for a range of industrial, institutional, medical, and food applications. This segment also sells a range of animal nutrition and specialty cleaning products. Operating data for FY 2004-2008 is shown below.

 

THE PRODUCT

The core product of the company has historically been baking soda, which is used in products within every business segment. The main advantage of baking soda is in its versatility of use. For instance, it is estimated that 95% of US households have a product containing baking soda at their home. Baking soda is not only used for cooking, but it is also an active ingredient in tooth paste, laundry detergents, pool cleaners, fire extinguishers, chemotherapy machines, deodorants, among many others.

(For more information about the versatility of baking soda, we recommend reading: “75 Extraordinary uses of Baking Soda”)

RECENT HIGHLIGHTS

  • Market share gains:  Throughout the financial crisis, CHD has been the only company in the home and personal care products sector that has seen its weighted average market share increase, according to ACNielsen.
  • Better manufacturing: new $170m plant is slated to open in York, PA, by the start of 2009 Q4, replacing an older factory in Brunswick, NJ. It’s expected to be at least 25% more efficient than the old location.

BARRIERS TO ENTRY

  • Manufacturing Advantage: The baking soda manufactured by CHD is more than 99% pure, which requires proper materials, equipment, and personnel training.
  • Government Regulation: baking soda must meet the requirements specified by the FDA as a substance that is Generally Recognized as Safe (GRAS). Distribution of baking soda is prohibited unless the product meets the GRAS specifications.
  • Supply Advantage:  soda ash deposits at the Green River Basin are large enough to meet the entire world’s needs for baking soda for thousands of years.
  • Cost Efficient: mining operation in the Green River is less expensive for production of soda ash than the synthetic soda ash process that predominates in the rest of the world.

QUICK VALUATION

We could use DCF to come up with company value estimates for the next few years to perpetuity. Instead, we’ll make our lives simpler by assuming the company will be able to generate earnings equal to at least its 3-year average EPS. The two quick calculations we show are the value of CHD with no growth, and its value with growth assuming terminal growth roughly equal to historical U.S. GDP.

PV = (Avg. 3-Yr EPS)/WACC = $35/share

EPV= (Avg. 3-Yr EPS)(1+G)/(WACC-G) = $63/share

(Assuming WACC~7%, G=3%)

Currently trading at $61/share, these quick calculations show the company may be currently trading at the top of its valuation range. Additionally, the stock price implies a 5.3% earnings yield, which is only slightly higher than the 4.6% 30-Year T-bill. Based on this price, there are likely other opportunities where investors could get a better return for their money. This is mainly the reason why CHD has not been added to our portfolio.

INVESTMENT RISKS

In our view, there are two things every potential investor should take a closer look at before investing in CHD.

1)     Cost of Raw Materials: the cost of soda ash, surfactants, diesel fuel, corrugated paper, liner board and oil-based raw and packaging materials used in the household and specialty products businesses  are not hedged (only diesel fuel costs for transportation are).

2)      Off-Balance Sheet Liabilities: Pension Plan was underfunded by USD -14mm in 2008 based on a discount rate of 6.58%. Company’s Post Retirement Benefits Plan was also underfunded by USD -22mm (We were not able to find 2009 numbers).

MANAGEMENT & EXECUTIVE COMPENSATION

CHD has one of the best independent boards in America. This is evident in the governance policies the company has developed over the years for executive compensation.  Over the years, the rewards given to company executives have been highly correlated with the stock price, as shown below.

 

SUMMARY

Church & Dwight operates and manages some of the most trusted brands in the world. Although the company is not trading at a bargain price, the earnings generated from its assets are protected by wide competitive advantages expected to continue in the future. The level of usage and versatility that CHD baking soda enjoys is hard to replicate, but because the stock is a bit too pricy we are not adding CHD to our portfolio.

 

Categories: Analysis · Investing · Value Investing
Tagged: america, arm & hammer, barriers to entry, best company, CHD, church & dwight, compensation, competitive advantage, moat, obama, sarah palin, Value Investing

ValueHuntr Reader Feedback

January 3, 2010 · Leave a Comment

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We are in the process of improving the blog to meet the needs of our readers. To that end, we are asking readers to fill out a short 5-question survey.  Please click the button below to proceed to the survey.

Categories: Value Investing
Tagged: blog, readers, survey, ValueHuntr

Value Focus Issue #8 Published

January 2, 2010 · Leave a Comment

The January 2010 issue of our monthly Value Focus newsletter has been released to premium members. To receive the issue, see HERE.

Categories: Value Investing
Tagged: Ben Graham, newsletter, publication, released, value focus, Warren Buffett

Why Value Investing Works So Well – A Presentation by Tweedy Browne

December 29, 2009 · Leave a Comment

Categories: Value Investing
Tagged: irrationality, ODIN, tweedy browne, Value Investing, wycoff

Fed Debates New Role: Bubble Fighter

December 2, 2009 · Leave a Comment

By Jon Hinselrath (WSJ)

Not so long ago, Federal Reserve officials were confident they knew what to do when they saw bubbles building in prices of stocks, houses or other assets: Nothing.

Now, as Fed Chairman Ben Bernanke faces a confirmation hearing Thursday on a second four-year term, he and others at the central bank are rethinking the hands-off approach they’ve followed over the past decade. On the heels of a burst housing-and-credit bubble, Mr. Bernanke now calls financial booms “perhaps the most difficult problem for monetary policy this decade.”

With Asian property prices soaring and gold prices busting records almost daily, the debate comes at a critical time. Mr. Bernanke wants to use his powers as a bank regulator to stamp out bubbles, but the Senate Banking Committee, which will grill him later this week, is considering stripping the Fed of its regulatory power.

At the same time, pending legislation in the House could leave Mr. Bernanke running a less independent institution. The House Financial Services Committee has passed a measure that would subject the Fed’s interest-rate decisions to scrutiny by the Government Accountability Office, an investigative arm of Congress. Mr. Bernanke and others at the Fed fear that with Congress looking over their shoulders, any decision they make about interest rates would be subjected to the winds of politics — making it harder to control inflation or financial bubbles.

Any changes would be months off at best, and the Fed might be successful in fending them off. In the meantime, officials are moving ahead to come up with plans to avoid another crisis.

Fed officials used to think there was little they could or should do to prevent bubbles from inflating. For one thing, identifying bubbles with any certainty was deemed to be too difficult. And even if they could be accurately pinpointed, pricking them might do more harm than good. Raising interest rates to stop a bubble, for instance, could slow growth in other parts of the economy that were otherwise healthy.

The Fed’s main strategy instead was to mop up after a bubble burst with lower interest rates to cushion the blow to the economy and restart growth. That strategy was a key conclusion of Mr. Bernanke’s writings on the subject of bubbles when he was a Princeton professor, and again when he first came to the Fed as a governor in 2002. It was an approach embraced by his predecessor Alan Greenspan.

Now, Fed officials admit the stance didn’t work. They’re groping for alternatives. Of the two methods to prevent bubbles — using regulations to protect the financial system from excess and changing monetary policy by raising interest rates — Mr. Bernanke falls on the side of greater regulation, an idea he has advocated in the past.

“The best approach here if at all possible is to use supervisory and regulatory methods to restrain undue risk-taking and to make sure the system is resilient in case an asset price bubble bursts in the future,” Mr. Bernanke said in answer to a question after a speech in New York last month.

Playing the interest-rate card, in contrast, is considered by many to be a more aggressive and risky move. On Tuesday, Philadelphia Fed President Charles Plosser said interest rates were “a very blunt instrument” to thwart a possible bubble. He said raising rates could “affect all other asset prices at the same time.”

But some on the Fed’s research staff are pushing senior officials to include interest rates in their plans — and some officials say they can no longer rule that out. Kevin Warsh, a Fed governor who spent seven years on Wall Street before moving to Washington in 2002, says he’s keeping close track of commodities prices, the dollar and movements in credit markets. The Fed, he says, has to be open-minded in its search for solutions to bubbles, including whether interest rates should be used to squash them.

With unemployment high and conventional measures of inflation low, the Fed’s top priority is to get the economy moving again. The Fed has said that means leaving interest rates low for at least several more months.

Yet the question of whether and how to tackle bubbles before they burst is becoming a growing concern amid fears of new bubbles developing in commodities markets and in emerging economies. Gold prices are up more than 50% in a year’s time. China’s Shanghai Composite stock index is up more than 75% this year. Stocks in Brazil are up even more. Oil prices have rebounded. They remain far below last year’s peaks but a return to those highs could fuel inflation in goods and services more directly than tech stocks or housing did.

“This is a very dangerous period,” says Frederic Mishkin, a Columbia University economist and former Fed governor. If a new bubble threatens to emerge and the Fed decides to fight it more aggressively, he says, it could damage an already weak economy. “You don’t want to be fighting the last war,” he says.

The debate extends far beyond the Fed. Researchers at the Bank for International Settlements, a Basel, Switzerland-based group that coordinates central-bank activities around the world, are pushing to address bubbles more aggressively. On a recent trip to Asia, the Fed’s Mr. Warsh and San Francisco Fed President Janet Yellen got an earful from finance officials in China and Hong Kong, who worry that low U.S. interest rates are prompting investors to borrow in the U.S. and drive up asset prices in Asia.

The issue of rising asset prices — and what, if anything, to do about them — surfaced last month at the Fed’s November meeting on the economy. Minutes released last week show officials worried about “the possibility that some negative side effects might result from the maintenance of very low short-term interest rates for an extended period.” One worry was “excessive risk-taking in financial markets.”

Mr. Bernanke helped to launch his central-banking career while a Princeton University professor in 1999 with a paper he presented to Fed officials at their annual Jackson Hole, Wyo., conclave, in which he warned against trying to prick bubbles. Mr. Bernanke and his co-author, Mark Gertler, a New York University economist, argued that the Fed should focus on controlling inflation, not trying to manage the cycle of booms and busts.

Mr. Greenspan agreed, and let the tech-stock bubble run its course. The strategy looked like a winner. The 2001 recession was mild; the unemployment rate never exceeded 6.3%. Gross domestic product, the value of the nation’s output, declined just 0.3% from its peak in the fourth quarter of 2000. As late as 2006, Fed officials were congratulating themselves and being applauded by many economists for the deft handling of that episode.

One of the few doubters was William Dudley, then chief economist at Goldman Sachs and now president of the New York Fed. He is one of the Fed’s more outspoken proponents of preventing bubbles, and has said it’s not as hard to spot them as many economists believe. “I can identify at least five bubbles that one could reasonably have identified in real time,” including the tech boom, Mr. Dudley said in 2006 speech. He knew, he said, because he had speculated against three of them himself when he was at Goldman.

Fed officials are now debating the differences between bubbles as a way to understand them better and come up with the right solutions. Two economists influencing the debate are Tobias Adrian, a New York Fed researcher, and Hyun Shin, a Princeton professor. Their work shows that the credit bust was preceded by an explosion of short-term borrowing by U.S. securities dealers such as Lehman Brothers and Bear Stearns.

For instance, borrowing in the so-called repo market, where Wall Street firms put up securities as collateral for short-term loans, more than tripled to $1.6 trillion in 2008 from $500 billion in 2002. As the value of the securities rose, so did the value of the collateral and the firms’ own net worth. That spurred firms to borrow even more in a self-feeding loop. When the value of the securities started to fall, the loop went into reverse and the economy tanked.

The lesson: The most dangerous part of a bubble may not be the rise in asset prices, but the level of debt that builds up at financial institutions in the process, fueling even higher prices. That means keeping these debt levels down might be one way to prevent busts.

The New York Fed’s Mr. Dudley and others want to stop these kinds of borrowing spirals. The New York Fed, for example, is looking to increase its oversight of the repo market. It’s considering whether to toughen collateral requirements on these loans so it’s not as easy for firms to ramp up their borrowing in a boom.

Daniel Tarullo, the newest Fed governor, is organizing a new Washington-based swat team of analysts, supervisors, lawyers and accountants whom Fed officials dub the “quantitative surveillance” group. They are to troll through data on big financial firms looking for risks lurking in the system that officials will try to stamp out.

Bank regulators in the U.S., Europe and elsewhere are also considering rules that would require banks to have bigger capital cushions to discourage them from expanding too aggressively.

Mr. Adrian and Mr. Shin find low rates feed dangerous credit booms, and thus need to be a factor in Fed interest-rate calculations. Small additional increases in rates in 2005, they say, might have tamed the last bubble. “Interest-rate policy is affecting funding conditions of financial institutions and their ability to take on leverage,” says Mr. Adrian. That, in turn, “has real effects on the economy.”

His co-author, Mr. Shin, says “clumsy financial regulations” aren’t enough to stop boom-bust cycles. “This would be like trying to erect a barrier against the incoming tide using wooden planks with big holes,” he says. Using interest rates is the “most effective instrument” for regulating risk-taking by firms, he says in a new paper.

No one at the Fed has yet come out in favor of raising interest rates to stop the next bubble, but the idea is being discussed more seriously among Fed officials. Mr. Bernanke has been following Mr. Adrian’s work closely.

One problem is that economists don’t have models that prescribe how much interest rates should go up when asset prices or financial leverage run to excess, though several leading researchers, including Mr. Shin and Mr. Adrian, are starting to work in this area.

Donald Kohn, the Fed’s vice chairman, was one of the strongest proponents of the old don’t-pop-bubbles view. Today, he says, he has much less conviction about that strategy. Still, he worries that using higher interest rates to tame an asset boom would be like using a sledgehammer to drive a tack — it might stamp out the boom but it would do a lot of peripheral damage in the process.

“You raise interest rates [to fight a bubble] and you damp all kinds of capital spending and consumer durable spending,” said Mr. Kohn in an interview.

Mr. Bernanke is leaving himself hedged. If he felt stamping out a bubble with higher rates would forestall a rise in inflation or stabilize the economy, “We’d have to think about that very seriously,” he told the New York Economic Club recently. “We can never say never.”

Categories: Value Investing
Tagged: bubbles, federal reserve, Investing

Valuefocus (Issue 7) to be Released Tuesday

November 30, 2009 · Leave a Comment

The latest issue of Valuefocus, our monthly Value Investing Newsletter will be sent to Premium Members on Tuesday December 1st. To become a premium member, visit HERE.

 

Categories: News · Value Investing

VIC Submission: La Jolla Pharmaceutical (LJPC)

November 9, 2009 · 1 Comment

Submitted: October 5, 2009

Accepted: November 1, 2009

OVERVIEW

I have encountered a great shorting opportunity within the nanocap universe with La Jolla Pharmaceutical (LJPC). LJPC is a biopharmaceutical company that engages in the discovery and development of orally-active small molecules for the treatment of autoimmune diseases, and acute and chronic inflammatory disorders. Because the company is currently trading at 5X net cash value ($0.22/share) and it is in the process of liquidating, this is a great shorting opportunity.

TIMELINE

In February 2009, the company was informed by an Independent Monitoring Board for the monitoring board that continuing the study of the Riquent drug was futile. LJPC had previously devoted substantially all of its research, development and clinical efforts and financial resources toward the development of Riquent.

In July 2009, LJPC announced that, in light of other alternatives, a wind down of the business would be in the best interests of stockholders.

VALUATION ESTIMATES

The Company has no other drugs in the pipeline, and has scheduled a stockholders meeting for october 31, 2009. The board expects the shareholders will approve the liquidation of the business at the stated date. Below is an estimate of the liquidation value of the company, not including the expenses to be incurred in the process of liquidation.

Cash and cash equivalents                              $8,509 (as of June 2009)
Total Liabilities                                                    $3,836
Off-Balance Sheet Obligations                        $0
———————————————————————-
Net Cash Value                                                     $4,673

Est. Additional Operational Expenses       $2,096 (through October 2009)
Adj. Net Cash Value                                           $2577

Adj. Net Cash Value per Share                      $0.04

I estimate the company’s liquidating value to be at $0.04/share at best, compared to the company’s market value of $0.20/share. Because expenses will have to be incurred to liquidate the business, we expect the actual cash distribution to shareholders to be below the estimated $0.04/share.

In a DEF14 form filed with the SEC on October 1, 2009 the company provided its estimates of stockholder distributions. The company’s management estimated that distributions will range from $0.028/share to $0.045/share, significantly below the current market value of $0.20/share.

LIKELIHOOD OF LIQUIDATION

Several reasons why I believe the company’s liquidation is certain:

- For over 6 months, LJPC explored strategic alternatives, including undertaking efforts to identify a merger, reverse merger, stock or asset sale, strategic partnership or other business combination transaction that would have a reasonable likelihood of providing greater value to our stockholders than they would receive in a liquidation, which did not result in the identification of any likely transaction.

- The board believes that there is a low probability that LJPC would be presented with, or otherwise identify, within a reasonable period of time under current circumstances, any viable opportunities to engage in an attractive alternative business combination or other strategic transaction that would provide enhanced value to stockholders.

- LJPC has only three full-time employees remaining, two of which make up the management team consisting of a President and Chief Executive Officer and a Vice President of Finance and Secretary.

RISKS

The biggest risk is the possibility of a merger or buyout above the current market value. This is unlikely, as the company has no patents nor other intellectual property that would encourage potential buyers to pay a value above LJPC’s net cash. The 5X premium to net cash value in unwarranted, as the likelihood of liquidation is high. This presents a great shorting opportunity for investors.


CATALYST

In July 2009, LJPC announced that, in light of other alternatives, a wind down of the business would be in the best interests of stockholders.

 PERFORMANCE AFTER SUBMISSION

Untitled

Categories: Analysis · Liquidation · Value Investing
Tagged: La Jolla Pharmaceutical, LJPC, nanocap, short, value investors club, VIC

ValueHuntr accepted to Value Investors Club (VIC)

November 6, 2009 · 1 Comment

We have just been accepted into the Value Investors Club (VIC),  an exclusive community of about 200 value-oriented investors.

Anyone can get guest access with a 45-day read-only delay, but only members get to exchange views in real-time, both in the form of idea write-ups and message board discussion. 

The outperformance of stocks recommended by members have made memberships a coveted commodity, and acceptance rate is extremely low. We are proud of the recognition and we look forward to contribute to both VIC and Valuehuntr Blog in the future.

Categories: News · Value Investing
Tagged: joel greenblatt, value investors club, ValueHuntr, VIC

David Einhorn Speech @ Value Investing Congress

October 20, 2009 · Leave a Comment

David Einhorn has once again electrified the audience at the Value Investing Congress. In today’s speech, he touched on Japan, the US economy, macro risks, and a shift on his ivestment style due to the crisis. His speech is located HERE.

Categories: Value Investing

Debating Shareholder Democracy

September 4, 2009 · 1 Comment

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(Dealbook)

Democracy can be a messy business — and that goes for Corporate America as well.

The long-debated issue of proxy access, which refers to the ability of shareholders to nominate directors to corporate boards, is coming to a boil this fall. That’s when the Securities and Exchange Commission is set to vote on a proposed rule that would make it much easier for directors not backed by company management to get a place on the ballot at the annual shareholder meeting.

Knowledge@Wharton, an online publication of the Wharton business school, just published an interesting analysis of the proposed rule, which many experts say has a serious chance of passing.

The rule drew a flood of comments from investors, businesses and trade groups during the comment period that ended last month. Here’s just a tiny sample of the opinions expressed:

Roy Bostock, the chairman of Yahoo, said that the proposed rule was “unnecessary” and “ill-suited to the wide range of companies in the marketplace” and argued that it could distract directors from the job of overseeing a business.
The prominent corporate law firm Wachtell, Lipton, Rosen & Katz said the rule “would have negative consequences for U.S. corporations and our nation’s competitiveness.”

But James P. Hoffa, the general president of the Teamsters union, expressed strong support for the rule and called it a “critical — and long overdue — reform.” And Joseph A. Dear, the chief investment officer of the California State Employees Retirement System, said it was a “historically significant reform that will enable investors to hold corporate boards accountable.”

If it is adopted, the rule would allow shareholders with a relatively small stake in a company — at least 1 percent for large companies, more for smaller ones — to nominate individual directors before a shareholder election, instead of having to present an entire slate of directors and wage an expensive proxy battle.

When she announced the proposal in May, Mary L. Schapiro, the chairwoman of the Securities and Exchange Commission, said it “represents nearly seven years of debate about whether the federal proxy rules should support — or stand in the way of — shareholders exercising their fundamental right to nominate directors.”

Many businesses are fiercely opposed to the proposed rule, arguing that it would have a destabilizing effect. Supporters say it will help democratize a process that is often little more than a rubber-stamping ritual.

David F. Larcker, an accounting professor at Stanford University, tells Knowledge@Wharton that the S.E.C.’s proposal is “opening up the proxy machinery to an additional set of people” and calls it a “big deal.” Others have serious concerns, some of which Knowledge@Wharton describes here:

Some say the proposed changes could make it easier for a shareholder to mount a takeover attempt. Others warn that hedge funds with significant company assets could infiltrate boards and push companies to take on high levels of risk for the fund’s short-term gain.

Charles M. Elson, the chairman of the John L. Weinberg Center for Corporate Governance at the Lerner College of Business and Economics at the University of Delaware, suggests the proposed rule will just “create a bigger mess.” He says it would step on similar, more flexible measures already in place in Delaware, where many large companies are incorporated.

“The S.E.C. would be a one-size-fits-all approach, which could work in some circumstances and not work in others,” he said.

Pavel Savor, a Wharton finance professor, sees some exaggeration on both sides of the debate: “People tend to overdramatize these things,” he tells Knowledge@Wharton. “It’s not a cure-all, and it’s not something that will permanently destroy corporate America.”

Categories: Value Investing
Tagged: rule, SEC, shareholder, Shareholder Rights, wharton