Published at: Old School Value Investing Blog
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Walgreen jumped bout 11% yesterday on the news that it ended it’s dispute with Express Scripts.
If you remember, Walgreen was a bad news pick based on the price drop after the Express Scripts break-up and Alliance Boots acquisition. Although Walgreen did not show up on the BWB 7 Screen, it has a history of strong financials and desirable intrinsic properties.
Yesterday’s response by Mr. Market was nice to see, but long term Walgreen investors are not out of the woods yet. As reported in the Q3 results, “Compared to the prior year, the strategic decision to no longer be part of Express Scripts Pharmacy Network as of January 1, 2012 impacted our quarterly results by a net $0.06 per diluted share including cost controls, at a total of $0.15 per diluted share year-to-date.“. Not only prescription transactions were down(10% in June alone), but revenues on same store sales suffered also(down 4.9% vs. Q2 2012) because those customers were not in the store to shop while they waited for that prescription to be filled.
The question to be answered now is, how many of those lost customers will come back to Walgreen for their prescriptions? CVS Caremark, who benefited from the dispute as an alternate supplier for Express Scripts, expects to retain about 50% of its new customers gained from Walgreen. Customers will return and some will be lost, this is the nature of retail. More importantly, the opportunity for new customers has grown with the return of the Express Scripts subscriber network.
Revenues will return, but not quickly. I expect the remainder of the year’s sales will still be affected by the dispute. Management expected a total loss of $0.21 per share for the year because the loss of the contract. It will be worth watching the Q4 results and seeing how much management attributes to the loss. Based on the numbers they have put out thus far, I would expect to see $0.06 or less tied to the Express Scripts contract dispute.
As for Mr. Market, I expect him to be a little hung over today. Look for the profit takers to exit and the price to drop a little as details emerge on the settlement. Now that the dispute is over with Express Scripts, the growth potential has returned to the domestic market. I still consider Walgreen a long position that will reach its Fair Value price of $45.00 or more.
Disclosure: I am Long WAG
Jinpan International Ltd. (Nasdaq: JST) announced preliminary financial results for the second quarter ended June 30, 2012.
Here are the numbers compared to a year ago same quarter:
| Category | Q2 2012 | Q2 2011 | % Gain/ (Loss) |
| Net sales | 55.6 | 58.3 | (4.6) |
| Gross Profit | 14.5 | 22.2 | (34) |
| Gross as % of Sales | 26% | 38.1% | |
| Net Income | 2.5 | 7.28 | (65) |
| EPS | .15 | .45 | (66) |
Also, per the news release management has amended the 2012 outlook per the following:
The sales number reports from two segments, domestic (China) and international. Domestic sales grew to 50.8M from 46.1M the same quarter last year. International sales took a big hit, 4.8M compared to 12.2M from last year’s second quarter. This was attributed to “…a change in the design by our primary OEM customer of their wind power product(s), which resulted in a decrease in our international sales in the second quarter.”
“Currently, we are waiting for our customer to provide new specifications, so we can make corresponding design changes to our cast resin transformer products and integrate our transformers into their newly designed wind power product(s).” International OEM sales have been down for a three month period and Jinpan is still waiting for specifications from this customer. This may be a flag signaling strained customer relations.
Once these specifications are received, Jinpan will have to modify/redesign their product and have it re-qualified. I would expect this to take some time and possibly affect International sales for the remainder of this year. Management expects this also, “Even though we experienced slower sales to our primary OEM customer, we do expect a pick-up in orders from other OEM customers in the second half of 2012.” This has also exposed a weakness of dependence on one major OEM customer (a 60% decrease in this sales segment due to one customer). I would like to see management move to fix this weakness.
I sensed some hesitation by management about Domestic sales for the remainder of the year also, “We also experienced some weakness in domestic order flows in the second quarter due to a softer economic environment in China.” Domestic sales were actually up by 9.25% this quarter compared to last year, why the warning?
“We have backlog of approximately $113 million at the end of June 2012 and believe that approximately 80% to 90% of the backlog will be shipped in 2012”. I assume that 113M figure is a net sales number. 80% of that would be about 90.5M for the last half of the year in addition to incoming orders. Last year Jinpan had 130.75M revenue over the last half of the year.
The revised numbers for Net Sales predict 0-5% growth this year. Using the worst case scenario of 219M would require Jinpan to achieve Net Sales of 120.6M over the last two quarters. Again, Jinpan had about 130M over the last two quarters for 2011 so it is possible, even more so if the backlog is delivered as promised.
The Gross Margin reduction is not too much of a concern for me. Jinpan has averaged a 38% margin over the last ten years and been in the 33% range three of the same last ten. Also, the net income number if reduced by 20% would be 19M. This is still well above the ten year average of 12.6M and better than seven of the last ten.
“We believe the second half of 2012 will be stronger for our business than the first half.”
Jinpan has some work to do if it wants to be a ‘zero growth company’ this year. There have been some weaknesses exposed regarding reliance on a single customer and possibly customer relations/communications. Jinpan plans to release its second quarter earnings results and conduct an earnings conference call in mid-August. I look forward to seeing how management addresses these issues and handles the remainder of the year, it could reveal a lot about the quality of management.
Transaction costs are the bane of investors everywhere. Whether the market is up or having its worst day ever someone makes money; that someone is the Stock Broker.
Consider the following fees charged by the following firms for trading stocks:
| Brokerage | Fees/Trade |
| Scottrade | $7.00 |
| E Trade | $7.99 – $9.99 |
| TD Ameritrade | $9.99 |
| Charles Schwab | $8.95 |
| Fidelity | $7.95 |
On the surface these fees may not seem like an excessive amount, but looking at it from the perspective of a new or small investor changes things a bit. For example, our new investor (let’s call him Mr. Value) has just saved enough to open his first brokerage account…a hard earned, hard to come by $1000. After long hours and study, Mr. Value has found the perfect first pick for his portfolio. Grabbing a “Dow 30” component for around $8.35 a share he makes his purchase. Not wanting to put all his eggs in one basket he opts to go with 75 shares, because he’s sure of his pick and round numbers are easier for math.
So, 75 x $8.35 = $626.25 + the 7.00 fee (which is 1.11% of the cost) will total $633.25 or $8.44 a share.
It’ll be another $7.00 to sell those 75 shares. $633.25 + $7.00 = $640.25 or 8.54 a share.
Just to break even Mr. Value’s investment has to grow 2.28%.
Mr. Value hopes his investments will grow at around 8% a year. The first year he hits that mark, minus the 2.28% fees and 3.24% average inflation leaves him a net of 2.48%. Even if we exclude the sell side since Mr. Value holds long term, he is at 3.64% if things go according to plan.
Wikipedia defines a stock broker as, “a regulated professional broker who buys and sells shares and other securities through market makers or Agency Only Firms.”
Professionals get paid when their services are utilized. So I suggest the following methods to keep transaction cost at a minimum:
“Our favorite holding period is forever.” – Warren Buffett
By its nature Value Investing should lend itself to lower transaction fees. Waiting for that fundamentally sound company at a fair price or less may take a while. When that fat pitch presents itself a purchase can be made in volume and held long term to minimize transaction cost and taxable gains.
It is my goal to go transaction free for one year from today. This commitment locks me into my current portfolio and helps remove the temptation to sell or purchase. I will continue to look for companies that meet my requirements for investment. If I find one worthy of purchase this will be another fail safe to bounce it off of: “Is this company, at this price worth not achieving my no-transaction goal?”
As posted on Old School Value – Thank you Jae Jun
I heard the other day that 85% of Americans own running shoes but only about 15% of them regularly run. We all know what we should be doing, but doing it is another thing.
The same is true when it comes to investing.
I tout myself as a value investor. Although there are many variations to the rules of value investing, the basic tenants are the same:
This easily quantifiable, emotionless step is usually taken care of with a stock screener.
I look at current ratio, earnings growth, earnings stability, dividend record and price to book. If a company can make it past my screen, a quick look at the last ten years statements will verify the condition of the financials.
Here is when it can start to get a little tricky.
Fair value is usually determined by estimating future earnings and multiplying them by a capitalization factor. This requires research of past performance, long-term prospects and company management; usually done by reviewing several years’ worth of 10K filings.
Two things become a problem here. First, it should go without saying that ‘estimating the future’ of anything is really nothing more than an educated guess. Second, the more time spent researching a company and its statements an emotional bond may develop.
Once an estimate of earnings and capitalization has been made, these numbers are usually plugged into a formula, i.e. Value = Earnings (8.5+ (2g)) and the result is fair value. But what if the number is not what was expected or desired? Suddenly you are emotional. Maybe you feel like you wasted all that time reviewing the company; maybe you really like the company now after learning more about it.
This is the dangerous path that may lead to manipulating the numbers to reach a desired value.
Long-term can become short-term with gains and losses.
Scenario 1: That Company bought at a bargain has now become an even bigger bargain. Doubt creeps in, conviction wavers. Three choices present themselves at this time; ride it out – sell and take what is left – or strengthen the position.
Scenario 2: That Company bought at a bargain has now become an overnight sensation. This scenario even has its pitfalls. Is it time to take profits now or let it ride until your long-term timeline? It all depends on how much confidence there is in the estimation of value and future prospects of the company.
Again, we all know what we should be doing, but doing it is another thing.
Knowing some of the error traps associated with value (defensive) investing allows for a plan of action to avoid them. Here are some suggestions that have helped me from time to time:
“A strong minded approach to investment, firmly based on the margin-of-safety principle, can yield handsome rewards. But a decision to try for these emoluments rather than for the assured fruits of defensive investment should not be made without much self-examination” – Benjamin Graham
Value investing is hard; not the concept, but the application.
“You never get a second chance to make a first impression.” – UNK.
There is no exception to this rule when it comes to investing in companies.
When searching for possible investment opportunities I use several tools to narrow down likely candidates.
First, I use a stock screen that is an adaption of the 7 criteria set forth by Graham in The Intelligent Investor. Once I have established a list of companies that have met the criteria, I begin to look a little closer. This is where I formulate my first impression of a business.
As I winnow through the list of companies, I enter each of them into a spread sheet and I am met with a graphical display of the company’s Earnings per Share (EPS) from the last decade, like the one below:
Or, sometimes I may see one like this:
I have not disclosed the names of the companies yet, so as not to prejudice your impressions.
Graham calls for the defensive investor to require “Some earnings for the common stock in each of the past ten years.” By itself this may not be too restrictive of a criterion, but when combined with the other attributes from the screen it becomes more difficult.
Especially when you consider the difficulties companies have faced since 2008. That time period alone culls many companies that were not able to stand up to the economic turmoil. In fact, I think it is a great reference for Value/Fundamental investors to have such a time period to hold as a measuring stick for companies.
If a company shows any negative earnings in the last ten-year time period the impression has been made. I will move on to the next one on the list.
Conversely, if the company has been positive for ten years, I now look at the trend line. A steady upward trend makes for predictable earnings and growth.
This may seem harsh and too restrictive for most investors.
I will be honest; I need the entire margin I can get. If that means passing on a company that has had a down year or two, so be it. I would rather be really right once than sort of right twice.
You enterprising investors need not despair; Graham has left an out for you.
When it comes to stock selection for the enterprising investor Graham calls for “No deficit in the last five years.” This will open up the field quite a bit.
I want some feedback from you…
Am I being too restrictive?
What do you use as a first impression when it comes to stock analysis?
Oh yea, the companies above: Coca-Cola and Ford.
Recently I was asked how I arrived at my ‘annual return rate if price reaches FVDCF price’ that I quoted in my stock articles on Seeking Alpha.
This part of the equation is derived from a Discounted Cash Flow Model using owner earnings plus estimated growth rate, discounted by a desired and realistic return rate over a 10 year period.
The sum of these values are then added to the firm’s Equity and divided by shares outstanding to come up with an estimated fair price after expected growth.
Here is an example using Microsoft (MSFT) that projects a value of $41.46
(click to enlarge)
Next, I take the current price and calculate the Combined Annual Growth Rate (CAGR) over a ten-year period to reach the FVDCF price calculated above.
In this case the CAGR required to reach the estimated price in a ten-year period would be approximately 3% (2.97%).
If I were to calculate Total Stock Return with dividends, assuming they stayed at the current level, the CAGR would be around 5%.
First, I aspire to look at investments of a long time period. I have determined that 10 years is my threshold for “long”.
I look at growth and price history, along with future prospects to evaluate if it is reasonable for the security in question to reach the estimated price level.
Secondly, I take that CAGR number that I have calculated and compare it to bonds and other types of investments I could have over the same time period.
Would I get a better return with less exposure to risk elsewhere?
That is the question I try to answer. If the answer is “no” and I have a high level of conviction with my valuation, then I have possibly found my next investment…
con·vic·tion [kuhn-vik-shuhn] noun: a fixed or firm belief.
When I make an investment I try to do so with conviction. I use a screening criteria, I reference case studies, formulas and graphs that serve to feed my analytical thinking. I use all these tools to build a case for investment and conviction of my assessment.
But what happens when I see my investment fall below my buy-in price and those red numbers show up on my holdings summary?
My conviction wavers.
My current worry is Walgreen. Walgreen Co., together with its subsidiaries, operates a chain of drugstores in the United States (and now Europe?).
If you are not aware of the past few days’ activity you must live under a rock. Just check out the news, articles and opinions from my favorite source for investing ideas and information.
My history with Walgreen started with what I call a BAD NEWS BUY. I Purchased Walgreen near a 52 week low based on the Express Scripts debacle. I liked it in the $33 dollar range and believed that the problem with Express Scripts was fixable and would be fixed in a matter of time.
After yesterday’s announcement of a deal to buy 45% of Alliance Boots for $6.7B the stock has dropped nearly 6%.
It is clear the Market is not happy with the acquisition. On the surface it looks like the biggest concerns are the exposure to the European economy, the price Walgreen paid for its stake in Alliance Boots and the company’s blind eye to the domestic issues it is facing.
The Numbers
WAG vs. the BWB screen requirements:
Revenue greater than 100M – This is a slam dunk for WAG. Since 2002 revenues have grown at a CAGR of 10% with an average margin of 29%.
Current Ratio greater than 2 – As of this writing WAG has a ratio of 1.55. This falls short of our criteria and will change after the dust settles from this acquisition.
Price to Book Ratio of less than 1.5 – As of this writing WAG is at 1.75
P/E Ratio – Using the last three year average EPS the P/E ratio comes in at 12.20, below the required 15.
Dividend Growth rate – 28% (5 year average.) WAG has paid dividends since 1933 and has a history of 37 years of increasing their dividend.
EPS Growth and positive earnings in the last 10yr period – WAG has been in the black for the past ten years and grown at an 11.5% CAGR, well above the required 3%.
WAG Price Data and Estimates:
| Method of Estimate | Price |
| 20x Avg EPS | $35.94 |
| Using the Graham Avg P/E | $35.97 |
| Graham Value Equation | $44.93 |
| Fair Value DCF | $46.63 |
| Price on OE Estimate | $63.81 |
A price range of $35.94 to $63.81 has been established by the above methods of calculation. Price history of WAG ranges from a low of $22.09(2009) to $49.96(2006) for the last ten year period.
My Conviction
I liked WAG in the $33.00 range and I like it now at an even lower price.
With a long term investment horizon, I believe WAG will return to its historical price levels and grow beyond. At an estimated future growth rate of 7%, WAG could provide a return of 5% annually if it reaches the FVDCF Price of 63.81 in the next ten years.
However, I will be watching the developments of this acquisition closely and researching it on a deeper level (with a follow-up article).
Bottom line – I believe WAG is a better company with this move and has the ability to make the most of it. Also, I have not lost the sight of reconciliation with Express Scripts on the home front.
Disclosure: I am long WAG.
Additional disclosure: I have strengthened my position on the news about Alliance Boots and the resultant price drop.
Jinpan International Ltd (NASDAQ:JST)
The demand for electricity has no intention of slowing anytime soon; consider these facts from the EIA Energy Outlook Report for 2011:
“In the IEO2011 Reference case, electricity supplies an increasing share of the world’s total energy demand, and electricity use grows more rapidly than consumption of liquid fuels, natural gas, or coal in all end-use sectors except transportation.”
“From 1990 to 2008, growth in net electricity generation outpaced the growth in delivered energy consumption (3.0 percent per year and 1.8 percent per year, respectively). World demand for electricity increases by 2.3 percent per year from 2008 to 2035 and continues to outpace growth in total energy use throughout the projection period (Figure 72).”
Also, growth varies by country. Those countries with an established grid and infrastructure sustain continued electricity growth and upgrades but are quickly outpaced by countries that have off grid locations that are being developed.
The chart below shows the expected generation growth through 2035 by country:
This is where Jinpan International comes into play. Jinpan (JST) is a manufacturer of cast resin transformers and switchgears, unit substations. Also, over the past eight years JST has grown its exposure to wind energy distribution products and entered into the OEM market for wind farm suppliers.
JST is one of only two cast resin transformer manufacturers in the world to achieve UL recognition.
Working in the Electric Generation Industry myself, I can vouch for the advantages of cast resin transformer vs. oil filled and VPI type as listed on the JST web site:
“Lower cost of ownership than oil-filled
Safety
Environmental Friendliness
Efficiency
Advantages of JST’s transformers over other cast resin transformers:
JST clearly states the key elements of its business strategy in the annual report and provides proof of adherence of this strategy:
JST vs. the BWB screen requirements:
Revenue greater than 100M – JST comes in above this requirement since 2007, with the 2011 year at 224M. Revenue has grown at a clip of 23% annually over the last 10yr period with an average margin of 38%.
Current Ratio greater than 2 – As of this writing JST has a ratio of 2.29
Price to Book Ratio of less than 1.5 – As of this writing JST is at 0.62
P/E Ratio – Using the last three year average EPS the P/E ratio comes in at 5.4, well below the required 15.
Dividend Growth rate – 3% (5 year average.) JST has paid dividends since 2003 and currently yields approximately 2%
EPS Growth and positive earnings in the last 10yr period – JST has been in the black for the past ten years and grown at a 20% CAGR, well above the required 3%.
JST Price Data and Estimates:
|
Method of Estimate |
Price |
| 20x Avg EPS |
$16.10 |
| Using the Graham avg P/E |
$8.04 |
| Graham Value Equation |
$20.73 |
| Fair Value DCF |
$28.07 |
| Price on OE Estimate |
$36.27 |
A price range of $8.04 to $35.08 has been established by the above methods of calculation. Price history of JST ranges from a low of $0.76(2002) to $24.51(2010) in the last ten year period.
I believe JST to be a solid investment opportunity in a growing market at the right price.
Strong, consistent revenue growth coupled with the highest margin vs. industry competitors (ABB and SI) puts JST in a positive light.
Also, JST has set itself apart based by being one of two producers with UL recognition and the superiority of its cast resin products vs. traditional oil filled. Successful development of new large scale cast resin transformers, and continued R&D projects seeking high margin product look favorable for the company.
Although the bulk of the revenues come from the China market (which is the largest growing market), JST continues to present its products globally. By becoming an OEM manufacturer for wind energy products it has successfully exposed itself to countries with established electrical infrastructures that are now looking to alternative generation methods.
Inventory and Net earnings have had a corresponding rise (26% and 23% respectively) over the last ten years, while accounts receivable has only grown at a CAGR of 3% vs. revenues.
Retained earnings have grown at 27% annually over the last ten and Treasury Stock is Present.
The latest ROA and ROE on owner earnings are 19% and 13% respectively.
At current prices (Sub $8.00) and a long term growth estimate of 8%, which I consider to be
1. Adequate Size
I look at companies that have annual revenue larger than 100M preferably for the majority of the past ten years. This keeps us out of small cap territory, but exposes us companies with growth potential.
2. A Sufficiently Strong Financial Condition
Current ratio greater than 2
3. Earnings Stability
Some positive EPS earnings in the past ten years.
4. Dividend Record
Dividend payout for at least ten years is stellar, but not mandatory, A dividend is required though.
5. Earnings Growth
EPS has grown at least 33% over the last ten-year period.
6. Moderate Price to Earnings Ratio
P/E ratio using the last three years avg EPS.
7. Moderate Ratio of Price to Assets
Price/Book ratio less than 1.5
On the surface this looks like a basic value screen, but digging deeper shows us some things
The earnings stability requirement is the first bottleneck. This eliminates any negative earners over the past ten years. With the bad year everybody had in 2008/2009 this really drops out companies that could not stand up to the recession.
Earnings growth is one that surprises me from time to time. 33% over ten years sounds pretty easy (a CAGR of 2.89%) but it still knocks a few out. We want companies with steady growth; if it can’t grow at least 3% a year is it really that good.
P/E ratio less than 15 is a value stalwart. But we add the twist of using the average of the last three years earning instead of the TTM data. The average data makes this a little tighter (usually my P/E ratio run higher than the TTM).
Finally, the dividend record drops off the companies without sufficient cash and financial stability to pay shareholders on a consistent basis, or perform share buybacks.
After running a basic screen at my broker, I run the results through the BWB analysis sheet to see who makes the cut. The last group was cut from 45 to 2 stocks that made the cut. Not the cut for automatic investment, just the cut for further research.
Remember, this is a slow methodical process. To get the returns desired from our investments, we are looking for select companies at fair (or undervalued) prices.
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