Tuesday, August 26, 2014

Fourth Pick in the WMD Portfolio - Raven Industries

The more real they are, the more fun blogs are to follow. So in that spirit, rather than talking about ideas in the abstract I maintain a hypothetical portfolio to track ideas where I'll semi-regularly (and hypothetically) invest and track buying (and where required selling) shares.

For tracking purposes I will use $1,000 to keep it nice and simple. The overall goal is long run income and dividend growth. Portfolio page with goals and tracking is here.

The current portfolio consists of Coca Cola, GlaxoSmithKline and IBM. Stalwarts all. Raven is a bit different than the rest, for one thing its a small cap with a $987M market cap, but its earned its place all the same. Raven has three main divisions: Applied Technology, Engineered Films & Aerostar Division and they serve industrial, agriculture and defense customers.

On the quantitative side, Raven has a low yield (1.8%) relative to the S&P, though that is a little bit more attractive if you compare Raven's yield of the Russell 2000 index which yields 1.3%.  Raven has some positives, for starters Raven is a Dividend Champion. They've paid dividends 27 consecutive years. On top of that,  Raven has committed to growing their dividend, they have a ten year annualized dividend growth rate of 15.5%.

Does Raven have a moat? Todd Wenning covered Raven in his informative investigative series on Small Cap moats:

"This business has two potential moat sources. One is switching costs; once a farmer has installed a Raven precision ag system across a fleet of equipment and learned how to use the programs, there's an added cost of switching to a competitor's offering. The second source is network effects; a reputable, well-established company with a wide breadth of support, service, and training has an edge over any newcomer."

Small cap moats are different from the behemoth moats like IBM in mainframes, Glaxo in vaccines and Coca Cola, but there is a case to be made that Raven, through advanced manufacturing skill and long term focus, has carved a profitable niche for itself. The numbers bear this out

Payout ratio44%
Fwd Dividend Yield1.8%
10 yr Div Growth15.5%
ROE 5 yr avg26%
Forward P/E18
(Source: Morningstar)

Raven is a manufacturer with a great track record and yet has no debt, this provides a margin of safety. If Raven can continue to come close to its long run ROE and dividend growth averages this should be a good investment over the 5-10 year timeframe. The shares are not super cheap but the company is very innovative (even providing tech (balloons) to Google for Project Loon). Its a shareholder friendly company and at today's prices, Raven is right about at its 52 week low.  Put it all together and it looks like a fair price for a high quality company with a years of dividend growth ahead of it.

Monday, August 18, 2014

High Yield Reads - 8/18/14

Summary of recent stories of interest, sometimes enduring, to investors:

The Wide Moat Dividend portfolio (model portfolio)  is designed to produce income and total returns, not drama. But there has been fair amount of the latter. There are only three stocks in there currently - Coke, IBM and GlaxoSmithKline, but they've managed to generate some interesting news

  • Stephen Lamacraft of Woodford  Funds provided a useful way to look at GSK's reengineering:

GlaxoSmithKline is currently a very unpopular stock – as contrarian investors, this is one of the reasons we like it, because its unpopularity is reflected in a very low valuation. To put this into context, Bayer recently acquired Merck’s consumer healthcare business for 7x sales. If you were to put Glaxo’s consumer healthcare business (it recently put its consumer healthcare assets into a joint venture with Novartis) on the same multiple, it would be broadly equivalent to half of Glaxo’s market capitalisation. 
By combining the potential valuation of the consumer healthcare division with the potential valuation of a world-class vaccines business and VIIV, a leader in HIV treatment, you get the current market value. As such you get a portfolio of existing pharmaceutical products and a strong pipeline of new drugs, in our view – for free! It’s worth mentioning that this division is no minnow with a potential valuation of £33bn, some 50% of the current market cap. 
Now, we are not suggesting that a corporate bidder is going to pay that sort of money for Glaxo’s consumer healthcare business any time soon – it’s just an interesting way of looking at the valuation opportunity that exists in the stock currently. The recent earnings disappointment has fuelled the market’s desire to focus on the short-term but, in doing so, it is ignoring a very interesting long-term story. Indeed, we are increasingly positive on that long-term investment case.

  • Continuing on the "significant amount of bad news already reflected in today's price", Barron's thinks the worst may be over at IBM.
  • Interview with Lou Ann Lofton on how Warren Buffett Invests Like a Girl. "With Buffett, he doesn’t care what Wall Street’s doing. He’s not going to be suckered into that. He buys what he knows, for the long-term, and manages risk as best he can. All of these things will help people make money—that’s what it’s all about."

Wednesday, August 13, 2014

IBM Will Survive and Thrive

IBM is the third stock I added to the Wide Moat Dividend portfolio. Its a company with substantial positives - a 2.4% yield with plenty of room to grow. IBM has a payout ratio of 25% and a five year dividend growth rate of 14.3%. The Return on Equity averages 75% over five years. And the price is right IBM's trailing P/E is 12.

In a market with next to no bargains, why is IBM on sale? The company gets lumped in with the other "old" tech - Cisco, Microsoft, Oracle, et al.  aka the IT shop of the 90s-2000s. No one wants to own the next Blackberry tech company that fades away. No doubt they all these players have their challenges with Cloud, Mobile, BYOD and on and on. But I think IBM is unique and in the best position of any of them to survive and thrive. Unlike Blackberry there is no one silver bullet that can take down IBM's franchise. Still the old tech sectors is on sale

(Source: Morningstar)

None of the old tech players are richly valued on conventional metrics. Investors are right to be concerned with how they each navigate the shifting sands of Cloud and Mobile. Cloud and Mobile present real challenges to each but in different ways. In some ways Microsoft is the most exposed here since they have both client and server side franchises. At the same time Microsoft is executing and moving aggressively to defend its turf, with Azure the Pepsi to Amazon/AWS' Coke in the Cloud space. Microsoft has yet to enjoy the same level of success in Mobile.

Cisco in theory is less exposed than Microsoft because Cloud and Mobile drive up demand in networking gear which they sell. However, the knock on effect of Cloud and Mobile is buyer concentration, where the large Cloud providers increasingly build their own systems soup to nuts and do not rely as much on companies like Cisco. Inside the enterprise, the data centers move to the Cloud which eliminates more sales potential from Cisco. On the Mobile side, sure the bandwidth utilization keeps going up, but then Cisco has to deal with entrenched, large scale players with more bargaining power. Oracle is a bit aimless, without many clear wins to point to, however, they are so deep in the backend that many of the new developments will take longer to reach their base. Mobile is a client side technology and Oracle has never had anything cooking there to begin with. Still the shrinking IT shop is a headwind for Oracle's growth.

That brings us to IBM. For a start, IBM is a totally different animal from the above players, for one thing they have a massive services business a la Accenture that the other players do not have. Steve Ballmer joked about why he avoided services saying if you are in the pharma business why would you want to go into the hospital business? Fair enough, and the services margins will never equal a hit software franchsie, but as Accenture proves when services are done well the result can be profitable and evergreen.  In IBM's case their estimated services backlog at December 31 was $143 billion. That should see them through a rough patch or two. This is a lower (but not low) margin business than software but way steadier and will help them ride through the vissicitudes of technology churn.

As to Cloud, IBM's core customers are among the least likely to headlong into the Cloud, think banks and other transaction oriented businesses.The Cloud is not going to deliver the control and security that these customers need. There is an old tech saying, if a Unix server goes down you have a bad day, if a mainframe goes down the world stops spinning on its axis.

“Planes don’t fly, trains don’t run, banks don’t operate without much of what IBM does,” Ms. Rometty said.

The shortage of growth at IBM is partly by design — and has been for years. Since 2000, the company has sold off businesses that collectively generated $16 billion in sales, including personal computers and disk drives. Since Ms. Rometty became chief executive in 2012, units with $2 billion in revenue have been shed, and when the sale to Lenovo is completed this year, she will have divested operations with revenue of $6 billion.

Profit trumps growth at IBM. “We don’t want empty calories,” Ms. Rometty said. “So when people keep pushing us for growth, that is not the No. 1 priority on my list.”

IBM’s largest single investment in growth is in helping companies exploit the digital data deluge from corporate databases, sensors, smartphones, the web, social networks and elsewhere. That push into the field now called big data began years ago, and Ms. Rometty played a central role in shaping the strategy before she became chief executive.

IBM's core customers have its technology woven into the fabric of their businesses. In many cases, they have been optimizing and extending the code since the 1970s. This is not going to be replaced by the Cloud.  and if anything will look to build their own private clouds with IBM's help and/or use . Then you have the Snowden effect, Ginni Rometty at Mobile World Congress:

"Enterprises will want—and need—to manage their data in the cloud with the same rigor as if it were on-premises. Companies will want to ensure visibility, auditability, security. This will be also be driven by regulation. Roughly 100 nations and territories have adopted data protection laws. In Europe, many countries require that citizens’ data be housed within national borders. This is why IBM is aggressively expanding its global cloud footprint. We currently have 25 data centers globally, and the new $1.2 billion investment announced in January will see the opening of 15 more, in the US, the UK, Australia, Japan, India, Canada, Mexico and China."

Ginni Rometty's speech was the first time an IBM CEO spoke at Mobile World Congress, and that portended a very interesting development in mobile.  IBM  did not have much going in mobile until recently, the Apple-IBM deal that Ginni Rometty and Tim Cook (an ex-IBMer) put together is still early days but could be a very big win.

Apple has the devices and the mobile platform, but you need servers and mainframes to do something interesting, Apple does not play there, has never played there and IBM has them in spades. Security is a core concern and IBM is a major player there as well. Its a deal right out of Ricardo. Its early days, Apple-IBM could be the Wintel of the Mobile world. If nothing else, the deal shows creativity on IBM's part to go from a bystander to being in the center of the ring in Mobile.

For sure, IBM has any number of challenges, I think the old guard of tech will see one or two of the current players not make the leap into this new world, its just the way of the tech world. I agree that as a group old tech players can fairly be discounted from the market P/E, but in IBM's case its overdone.
 I think IBM has a better shot than any of the old guard at getting the next waves right and they have several ways to win - Cloud, data center, services, and mobile partnership with Apple. IBM should not only weather the storm, they have ways to thrive in Cloud and Mobile and continue to innovate.

On top of that an IBM investor gets as shareholder friendly a business as there is, IBM's repurchases and dividend policies are top notch.

IBM Dividend Chart

IBM is in a solid place on fundamental metrics. It does compete in highly contested spaces, but its unique mix of franchises and R&D (repurchases and dividends) give investors a decent chance of earning solid total returns over the long term.

Tuesday, August 12, 2014

GlaxoSmithKline - Stout Yield Worth the Risks?

GlaxoSmithKline is the second stock that I added to the Wide Moat Dividend (WMD) portfolio. The positives are pretty clear - a 5.6% yield really stands out in this yield parched world. All the better when it comes from a defensive company like Glaxo and sells for a discount to the market, Glaxo's trailing P/E is 14. With a decent price and a five year average ROE at 58%, this is a stock that Joel Greenblatt would love, and in facts its one of his holdings.

Still as Joel Greenblatt is the first to point out, you do not make it through his magic formula screen when everything is rosy. There has to be a lot of hair on any company that can those generate those ROEs and still sell so cheaply - Glaxo faces a number of near and mid term challenges.

As great as the yield, P/E and ROE metrics are, there are troubling numbers, too. Glaxo's payout ratio is 81% and its Debt/Equity is 2.4. There is not a lot of room to maneuver here if things go poorly. However there are some factors that balance out some of the negative.

The stock price was hit when Glaxo recently lowered guidance and stopped buybacks. However, for the purposes of the WMD portfolio I care more about the dividend than buybacks. On dividends, the the focus of Glaxo management shines through, they raised the dividend 6%.

I use a simple 5+5 metric for the WMD portfolio, the yield plus dividend growth should exceed ten percentage points. With a 5.6% yield plus a 6.6% five year annualized dividend growth rate, Glaxo earns a 12.2. Things are not perfect at Glaxo, but prioritizing dividends over buybacks is a good tradeoff here in my view.

The list of challenges facing Glaxo is not short, however that is what gets you a price like we see today. There are not guarantees, but management's priorities appear to be in order, favoring shareholders. Despite its current standing as sector whipping boy, Neil Woodford views Glaxo's troubles as temporary, has Glaxo as his fund's second largest holding, around 7% of the fund. Woodford's comments could be construed as talking his book until you realize that he has purchased his Glaxo shares in the last two months.

There is a lot to do for Glaxo to be successful, like any pharma company they have to continue to roll out successful platforms, in Glaxo's case its respiratory. The company is adding less glamorous areas like vaccines and consumer health (which will soon represent more than half Glaxo's income). One analyst derided them as "The market is changing around them, and there's a sense Glaxo is the granddad stuck in the corner." I have no problem with boring, actually that sounds favorable to me.

Its not a no brainer investment, despite the gaudy price, yield and quality metrics. While Glaxo's risks are real, at a 5.6% yield, investors have a chance to earn a stout income as the process unfolds.

Second & Third Picks in WMD Portfolio - GlaxoSmithKline & IBM

The more real they are, the more fun blogs are to follow. So in that spirit, rather than talking about ideas in the abstract I maintain a hypothetical portfolio to track ideas where I'll semi-regularly (and hypothetically) invest and track buying (and where required selling) shares.

For tracking purposes I will use $1,000 to keep it nice and simple. The overall goal is long run income and dividend growth. Portfolio page with goals and tracking is here.

The first pick was Coca Cola, today I am "adding" two other great dividend payers - GlaxoSmithKline and IBM.

Its very hard to find a 5+% dividend yield today from a high quality operation, but that's what GlaxoSmithKline offers. The current yield is 5.5% albeit with moderate growth (6.6% five year annualized dividend growth).

IBM's forward dividend yield is 2.4%, that is not super high but still well above the overall market. Since their payout ratio is 25%, it can grow comfortably for many years. IBM management is willing to raise the dividend with five year annualized dividend growth at 14.3%. Its as high quality a company as there are anywhere in the world. The 5 year average ROE is 75% all for a very good price, the trailing P/E is 12. About the only negative on IBM's metrics is that debt has risen to do buybacks, but at this price point is surely makes sense and the company can cover its payments.

Debt/Equity 2.4 2.0
Payout ratio 81% 25%
Fwd Dividend Yield 5.6% 2.4%
5 yr Div Growth 6.6% 14.3%
ROE 5 yr avg 58% 75%
Trailing P/E 14 12
(Source: Morningstar)

These companies are not perfect, both have higher debt loads than you would like. Glaxo's payout ratio is a bit too high. However, they both should have no problem meeting their debt obligations. One metric for selection I use is a 5+5 metric - dividend yield plus dividend growth should be 10 or higher. Both GSK (12.2) and IBM (16.7) clear this hurdle with room to spare. The quantitative side looks excellent; however there are qualitative reasons why Glaxo and IBM are priced cheaply and I will explore these in future posts.

Sunday, August 10, 2014

High Yield Reads - 8/10/14

Summary of recent stories of interest, sometimes enduring, to investors:

  • Eddy Elfenbein on a topic that's near and dear to many investors - what poolside investing is really all about. I agree with that watchlists trump screens, but I still like to run screens as a way to build the watchlist. 
  • Tim McAleenan on how focusing on Yield on Cost to take the stupid out of investing. Tim uses the same example that originally got me interested in yield on cost - Buffett's Coke purchase which pays him $488M/year in dividends an rising, on an original $1.3 Billion purchase that is good for a 37% yield on cost. Every year. And growing. Its easy to see why academics dismiss yield on cost, if you ignore trading cost, opportunity cost, and assume a spherical cow of uniform density, err I mean perfect market timing, then YOC is irrelevant; however back in the real world its an excellent North Star for individuals, individual investors should embrace it as part of a long term strategy.
  • Forever Investor - AstraZeneca rejected Pfizer's buyout bid. It was fair to ask if AstraZeneca's management talk about the pipeline was more narrow self interest or more shareholder friendly. I tended to think the latter at the time, but we got an additional positive developments in that the management wasn't just talking, they were buying north of 3 million pounds of shares. 

Thursday, August 7, 2014

Investing Lessons from the Best Trade in NBA History

The sports world is atwitter over Kevin Love joining Lebron James, Kyrie Irving and company in Cleveland. Is this is the greatest trade of all time or is it Red Auerbach getting Robert Parish and Kevin McHale in return for Joe Barry Carroll (aka Joe Barely Cares)?

Actually neither. The best trade by a wide margin involved a team and management that mostly no one  remembers, and no players.

Back in the 1970s, the NBA had a rival basketball league called the ABA. When the ABA folded, four teams, including current champ San Antonio, joined.  Two other teams cut financial deals, one of which proved remarkably successful:

"In the summer of 1976, with the ABA at the point of financial collapse after nine years, the six surviving franchises (the Virginia Squires went bankrupt immediately after the final season) began negotiating a merger with the NBA. But the senior circuit decided to accept only four teams from the rival league: the Nets (the last ABA champion), Denver Nuggets, Indiana Pacers and San Antonio Spurs.

The NBA placated John Y. Brown, owner of the Kentucky Colonels, by giving him a $3.3 million settlement in exchange for shutting his team down. (Brown later used much of that money to buy the Buffalo Braves of the NBA.) But the owners of the Spirits, the brothers Ozzie and Dan Silna, struck a prescient deal to acquire future television money from the teams that joined the NBA, a one-seventh share from each franchise, in perpetuity. With network TV deals becoming more and more lucrative, the deal has made the Silnas wealthy, earning them $186 million as of 2008, according to the Cleveland Plain Dealer, and $255 million as of 2012 according to the New York Times. (The NBA nearly succeeded in buying out the Silnas in 1982 by offering $5 million over eight years, but negotiations stalled when the siblings demanded $8 million over five.) On June 27, 2007, it was extended for another eight years, ensuring another $100 million-plus windfall for the Silnas. In 2014, the Silnas reached agreement with the NBA to end the perpetual payments and take a lump sum of $500 million instead. In the last few years of the deal, the Silnas were receiving $14.57 million a year, despite being owners of a team that hadn't played one minute of basketball in 35 years."

What a deal! The Silnas were clearly in the right place at the right time, no one knew what the future value of the NBA TV contracts would be. The Silnas played their hand well. They did not take a one time payment, instead they looked to the long run, recurring cash payments. 

Most people cannot own a pro sports team, but income investors can learn a lot from this mindset. Instead of looking for stocks that will pop this year, why not look out a decade or so to find opportunities? Sure there are stocks with potential to grow more in the near term than Coca Cola or IBM or Glaxo Smith Kline, but over the long term these companies should deliver income and income growth far into the future. These are three companies with excellent dividend track records.

GSK Dividend Chart

Coke, IBM and Glaxo, all deliver above average dividend yields, all are in a defensible competitive position that can easily last a decade, and have long run dividend track records to demonstrate their moats.

Fwd Yield 5 yr Avg Div Growth
Coca Cola 3.1% 8.1%
Glaxo Smith Kline 5.4% 6.6%
IBM 2.4% 14.3%
(Source: Morningstar)

These three defensive companies provide deliver decent to excellent current yields; and decent to excellent dividend growth. Its the kind of investment profile the Silnas would love. They turned down offers in the range of one time $3-5 million and were able to instead earn upwards of $750 million through focusing on long run income. In 1987, near the time the Silnas were turning down a $5 million buy out offer, Glaxo Smith Kline paid its shareholders $0.18 in dividends, today that payout stands at $2.40. Thinking in decades pays.