Sunday, September 25

Week 273 - The “Great Game” Will Be Won (or Lost) in Africa

Situation: The “Great Game” is a 19th Century term that refers to competition between the British Empire and Russia for dominance of Central Asia. Now, a similar diplomatic game is being played in Africa between the US and China. Much more capital (and diplomacy) is being invested by China, which is sending workers to execute ambitious infrastructure projects. Given that large sub-Saharan countries are among the fastest-growing emerging markets, investors need to stay abreast of Foreign Direct Investment. Much of that FDI is done at the corporate level, aided perhaps by loans from the US Export-Import Bank. But the China-Africa Industrial Cooperation Fund has been loaning far larger sums to Chinese companies. 

Mission: The population of Africa is growing 3.3%/yr and is on track to double by 2040, reaching two billion. Investors need to know which publicly-traded companies are making a strong push in Africa, what their strategies are, and whether or not ROIC exceeds WACC. We will confine our attention to international companies on the 2015 list of the top 500 companies in Africa, which is an article that is supplemented by a discussion of recent developments

US companies on the Top 500 list include Newmont Mining (NEM), Wal-Mart Stores (WMT) and Exxon Mobil (XOM). Major International companies include Orange (ORAN, a French telecommunications company), Total SA (TOT), AngloGold Ashanti (AU), Unilever plc (UL), Harmony Gold (HMY), Nissan Motors (NSANY), Diageo plc (DEO), ArcelorMittal (MT) and British American Tobacco (BTI).

Execution: see Table.

Administration: US companies face a number of problems that deter investment. The near-absence of shopping malls in even the largest country (Nigeria) has made it difficult for Wal-Mart Stores, and its partner in South Africa (Massmart), to expand operations beyond South Africa. McDonald’s has restaurants in only 3 African countries (Morocco, Egypt, South Africa) but will soon open one in Tunis (Tunisia) and one in Lagos (Nigeria). The problems that prevent McDonald’s from opening restaurants in the other 49 African countries include: 1) difficulty maintaining the security of its food supply chain to be certain that its meals are safe for consumption; 2) unreliable electric power grids that make it necessary to install back-up generators; 3) low average caloric intake because the country's population has insufficient disposable income. Nike has not opened any retail outlets in Africa, even though wholesale and Internet sales are strong and growing. Procter & Gamble derives 40% of its sales from emerging markets and has built a new plant in South Africa to support sales that are growing there, as well as in Kenya and Nigeria. Microsoft is also pushing into Africa. Newmont Mining has two large gold mines in Ghana, and Coca-Cola operates across an extensive distribution network

You get the picture: Africa is full of developing countries, yet none outside of South Africa are developed. The overriding theme remains one of resource extraction, mainly gold and oil. Shopping centers are beginning to appear but power grids support only 40% of demand. So, diesel generators are widely used in even the largest country (Nigeria). Companies in the Health Care industry are only beginning to find a foothold. Nonetheless, Unilever plc (UL) has built a strong market in consumer staples and Nissan Motors’ (NSANY) Renault cars have sold well for over 50 years. 

Bottom Line: Except for South Africa, infrastructure remains too limited to attract Foreign Direct Investment beyond that needed to extract, and sometimes process, natural resources (including agricultural products). Business is not booming. Direct commercial flights on US carriers to Africa have not been profitable; Delta is the only remaining carrier, and it continues to reduce available seat-miles. But major US corporations continue to expand operations in Africa, and China is making a big push.


Risk Rating: 7

Full Disclosure: I dollar-average into XOM and also own shares of WMT.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 18 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is the current 16-Yr CAGR found at Column L in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is based on returns from a stock index of similar risk to a portfolio of individual stocks, i.e., the S&P 400 MidCap Index.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, September 18

Week 272 - Ten Commodity Producers with Improving Fundamentals

Situation: There are only a few ways that a retail investor can buffer her stock portfolio against losses during a Bear Market. To build that buffer, we suggest including stocks from 4 different types of companies:

1) those that are “shareholder-friendly” in that the company pays a good and growing dividend, e.g. Johnson & Johnson (JNJ); 

2) those that have Tangible Book Value and maintain a clean Balance Sheet in that long-term debt is less than 30% of total assets and the company is able to fund its dividends from Free Cash Flow, e.g. Wal-Mart Stores (WMT);

3) those that sell products having strong Brand Recognition worldwide, based on value-pricing and utility, e.g. Microsoft (MSFT); 

4) those that produce commodities and have a stock price history that roughly tracks the commodity “supercycle” rather than the S&P 500 Index. This week we look more closely at that group of companies, to uncover stocks likely to track the next commodity supercycle.

This is a timely endeavor because there is reasonable evidence that the next supercycle is just now starting. In other words, the Dow Jones Commodity Index has recently “tested” the low set in late 1998, and is now rising. Yes, the last commodity supercycle began following a recession in Asia and was launched by a massive build-out of infrastructure in China that didn't stabilize until 2014. The trigger for the next supercycle will only become clear in retrospect, but Creative Destruction can be counted on to co-produce the event. Brexit may be the herald for what’s coming. 

Mission: Using the 2016 Barron’s 500 List, we’ll select commodity producers that have shown improvement based on these metrics that Barron’s editor uses to rank companies with sufficient revenues to be included on the Barron’s 500 list: 1) median 3-yr cash-flow based ROIC; 2) 2015 ROIC vs. 3-yr median; 3) 2015 sales growth. Then we’ll analyze those companies by using our standard spread-sheet (see Table).

Bottom Line: Some commodities track (or even predict) market cycles. For example, the American Chemistry Council’s “Chemical Activity Barometer” tracks the economy and is helpful in predicting recessions. But we’re looking for a way to track (or even predict) the rise and fall of a Commodity Supercycle that spans 2 or 3 market cycles. Those cycles are long because large amounts of capital have to be deployed upfront to get things out of the ground in scalable quantities, whether those things are in liquid, solid, or plant form. We’re looking for a company whose stock was moderately impacted by recessions in 2001 and 2008 but mainly tracked the infrastructure buildout in China. Mosaic (MOS), a fertilizer producer, is one example; another is Caterpillar (CAT), which makes heavy equipment used in construction, mining, drilling and farming.

Risk Rating: 8 (where Treasuries = 1 and gold = 10)

Full Disclosure: I dollar-average into XOM, and own shares of CAT and ADM.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 16 in the Table. Purple highlights denote Balance Sheet issues and shortfalls in TBV growth. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is current 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, September 11

Week 271 - Barron’s 500 Dividend Achievers with a Durable Competitive Advantage

Situation: Warren Buffett likes to know a company’s Tangible Book Value (TBV) before digging deeper to see if the stock price is attractive. TBV represents physical assets that can be sold. Intangibles include patents, and the dollars above book value that were paid for strategic acquisitions that enhanced the company’s brand value. TBV is the company’s brand value, and estimates can vary widely on what that’s worth. Mr. Buffett looks for steady growth of TBV (at least 8% a year) with no more than two down years in the prior decade. Such companies have what he calls a Durable Competitive Advantage (see “The Warren Buffett Stock Portfolio” by Mary Buffett and David Clark, Scribner, New York, 2011). Remember: TBV is stuff that has real value, not patents, not brand names, and not the difference between the original cost (for property, plant, and equipment) and the estimated replacement cost. 

The problem is that most large companies have negative TBV. Why? Because their managers think it is preferable to borrow money for expansion and advertising, using TBV as collateral. But some companies hold out for the old way and maintain a strong Balance Sheet. Investors gravitate toward buying stock in those companies, which often results in those stocks becoming overpriced. That means stockpickers need to dig deeper into Balance Sheets, and look at each company’s prospects for growth, to find the few remaining bargains.

Mission: Find the few Dividend Achievers that have a Durable Competitive Advantage. 

Execution: Compare 2016 & 2015 Barron’s 500 rankings using the buyupside website to determine Total Return/yr since our key benchmark (VBINX) was introduced on 9/28/1992, and the BMW Method website for the 25-yr CAGR in each stock’s mean price. Include our Balance Sheet package (see Appendix below), and calculate the Net Present Value for buying $5000 worth of each stock.

Administration: see Table.

Bottom Line: We’ve come up with 8 Dividend Achievers that have a Durable Competitive Advantage. Five look to be good long-term bets for dollar-cost averaging. Exxon Mobil (XOM) cannot pay its dividend from Free Cash Flow (FCF) because the price of oil has collapsed, and its Weighted Average Cost of Capital (WACC) still exceeds its Return On Invested Capital (ROIC) even though the price of oil has retraced 20% of its 70% loss. The two financial companies, Travelers (TRV) and Franklin Resources (BEN), are still recovering from the Lehman Panic, which pulls their 2016 Barron’s rank lower than their 2015 Barron’s rank and produces volatility in their stock prices (see Column I in the Table). 


Risk Rating: 6 (where Treasuries = 1 and gold = 10)

Full Disclosure: I dollar-average into NKE and XOM, and own shares of ROST, TJX, and CMI.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Purple highlights denote Balance Sheet issues and shortfalls in TBV growth. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found here


APPENDIX: These are our criteria for a clean Balance Sheet.

1. Total Debt:Equity is under 100% (or under 200% if the company is a regulated public utility). That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is the most important marker of a company’s “general financial condition.” That ratio needs to be under 30% (35% if a regulated public utility). Long-term debt has to either be renewed at maturity or returned to the lender. In a financial crisis, the rate of interest that bankers charge for a renewal (“rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling assets or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies mainly in the perceived value of their brand, which accountants call “goodwill” when the company is sold for more than its book value. But remember that property, plant and equipment are carried at historic cost when calculating book value. So, goodwill is more than just the perceived value of the brand. It’s the buyer’s perception of current value for patents, property, plant, and equipment. TBV may be negative for a short period after a company restructures by selling non-strategic assets to pay down LT debt. Procter & Gamble (at Line 16 in the Table) is a current example. 
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow (i.e., “cash from operations” minus capital expenditures).

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

Sunday, September 4

Week 270 - Dividend Achievers Among the Top 100 Global BrandZ

Situation: You know that brand recognition drives sales. And the managers of those highly-recognized companies know that sales will keep rising in almost any economic environment. They’d rather expand operations and buy more advertising space than tidy up their Balance Sheets, which means needing to borrow money at some point to pay the quarterly dividend. If that were to persist, investors and banks would start to withhold cash needed for strategic initiatives. 

But if the brand is strong enough, that day just never seems to arrive. Look at Colgate-Palmolive (CL) and Coca-Cola (KO). CL has negative book value, and KO shares trade at 8 times book value, instead of a reasonable 2-3 times book value, which is enough to account for intangibles (brand value, patents) and appreciation of items carried on the books at cost (property, plant and equipment).

Mission: Determine the importance of brand value vs. a clean Balance Sheet in protecting stock prices during a Bear Market.

Execution: Assemble a list of companies sponsoring the strongest global brands, specifically US companies that have raised their dividend annually for 10+ yrs (Dividend Achievers). Assess their Balance Sheets and growth trends; calculate Net Present Value (NPV) of purchasing each company’s stock.

Administration: We’ll start with the 100 Top Global BrandZ list for 2016. Brand rank and brand value for each of the 18 Dividend Achievers among them are summarized at Columns AC-AE in the Table. We compare long-term total returns in Column C (i.e., since the Vanguard Balanced Index Fund started trading on September 28, 1992) with 6-yr total returns during the 6-yr “sub-prime crisis” in Column D. We chose that “risk” period because the Case-Shiller Home Price Index (1890 = 100) peaks at 198.01 in the first quarter of 2006 and falls to a trough of 113.89 in the first quarter of 2012. That original index now has a value just over 160 but it has been sold and is now called the S&P CoreLogic Case-Shiller US National Index. The new index is normalized to have a value of 100 in January of 2000 (instead of 100 in 1890). That resets the “old” values given above to 183 for the peak in the “new” index, 140 for the trough, and 180+ for the current value. 

Home prices relate to brand values because both tend to be driven by the spending habits of high net-worth individuals. 

The US stock market has recovered even faster than home prices to reach all-time highs. The cyclically-adjusted price earnings ratio (CAPE Index) has only been this high 3 times in the past century (1929, 1999 and 2007), which is a matter of concern to the US Treasury economists. Why? Because it correlates with other predictive metrics that have also reached historic extremes.  

Our goal is to see which of the 18 companies performed better during the 6-yr crisis vs. the 24-yr period overlapping the crisis. We then examine the Balance Sheets of those companies, by using the same 4 ratios that we have used in recent blogs (see Columns Y thru AB in the Table) to see whether those resilient companies make a habit of keeping a clean Balance Sheet.  

During the 2006-2012 crisis, 6 of these 18 companies outperformed their 24-yr total return records: McDonald’s (MCD), YUM, Nike (NKE), International Business Machines (IBM), Coca-Cola (KO) and Verizon Communications (VZ). However, VZ, YUM and MCD have credit ratings of BBB+ or lower, which indicates that S&P auditors have identified Balance Sheet “issues”. NPV calculations are based on long-term rates of price appreciation and dividend growth. Those calculations show that 3 of the 6 “out-performers” (NKE, MCD and YUM) are among the 4 most rewarding stocks to own out of the 18. But NKE is the only one to be found among the 5 companies that have a clean Balance Sheet (NKE, COST, MSFT, WMT, FDX)

Bottom Line: Managers of companies with strong brands don’t have to worry much about credit ratings. Why? Because a strong brand is worth tens of billions of dollars; so, an investor or loan officer can always be found. Look no further than Yum! Brands (YUM at Line 3 in the Table). It has a sub-prime S&P credit rating (BB) vs. an excellent S&P stock rating (A+/M).  

Risk Rating: 5 (where Treasuries = 1 and gold = 10)

Full Disclosure: I dollar-average monthly into XOM, NKE, MSFT, PG and T, and also own shares of CVS, KO, WMT, and MCD.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 25 in the Table. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is the mean 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx). 

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com