Friday, December 14, 2012

Dividend Stocks With Recent CEO Buys

As a value investor, I often screen for quality stocks to buy for the long run. I am quite interested in a business that is growing and has a history of paying consistent dividends over time. The dividend yield needs to be decent, and more intriguingly, the CEOs have to be getting bullish on their own stocks. Thus, to search for those opportunities, I set up a screen with 5 main criteria: (1) the market cap is more than $1 billion, (2) minimum 10 years of paying dividends, (3) dividend yield should be at least 1%, (4) 10 year annualized EPS growth should be at least 4%, and (5) within the last 2 months, the CEO bought the company’s stock. Here are the top 3 results.
The Procter & Gamble Company (NYSE: PG) is one of the global leaders in the fast moving consumer industry, operating in more than 180 countries, with two main global business units: Beauty and Grooming, and Household Care. In the last 3 years, the biggest customer of the company has been Wal-Mart, accounting for 14%-16% of the total sales. P&G is known for paying consistent and growing dividends. In the last 10 years, the dividend has grown from $0.82 per share in 2003 to $2.14 in 2012. The current dividend yield is 3.2%. In the same period, P&G has experienced a 7% annualized growth in its earnings per share, from $1.85 to $3.66. Currently, P&G is trading at $70.22 per share, with the total market capitalization of $192.33 billion.
In October, its current Chairman and CEO, Robert McDonald, has indirectly purchased 5,564 shares in the open market at an average price of $70.14 per share, with the total transaction value of more than $390,000. Bill Ackman, an activist hedge fund manager, has acknowledged the value of P&G by putting more than 21% of his total $8.9 billion portfolio into the company as of September this year. He mentioned that P&G has been trading at a historically low multiple on depressed earnings. Currently, P&G is valued at 15.7x forward earnings.
Raymond James Financial (NYSE: RJF) is the financial holding company with more than 225 locations in the US, providing diverse financial services to clients, including asset management, capital markets, securities lending, etc. In the last 3 years, the majority of its revenue has come from Private Client Group, accounting for more than 63.5% of the total group revenue. The company has paid out consistent and increasing dividends in the last 10 years. The current dividend yield is 1.4%. Its EPS has grown from $0.78 in 2003 to $2.20 in 2012, marking an annualized growth of more than 10.9%.
In December, the CEO of Raymond James Bank purchased 165 shares at $32.13 per share, with the total transaction value of only $5,300. Jeffery Trocin, the company’s CFO, has purchased the similar small positions. However, looking deeper, several insiders have exercised their options at lower prices and simultaneously sold them in the open market. Raymond James is trading at $37.51 per share, with the total market capitalization of $5.17 billion. It is valued at 11.1x forward earnings.
UGI Corporation (NYSE: UGI), incorporated in 1991, is the distributor of propane and butane, natural gas and electric services, and other energy related services, with the majority of its income coming from the Gas Utility segment, accounting for more than 40% of its net income. In the last 10 years, UGI has increased its EPS from $1.15 to $1.76 per share, creating an annualized growth of 4.4%. Along with it, its dividend has grown from $0.57 in 2003 to $1.06 per share. The current dividend yield is 3.3%. Recently, Robert Beard, the CEO of UGI Utilities, has bought 500 shares at around $33.11 per share, with the total transaction value of only $16,555. However, like Raymond James, several insiders have been exercising their options at a lower price then selling it for the market price.
Foolish Bottom Line
The screen is just to help investors narrow down the investment opportunities. We need to dig deeper to find a suitable stocks for our own portfolios. Personally, I think the CEO buys of Raymond James and UGI seem to be symbolic only, with very low value. Among the three, income investors might consider P&G, with a global strong footprint, to hold for the long run. 

What is Berkshire Hathaway Truly Worth?

Investors like to follow every single step of Warren Buffett, the most successful investor of all time. Over the years of managing Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), he has been quite reluctant to repurchase the company’s shares in the stock market. However, in a 2011 annual letter, Buffett wrote that he would buy back stock “aggressively” at the limit price of 110% book value or lower. Recently, Berkshire Hathaway announced that it has bought 9,200 Class A shares for $131,000 per share with the total transaction value of $1.2 billion from the estate of a long-time shareholder, simultaneously raising the cap to repurchase up to 120% of the book value. Should we follow Warren Buffett into Berkshire Hathaway now? Let’s look deeper to roughly determine its intrinsic value.
Warren Buffett and his partner, Charlie Munger often mentioned that they constantly studied segment figures, as the consolidated number would obscure the earning power of each business segment. In order to valuing Berkshire Hathaway, I would divide it into two main segments: The operating business and the value of its investments, both backed by the float generated from the Insurance business. 
The Insurance Business
Berkshire Hathaway is known as an insurance company, as it is the main business operation. The insurance business generates a lot of float, the amount of cash that Berkshire Hathaway gets from writing insurance policies. If the company were breakeven with its underwriting business, the float the Berkshire Hathaway manages would be “free.” In 1970, the float was only $39 million, and in 2011, it has increased significantly up to $70.57 billion, with a compounded annual growth of more than 20%. It is magnificent that the 20% annualized growth is spreading out in more than 40 years. As of September, the float that Berkshire Hathaway reported was $72 billion.
If we conservatively assume that in the future, the Berkshire Hathaway float would grow only a fourth of its historical growth, or 5%, the company would generate only 10% return on its float, or $7.2 billion, and the discount rate was 10%. With Gordon Growth Model, the value of its insurance business would be $151.2 billion.
Annual earnings ($bil)
Infinity Growth
Discount rate
Terminal value ($bil)
Operating Businesses
The float is one of the main sources to fund Berkshire Hathaway’s investments for acquiring businesses classified into three sub-segments such as: Regulated Capital Intensive Business (Burlington Northern Santa Fe and MidAmerican Energy), Manufacturing, Service and Retail Operation; and Finance and Financial Products. Over the last 3 years (2011, 2010 and 2009), the average pre-tax earnings of the operating business (including insurance underwriting income) were $15.2 billion. Applying a 10% earning yield, the total value of all operating businesses in Berkshire Hathaway would be $152 billion.
The Fair Value of Investments
As of September, the total investments booked in Berkshire Hathaway’s balance sheet was around $133 billion. The majority of its investments were in equity securities, $87 billion, and $31 billion was invested in fixed maturity securities. Warren Buffett is famous for his stock picks, thus the $87 billion in equity securities would comprise its 38 stocks in Berkshire Hathaway’s stock portfolio. Coca-Cola (NYSE: KO) was still the biggest holdings, with 400 million shares, of nearly $15.2 billion in total value, accounting for 20.1%. Wells Fargo(NYSE: WFC), the long-term holding that Buffett first initiated his purchased in 1989, ranked the second. Berkshire Hathaway currently owned more than 422.5 million shares of the bank, with the total value of nearly $14.6 billion, accounting for 19.4% of the total portfolio.International Business Machines (NYSE: IBM), which Buffett just recently purchased last year, stood in the third place. Berkshire Hathaway bought more than 67.5 million shares of IBM, with the total value of $14 billion, accounting for 18.6% of the total portfolio. 
Now the Estimated Intrinsic Value…
Putting it all together, the intrinsic value of Berkshire Hathaway is the sum of two parts: the fair value of its investments (could instead use the value of the insurance business), and the value of its operating businesses. The insurance business was conservatively estimated to be worth $151.2 billion, the fair value of its investments was $133 billion (as of September 2012), and the estimated value of the operating businesses was $152 billion. So the intrinsic value of Berkshire Hathaway would be around $284 - $303 billion. The current enterprise value of the company is $231.41 billion. So Berkshire Hathaway is trading 23% - 31% off its intrinsic value.
Foolish Bottom Line
The move to buy back $1.2 billion from the estate of a long-time shareholder would increase the value of Berkshire Hathaway further. As of September, the book value of the company was $184.6 billion. Warren Buffett has effectively raised the repurchase cap of 120% book value, or $221.52 billion. Clearly, the intrinsic value of Berkshire Hathaway would not stand still but increase over time. As usual, investors might consider aligning with this legendary investor into Berkshire Hathaway for a long time.

$16 Million CEO Buy

Charlie Munger often advised investors to go to where there is little or no competition. That is why I like to search for investment opportunities in micro and small cap stocks, which often have little or no analyst coverage. The investment opportunity often comes when the insiders of those micro and small cap businesses buy the companies’ stocks in the market. This is currently the case with PHI Inc (NASDAQ: PHII). Al A. Gonsoulin, the Chairman and CEO, has purchased 503,665 shares at the price of $31.78 per share, with a total transaction value of more than $16 million. It accounted for 3.3% of the current total market capitalization of $482.5 million. With that huge CEO buy, should investors buy in as well?
Business Snapshot
Since 1949 PHI has been a helicopter transportation provider to the oil & gas industry, hospital for emergency services, and US governmental agencies. In the end of 2011, PHI had 259 aircraft, 167 of which were dedicated to oil & gas segment customers, including Shell Oil, BP, ConocoPhillips, ExxonMobil, and ENI Petroleum. Over the last 3 years, the majority of PHI’s revenue has come from the Oil & Gas segment, accounting for around 65% - 67% of its total revenue; whereas the Air Medical segment accounted for 31% - 33% of total revenue.
Historically Positive Operating Income and Cash Flow, but Fluctuating
In the last 10 years, on the base of increasing sales trend, PHI has managed to deliver consistently positive operating income and 9 years of net profits. However, the EPS and the operating cash flow generated have fluctuated quite a bit. 
It is a low margin business, with low return on equity. During the same time period, its margin has been hovering between 0.9% to 5.8%, and the return on equity has fluctuated in the range of 1% to 8.8%. Trailing twelve months, the margin was 2.9% and its ROE was 3.7%.
Decent Debt Level to Finance High PPE, Which Requires High CAPEX
Because PHI owns aircrafts and uses its assets to provide the services to customers, we can expect that PHI would book large PPE (including aircrafts purchases) in its balance sheet. Because of the large PPE item, in order to stay competitive PHI needs to reinvest a good portion of cash to maintain those aircraft for future services to customers. Thus, the free cash flow would be dampened due to those high capital expenditures. Indeed, over the past 10 years, even though with consistently positive operating cash flow, the free cash flow has been negative for 10 years because of high capital expenditure.  
So how does PHI finance its aircraft? The company has financed its aircraft via both equity and debt financing; as of September 2012, it had nearly $500 million in stockholders’ equity, only $74 million in cash, and nearly $370 million in long-term debt. Thus, the low net margin was due to two main factors: the depreciation of the aircraft and the interest expenses it had to pay yearly.
Not the Most Attractive Candidates
Compared to its peers, including Air Methods Corporation (NASDAQ: AIRM) and Bristow Group (NYSE: BRS), PHI is not an outstanding performer.

Net margin (%)
ROIC (%)
Div yield (%)
Its net margin and return on invested capital is the lowest among the three, and PHI is not paying any dividends currently. Only Bristow is paying 1.4% dividend yield to its shareholders. Air Methods enjoyed the highest margin and return, 10.16% and 11.24%, respectively, much higher than those of Bristow and PHI. It is also valued at the cheapest valuation, only 7.87x EV/EBITDA, whereas it’s 8.4x for PHI and 10x for Bristow.
My Foolish Take
Maybe Gonsoulin, the chairman and CEO, is seeing something different in the company. However, Air Methods is the most attractive company among the three in terms of operating figures and financial valuations.

Are These Two Global Banks a Buy After Legal Charges?

Large legal fees have just come from US financial authorities for global British banksStandard Chartered PLC (LSE: STAN) and HSBC Holdings PLC (NYSE: HBC). Standard Chartered has agreed to pay the fine of $327 million to settle charges of money laundering from 2001 to 2007. HSBC took a much harder hit, of up to $1.9 billion, including $1.25 billion in forfeiture and $655 million in civil penalties. Let’s look deeper into how those charges will affect each banks’ earnings.
Standard Chartered Bank focuses its operation in 24 emerging markets, including Asia, Africa, and the Middle East, with the majority of its operating income coming from Hong Kong, Singapore, Korea, India, etc. Out of $10.15 billion in total net interest income in 2011, $5.52 billion was from wholesale banking and $4.63 billion was from consumer banking, nearly 20% lower than wholesale net interest income. Within the consumer banking segment, the majority of its income came from cards, personal loans, and unsecured lending, whereas the other areas such as wealth management, deposits and mortgaged and auto finance were in the range of $1.27 - $1.48 billion in operating income. In the wholesale banking segment, financial markets accounted for the majority of operating income, nearly $3.7 billion, or about 55% of total wholesale banking income.
In the last 2 years, the bank’s net interest margin has been quite decent, around 2.2% - 2.3%. The decent net interest margin was sustained because  the majority of deposits were interest-bearing current accounts, savings deposits ($150 billion), and time deposits ($193 billion). In addition, it is interesting to see that Standard Charted has managed to diversify their loans somehow similarly to individuals and wholesale banking in several areas, including mortgages, commerce, financial, manufacturing, and communication. In 2011, Standard Chartered booked more than $4.9 billion in profit. Thus, the $327 million fine would represent only 6.6% of its total 2011 profit. In addition, Standard Chartered has consistently delivered sustainable profit and return on equity. Trailing twelve months, the return on assets was 0.86% and the return on equity was 12.15%. 
Though the fine for Standard Chartered would not affect the bank’s profit much, HSBC took a much harder hit. HSBC was fined $1.9 billion, whereas its net profit in 2011 was nearly $18 billion. Thus, the fine represents nearly 11% of its 2011 profit, a much larger percentage than Standard Chartered’s. Like its peer Standard Chartered, the majority of profits come from Hong Kong and the other parts of Asia. In the last 2 years, HSBC’s net interest margin is a bit higher than that of Standard Chartered’s; 2.51% in 2011, and 2.68% in 2010. However, in terms of profitability, the return generated on assets and equity have been lower than its peer in the recent years. Trailing twelve months, the return on assets was 0.58% and the return on equity was only 9.3%. Those two banks have been a consistent dividend payers over time. HSBC is paying shareholders a dividend yield of 4%, whereas Standard Chartered is paying 3.3%.
It is interesting to see that HSBC even edged higher after the legal fine announcement. Since the middle of November, HSBC has climbed from $47.50 $51.84 per share currently. Standard Chartered took the hit after climbed from $22.56 to $24.10 per share in the beginning of December. It decreased to $23.83 currently.
My Foolish Take
Those legal charges came quite unexpectedly. We would expect the shares of those two banks would move lower after the news. With global footprints, especially in emerging parts of the world, those two banks look destined to be long-term winners. Investors might wait for lower movement of the share prices to initiate some positions.   

Should We Worry About Debt-Financed Special Dividends?

Before year end, many major corporations are busy preparing special dividends for shareholders, in order to avoid the effects of the “fiscal cliff” next year. They choose different methods of paying dividends, either with their cash on hands or with the newly issued debts. It would be advantageous for the company as it can take advantage of ultra low interest rates. However, investors need to be careful, as debt could be advantageous to one company, but it might be harmful to another. It depends on the business operation, existing leverage, debt terms, and return on the employed cash to determine whether it’s advantageous or harmful. 
Costco (NASDAQ: COST) is an outstanding example of issuing debts to pay dividends. For Costco, the debt is divided into three tranches due in December 2015, 2017 and 2019, with an equivalent amount of principals. The interest is low, at only 0.65%, 1.125%, and 1.7%, respectively, much lower than its return on invested capital of 9.1% - 12.25% in the last 10 years. By taking $3.5 billion in debt on its balance sheet, the total amount of long-term debt is estimated to rise to $4.9 billion, with the D/E around only 0.4x. In addition, this amount of debt would cost Costco $40.58 million more in terms of interest expense annually. The interest coverage would still quite comfortable for Costco, of 20.3x. So Costco’s debt issuance to pay special dividend is the right act for both shareholders and the company itself.
Brown-Forman Corporation (NYSE: BF-A) (NYSE: BF-B), the alcoholic beverage manufacturer, has announced that it will pay a special dividend of $4 per share. The special dividend would be paid on Dec. 27 to shareholders on record as of Dec. 12. With more than 210 million shares outstanding, the amount for the special dividend is approximately $815 million. Interestingly, Brown-Forman would finance this special dividend amount with its cash and newly issued debts. Cash to be used would be $100 million, and the newly issued senior unsecured notes would be $750 million for this purpose, in three equal tranches due in Jan 2018, 2023, and 2043, with the interest rates of 1%, 2,25%, and 3.75%, respectively.
As of October 2012, Brown-Format had around $501 million in long-term debt. With the newly issued debt, the total long-term debt would increase to $1.25 billion. The debt/equity ratio at that time would be 0.53x. The interest expense would increase by nearly $18.13 million to about $50 million. With the trailing twelve month operating income of $840 million, the interest coverage would be very comfortable at 16.8x. 
Furthermore, in the last 10 years Brown-Forman has consistently delivered a double-digit return on invested capital, in the range of 15% - 21.1%. Trailing twelve months, its ROIC was nearly 20%. So it is better for both company and shareholders if the company employs cash in the business operation to earn a high return on invested capital. So issuing low cost debts to pay dividends is a good move, which ultimately benefit Brown-Forman’s shareholders. 
Other companies, such as Limited Brands (NYSE: LTD) and Carnival Corporation (NYSE:CCL), also announced their special dividends of $3 per share and $0.5 per share, respectively. For Limited Brands, the special dividend would cost  around $864 million, higher than its $547 million cash on hand. So I expect that Limited Brands would issue debt to partially fund for its special dividends. With negative equity, increasing amounts of long-term debt over time, and fluctuating operating performance, investors would expose to more risks if more debt were issued.
For Carnival, the special dividend would be amount to more than $388 million, less than its cash on hand at $568 million as of August this year. However, it also issued $500 million in notes due 2017 for general corporate purposes (might include special dividend payment). After issuance, the long-term debt would increase to nearly $8.8 billion, accounting for only 36.4% of its equity, a comfortable level. With the dominant market leader position (50% global market share), this largest global cruise operator would be in a very good shape after special dividends and only a small amount of newly issued debts.
Foolish Bottom Line
Investors couldn’t go wrong when investing in the well-established market leaders. Looking deeper, Costco, Brown-Forman, and Carnival took advantage of the low cost debt financing to finance special dividends and general corporate purposes while maintaining strong balance sheets to further enhance shareholders’ value.

Which Airline Should You Invest In?

“If you want to be a millionaire, start with a billion dollars and launch a new airline.” – Richard Branson 
Indeed, Warren Buffett, the most successful investor of all time, has the same opinion about the airline industry. Along with its significant growth over a century, the airline industry has brought negative aggregate value for investors. Buffett commented that the growth of the airline industry, which demanded huge capital to fuel that growth, would earn little or no money. Indeed, the business of filling seats with fixed huge operating costs is no fun for investors at all. However, I just come across one interesting airline, which carries no debt and has been generating positive cash flow for the last 3 years. It is Spirit Airlines (NASDAQ:SAVE)
Operate as its stock symbol indicates
Like its stock symbol, SAVE, Spirit Airlines is famous for its ultra-low cost (UCLL) strategy for passengers flying in the US, the Caribbean, and Latin America regions, serving 48 airports. Because of its low cost model since 2007, it has maintained to be profitable in the last 5 years, even during the period of fuel price volatility as well as economic recession. The UCLL model has enabled Spirit Airlines to offer low airfare to passengers. The average base fare was reported to be around $77-$85 in the period of 2009-2011. Indeed, as Warren Buffett mentioned, the airline industry offered customers a commodity-like product. It is a business of filling seats, and customers would like to pay the lowest cost to fly, regardless of the airline brand. As any other commodity business, the company with the lowest operating cost will be the winner. In the last 3 years, the operating margin of Spirit Airlines has been in the range of 8.8% - 15.9%.
Lowest cost among low-cost airlines
Its operating margin is much higher than those of other low cost airlines including Southwest Airlines (NYSE: LUV) and JetBlue Airways (NASDAQ: JBLU). 3 years average, Spirit Airlines’ operating margin is around 12.74%. The 3-year average operating margin of Southwest Airlines is only 5%, whereas JetBlue’s is 8.15%. In addition, Spirit Airlines enjoyed the highest double-digit return on invested capital compared to the other two airlines.

ROIC (%)
As it can be seen above, Spirit Airlines’ return on invested capital is five times higher than that of Southwest Airlines and more than seven times higher than that of JetBlue. Interestingly, it is able to achieve that high return without any help of leverage, whereas Southwest Airlines’ D/E is 0.4x and JetBlue’s is 1.4x. Indeed, Spirit Airlines has a strong balance sheet, with a debt-free operation. As of September 2012, it had $560 million in stockholders’ equity, nearly $400 million in cash and no debt.
Its operating efficiency has reflected in the share price. Since the middle of 2011, Spirit Airlines has outperformed the other two peers by wide margins. 
Spirit Airlines has returned more than 48% in two years and a half, whereas Southwest and JetBlue experienced decline in the same period.
Currently, Spirit Airlines is trading at $17.14 per share, with the total market capitalization of $1.21 billion. The market is valuing Spirit Airlines at only 7.7x forward earnings. It is cheaper than Southwest Airlines’ valuation of 9.4x forward P/E but a little more expensive than JetBlue’s of 6.3x forward earnings. 
My Foolish Take
Spirit Airlines, with far more superior return as well as operating margin, should receive far higher valuation than Southwest and JetBlue. At the current valuation, I think the market undervalues the business intrinsic value. 

Victoria Secret's Owner is Not a Buy After Special Dividend

A specialty retailer of personal care products, accessories, and intimate apparel for women just announced a special dividend of $3 per share on the existing yield of 2%. The special dividend would give investors nearly 5.8%, on the trading price of $51.96 after hours. With more than 288 million shares outstanding, the special dividend would be $864 million, higher than the company's cash on hand at $547 million. That retailer is Limited Brands (NYSE:LTD), the owner of Victoria’s Secret, Henri Bendel, La Senza, etc. Is this stock attractive after its special dividend announcement? 
Historical market performance
It seems like the women spiced it up! They love the brands so much that the stock has outperformed its peers, including The Gap (NYSE: GPS) and Hanesbrands (NYSE: HBI), by a wide margin. 
The total return is made by the combination of capital gains return and dividends return. In the last 5 years, including dividends, Limited Brands has gained by more than 260% for its shareholders, whereas Gap and Hanesbrands only gained 63% and 21%, respectively.
Back up by Consistently Positive But Fluctuating Performance
In the last 10 years, Limited Brands has managed to deliver consistent positive net income and generate positive free cash flow.
USD million
We can see that in the previous 10 years, Limited Brands experienced a fluctuating performance with ups and downs in revenue, EPS, and free cash flow. The 10-year growth of revenue, EPS, and free cash flow are 2%, 10.9%, and 5.5%, respectively.  Interestingly, the number of shares outstanding has been reduced over the same period, from 522 million shares in 2002 to only 288 million shares currently. It means that over time, Limited Brands has kept retiring its shares in the market. In the last 5 years, it has spent more than $3.5 billion to repurchase its shares.
Balance sheet big changes
In the last several years, there have been some big changes in the balance sheet. The total stockholders’ equity has been significantly reduced from $2.2 billion in 2008 to only $137 million in the beginning of 2012, and it even decreased to -$515 million. Along with the huge decline in total stockholders’ equity, the long-term debt has increased from $2.9 billion to nearly $4.5 billion. It seems that Limited Brands has shifted its capital structure from equity financing to debt financing recently. With that recent trend, I would expect that Limited Brands would partly rely on debt financing to pay the recently announced special dividends, along with its cash on hands.
Peers Valuation
Limited Brands is trading at $50.66 per share, with a total market capitalization of $14.61 billion. The market is valuing Limited Brands at 9.52x EV/EBITDA. Hanesbrands is valued at a little higher than Limited Brands, at 10.68x EV/EBITDA. Gap is the cheapest among the three, with only 6.41x EV/EBITDA. Limited Brands is paying the highest dividend yield among the three (2%), whereas Gap is paying 1.6% and Hanesbrands is not paying any dividend currently.
Foolish Bottom Line
With the tendency to rely more on debt financing, historical fluctuating performance and the not so low valuation, Limited Brands is not a stock of choice even with the special dividend. Among the three, I would rather pick Gap because of its cheap valuation and the decent dividend yield.

This Fastener Supplier is Still Pricey

Fastenal Company (NASDAQ: FAST) has seen some mixed signals of insider transactions since November. I’ve seen several articles mentioning that Daniel Florness, the company’s CFO, just bought 2,645 shares at an average price of $41.50 per share, with the total transaction value of nearly $110,000. However, dated in November, Robert Kierlin, the Independent Chairman, sold 200,000 shares, with the total transaction value of more than $8.3 million. So are insiders bullish or bearish?
Business Snapshot
Fastenal sells fasteners and other industrial and construction supplies in more than 2,500 stores globally, with the majority of the stores located in the US and Canada, via 14 distributions centers in North America. The product, which brought the majority of the revenue to Fastenal, is a threaded fastener, accounting for around 42% of the total sales in 2011. The good thing is that Fastenal sources its product from a diverse base of suppliers as well as customers. No single supplier took more than 5% of the company’s total purchases in 2011, and no single customer took more than 10% of the total revenue in the last 3 years. 
A decade of good growth and fascinating return
In the last 10 years, Fastenal has experienced continuous growth in top line, bottom line and its free cash flow.
In the last 10 years, its revenue has more than doubled, whereas its EPS has increased more than fourfold. The most impressive growth lies in its free cash flow. In 2004, the company generated only $5 million in free cash flow. Trailing twelve months in the third quarter of 2012, the free cash flow has increased up to $248 million.
Furthermore, in the last 10 years, Fastenal has demonstrated consistent double-digit return on equity and return on assets, while using little financial leverage. 

ROA (%)
Financial Leverage
ROE (%)
What a sustainable performance! The 10-year average ROA and ROE are18.7% and 21.3%, respectively. Trailing twelve months, its ROE, which is equivalent to its ROIC, is 26.64%.
The high return over time has been achieved without any leverage. As of September 2012, it had $1.66 billion in stockholders’ equity, $223 million in cash, and no debt. Currently, Fastenal is trading at $42.06 per share, with a total market capitalization of $12.46 billion.
Peers comparison
Trailing twelve months, Fastenal has the highest operating margin (21%) among its peers, including MSC Industrial Direct (NYSE: MSM)  (18%) and W.W.Grainger (NYSE: GWW)(13%). The operating margins of all three companies are higher than that of the industry average, only 8%. In addition, all three are paying somewhat equivalent dividend yields. Fastenal is paying a 1.8% dividend yield, whereas W.W.Grainger is paying 1.6% and MSC is paying a 1.5% yield. Among the three, Fastenal has the most expensive valuation, of 17.3x EV/EBITDA. The cheapest belongs to MSC, at only 9.4x EV/EBITDA, whereas the market is valuing W.W.Grainger at 10.8 EV/EBITDA.
Foolish Bottom Line
Indeed, Fastenal has delivered consistent returns over times for its business and for its investors. The other two peers also had a similar track record of consistent performance. However, Fastenal seems to be pricey at the moment, compared to its peers. I’d rather wait for more pull back in the stock before initiating any positions.

Buy This Specialty Retailer for a High Growth Portfolio

Francesca’s Holdings Corp (NASDAQ: FRAN) just received the upgrade from Jefferies from Hold to Buy with a price target of $38 per share, due to its lower valuation, new management, and attractive operating characteristics. It is currently trading at only $23.83 per share. This means that Jefferies put a high price target of nearly 60% above its current price. It sounds attractive, so should we follow?
Business overview
Francesca is considered to be one of the fastest growing specialty retailers in the US, with upscale boutiques for female customers from 18-35 years old. Apparel has brought the majority of revenue to the company, with 51% of its net sales; this segment includes dresses, Tops, Denim, Pants, Skirts, etc. The second largest revenue source was Jewelry, with 20% of net sales. Accessories and Gifts accounted for 16% and 13% of the total revenue, respectively.
Francesca doesn’t own a manufacturing facility, but rather source its merchandise from more than 200 vendors. While no single vendor took more than 15% of its merchandise, the top 10 vendors accounted for 42% of its total merchandise in 2011. Interestingly, the largest and second largest vendors of Francesca, KJK Trading Corporation and Stony Leather, were owned by the retailer’s founders’ relatives. KJK Trading is owned by a brother-in-law of one of Francesca’s founders, and Stoney was owned by two of Francesca’s other founders. 
Growth Story and Growing Balance Sheet Strength
In the last 5 years, Francesca has grown its Boutiques rapidly. In 2007, it had only 78 boutiques including Mall and Lifestyle centers. In 2011, the number of Boutiques has increased to 283. The total sales per average square foot also increased from $401 in 2007 to $554 in 2011. During the last 3 years, it consistently experienced positive comparable sales growth; 9.8% in 2009, 15.2% in 2010, and 10.4% in 2011.
Furthermore, its revenue, net income, EPS, and cash flow have increased significantly during the last 3 years as well. 
USD million
Net Income
The negative net income in 2009 was due to a $62 million payment for a preferred dividend; otherwise the net income in 2009 would be $11 million. 
In addition to the recent superior growth history, the balance sheet looks strong currently. As of July 2012, it booked $43 million in stockholders’ equity, $7 million in cash, only $5 million in long-term debt. Notably, the firm incurred $88 million in long-term debt in 2010, which it has reduced significantly quarter by quarter.
Unique boutique strategy
Looking deeper, Francesca has a unique strategy for its boutiques. It’s called board and shallow merchandising strategy, enabling the company to customize to ever changing shoppers’ preferences. The retailer would have a big merchandise selection but with small inventory, when a particular item is sold out, it would never be sold again. That triggers the sense of exclusivity and freshness to shoppers. So they just keep coming back to the boutiques to check out new items, and they urge to buy, as they know they can’t buy that item again when it is sold out.
Comparable valuation
Compared to its peers Ann Inc (NYSE: ANN) and Urban Outfitters (NASDAQ: URBN), Francesca is the fastest growing retailer. The quarterly revenue year-over-year growth of Francesca was 44%, whereas it was only 9% for Ann and 14% for Urban Outfitters. In terms of earnings valuation, Ann seems to be cheapest among the three, with 15.55x trailing P/E; whereas Urban Outfitters is the most expensive, with 27.9x P/E, and Francesca is valued at 26.27x P/E. However, if we factor in the potential growth, Francesca is the cheapest, with only 0.77x PEG, whereas Ann and Urban Outfitters are valued at 1.23x PEG and 1.38x PEG, respectively.
Foolish Bottom Line
Francesca seems to be the good aggressive growth choice for investors. With the unique merchandise strategy and small boutique stores, Francesca has significantly higher margins compared to its peers due to less rental, staff, and inventory expenses. However, with nearly 14x EV/EBITDA, it seems a little pricey. Personally, I think investors could put a small portion of their portfolio to ride the growth of this boutique retailer.