Monday, January 7, 2013

Bill Ackman's Analysis on Herbalife (Last Part)

This is the third article in the 3-article series to recoup Bill Ackman’s analysis on one of his highest conviction investments he has ever made, shorting Herbalife (NYSE: HLF). In the previous articles, Ackman has pointed out the irrationality of Herbalife for its 30+ year extremely high growth and the significant volume even with a much higher price than other peers. He also mentioned four adjustments needed to be made to truly reflect Herbalife’s business models in terms of, retail price, internal consumption, retail profits and recruiting rewards. This article will summarize Ackman’s analysis on the company’s statements about supervisor’s compensation, the real “success” of Herbalife’s distributors and several other red flags.
5 Deceptions…
The question of why the company sold many commodity products without advertisement, at the very high price, has been raised. The answer was because it bundled its products with a business opportunity. A pyramid scheme as Ackman mentioned in his presentation was “the organization is deemed a pyramid scheme if the participants obtain their monetary benefits primarily from recruitment rather than the sale of goods and services to consumers.” He went on with the list of 5 deceptions that Herbalife has made.
First, in the table of active leaders and average earnings in different distributor’s levels, Ackman claimed that the company has moved 93% of its US distributors with the base earning of $0, off the table. Second, the “gross” earnings were shown in the average earnings, not the net earnings. Distributors were additionally charged with a lot of expenses, Ackman said following the former Herbalife non-sales leader’s blog, the expense was around $2,000 in 3 months for website setup, Decision Package, etc., not including the money to purchase Herbalife’s products. Third, he said that Herbalife did “cherry-picking active leaders” with the highest earnings. Fourth, the company overstated that over 25% of distributors would reach
Supervisors, however, data have shown the percentage of sales leader over total distributors has been lower than 25% for the last 4 years. And the last deception Ackman pointed out was the difficulty to get to the top. He gave out the example of Ireland, Herbalife began its business in this country in 2000, and in ten years, no one had successfully got in the Millionaire Team. In the period of 2004-2009, Bill Ackman estimated that the chance to get into the President Team would be 1/10,000.
Highest Payout to the Top Distributors
Compared with other peers in the MLM industry including Nu Skin (NYSE: NUS) andTupperware Brands (NYSE: TUP) and Medifast (NYSE: MED), Herbalife was paying the highest commissions for its top 1% distributors. Medifast was paying only 31% of total commissions to its top 1% distributors, whereas the rate was 49% for Tupperware, Nu Skin was quite high, at 80%, but not as high as Herbalife, of 88%. Ackman laid out the comparison of the distribution compensation of Herbalife and Avon Products (NYSE: AVP). Avon’s royalties were descending from the first to the third level, and the recruiting rewards stop at the fourth level. Differently, Herbalife was paying flat royalties, in addition, the recruiting rewards were added up by the Production Bonus and Mark Huges bonus. Thus, the total payout of Avon was 14.7%, whereas Herbalife had the total payout of 23%. 
Why Herbalife Could Keep Going in More Than 30 years?
Many people might wonder if it was a pyramid scheme, why it has kept operating and expanding for the last 30 years? Ackman said that it just kept entering new countries. In any countries, Herbalife experienced the “pop and drop” phenomenon. It means the sales in a new country could “pop” significantly, then “drop,” then Herbalife didn’t disclose the sales in that country separately. The example was Japan after 2005, Israel after 2001, and Spain, France, Germany after 2001, etc. In addition, in order to make earnings smooth, Herbalife re-classified the countries several times in the last 5 years, particularly in 2006, when South America was grouped in one reporting region with Southeast Asia. Ackman thought that the future growth might be very limited for the company, as in the 2008-2011, Herbalife has entered 14 countries with an average GDP per capita of more than $4,200, including Lebanon, Georgia, Mongolia, Ghana, Vietnam, Ecuador, etc.
Foolish Bottom Line
I myself find the presentation quite fascinating. Bill Ackman has dug deeply into the facts and figures for his short-the-stock thesis. Different investors might have different views, different opinions. It is worthwhile for us to be informed, and to gather all pros and cons about each investment we would like to establish positions. On the last note, Bill Ackman pledged that he would donate all the personal after-tax profit from Herbalife’s trade to charity. (Investors might see the full presentation on the Business Insider website.) 

Bill Ackman's Analysis on Herbalife (Part II)

Following the previous article on Bill Ackman’s analysis of Herbalife's (NYSE: HLF)tremendous growth within the previous 30 years and the irrationality of having a high product price with little R&D and marketing expenses, this article will summarize his analysis on the company’s business and remuneration models. Bill Ackman has shown that Herbalife claimed retail made up around two thirds of the profit for the distributors in the company, to convince that the retail opportunity was larger than recruiting rewards. There are four points, which should be made clear: (1) suggested retail price and actual retail price, (2) internal consumption and retail profit, (3) wholesale commissions and retail profits, and (4) the recruiting rewards were included in SG&A.
Suggested and Actual Retail Price
The surcharge of 7% was applied to all distributors of the company for packaging and handing on the Suggested Retail Price from Herbalife. In some other markets, more fees were charged such as administrative fees, freight charge, etc. Thus, in order to make a profit, all those additional charges need to be passed through to the end users. That would push up the true suggested retail price for distributors in order to earn “full retail profit.” However, according to Ackman, consumers can go online and purchase the products at around a 40% discount in the adjusted suggested retail price. One of its peers, GNC Holdings' (NYSE:GNC) products was identified to be sold on eBay for a 2% premium to the adjusted suggested retail price. In addition, GNC’s Lean Shake products were sold at similar prices to Herbalife’s Formula 1 (750g), which was more proof that those products were commodities. He came to conclusion that the Suggested Retail Price was artificially high, which was not related to the real price to be sold to the end users.
Internal Consumption and Retail Consumption
Internal consumption means the sales to the distributors including sales leader and non-sales leaders, whereas the retail consumption means the sales to the retail customers. David Einhorn has asked Herbalife about the sale made outside the network and sales inside the distributor base. Ackman quoted Herbalife’s answer:
We don’t track this number and do not believe it is relevant to the business or investors.”
Ackman wrote that the company believed that the majority of the distributors signed up just to purchase the products at the minimum discount of 25%. The model sounded similar to the membership model of Costco Wholesale (NASDAQ: COST). Indeed, in 2009, the CFO has mentioned that the two models were similar. However, comparing between Costco’s membership, GNC’s membership and Herbalife’s membership, it was quite different.

Source: Business Insiders
The renewal rate for Herbalife was said to be around 10%, whereas Costco’s was 90% and GNC’s was 70%. The other two companies didn’t require any paperwork, whereas Herbalife offered a very long distributor agreement. If the products get returned, Herbalife’s membership would be lost, whereas the product return policies of the other two was much more flexible. 
Retail Profit and Wholesale Commissions
Bill Ackman pointed out that when the product was purchased directly from Herbalife from a non-sales leader, the transaction was accounted as if the sales leader purchased the product. Thus, the Wholesale commissions for sales leader was hidden in the Distributor Allowances in the company’s P&L. It was to increase the “retail profit” amount. According to Ackman, the Wholesale commissions should be accounted as recruiting rewards, and all the commissions paid to upline sales leaders should be accounted as operating expenses of the company.
SG&A Item Included Recruiting Rewards
In Herbalife’s income statement, Ackman said that the Distributor Allowances item included the Retail Profit and the Wholesale Commission, Royalty Overrides included Royalty Overrides, Production Bonus and Mark Huges Bonus, and SG&A might include Vacations and Promotions. Since 1997, the SG&A and the Royalty Overrides have moved side by side with each other. It was disclosed that, 15% of net sales in 2007, or 54% of the SG&A was “Distributor Facing” expenses in 2008 Investor Day of the company, and actually “Distributor Facing” was sort of Royalty Overrides.
In conclusion, Ackman came to the conclusion that with the reasonable assumptions, Herbalife distributors could earn an extremely small amount of profit, around $5 per month. In addition, whereas Herbalife’s presentation showed that the payout for recruiting rewards were only 31%, but when the internal consumption, retail price adjustment, wholesale commission and SG&A were taken into account, the recruiting reward payout was as high as 92%.
In the coming article, we will see how Ackman pointed out the misleading figures in the company’s statement about US supervisors’ compensation, the Herbalife business is actually really easy or not, and several red flags compared to other MLM’s companies. 

Bill Ackman's Analysis on Herbalife (Part I)

Bill Ackman recently attacked Herbalife (NYSE: HLF) aggressively. In the interview with Bloomberg, he made it public that he shorted an enormous amount of Herbalife’s stock, more than 20 million shares, with the total position value of more than $1 billion. He believed that the company was a pyramid scheme based on “very careful and thorough analysis of every fact.” He said: “This is the highest conviction I have ever had about any investment I have ever made, full stop.” I had a chance to watch the live webcast of his presentation. He gave all the findings in a 342-slide presentation starting with the question: “Who Wants to be a Millionaire?”
Tremendous Growth and Extremely High Margin
Like other multilevel marketing, Herbalife bundled its products with business opportunities to make money and get rich. Since 1980, the “retail sales” of the company have grown from $2 million to $5.4 billion in 2011, marking tremendous annualized growth of 29% in more than 30 years. Ackman compared it with several other well-known consumer and household product companies with long history legacies such as Church & Dwight (NYSE: CHD) andEnergizer Holdings (NYSE: ENR). Both Church & Dwight and Energizer were founded in the 19th century, with trailing twelve months revenue of $2.8 billion and $4.6 billion respectively, and they had enterprise value of $7.2 billion and $6.7 billion respectively. Herbalife was founded in 1980, and it has already generated revenue of $3.9 billion with total enterprise value (pre-Einhorn question) of $8.1 billion. Over the last 12 months, the other two companies had a gross margin of 43.9% and 46.8%, but Herbalife enjoyed a questionably high gross margin, of 80.2%, and that raised the question.
Significant Volume on High Price Products
Interestingly, Bill Ackman pointed out that Herbalife Formula 1, the nutritional powder reached sales of 6 times higher than that of Ensure (Abbott), Slim-fast (Unilever) and Lean Shake ofGNC combined. It might be because the products were much cheaper. However, he showed that the retail price per 200 calorie serving of Formula 1 was $2.87, much higher than Ensure, of $1.03, Slim-Fast, of $1.04 and Lean Shake, of $1.74. In addition, the Multivitamin tablet was priced at $0.26 per tablet for Herbalife, more than triple the average price among Centrum, One a day, of only $0.08. 
… Not a Product Company
The higher retail price was absurd because Herbalife’s products were not “proprietary products for which there is limited competition,” it also didn’t spend much money on advertisement. The company said it did a lot of research and development in the company, but Ackman pointed out from the company’s report that the R&D expenses were not material and the company had only 1 US patent relating to the herbal supplement for weight loss. Furthermore, unlike other consumer companies, which their products were often advertised to the end users, Herbalife advertised its own name, not its products. Ackman quoted the Herbalife Annual Report in 2005:
“We generally do not target promotions or advertising at any particular product or brand. Our significant promotions are generally aimed at generating increased levels of recruiting and retention of distributors.”
Ackman went to the conclusion that Herbalife was not a product company, but a company to sell business opportunity.

Source: Business Insider
In the next article, I would go on to recoup Ackman’s analysis of the compensation scheme and Herbalife’s business models. Different investors might have different opinions and perspectives. It is worthwhile for investors like us to consider all the facts and figures from all aspects to determine our own course of actions. 

This Leading Pharmaceutical Business Is a Buy

In the third quarter, Walgreen (NYSE: WAG) has been a target of several famous investors including George Soros, Tom Gayner, and Leon Cooperman. For George Soros and Leon Cooperman, Walgreen is a new buy for them, with 3.6 million shares and 1.88 million shares respectively. Tom Gayner increased his holdings of Walgreen by nearly 150%, to 2.15 million shares. It seems that all three investment gurus have seen the value of this pharmaceutical retailer going forward. What do they see in Walgreen? Should investors buy Walgreen for themselves?
Business snapshot
Walgreen is the biggest pharmaceutical store chain in the US, providing shoppers with prescription and non-prescription drugs, household foods, convenience, personal care, beauty care, and fresh foods. In fiscal 2012, Walgreen owned total 8,385 stores including 7,930 Drugstores, 11 Specialty Pharmacies, 366 Worksite Health and Wellness Centers, 76 Infusion and Respiratory Services Facilities, and 2 Mail Service Facilities. The majority of its revenue derived from the sale of prescription drugs, accounting for around 63% of total sales. The second and third biggest revenue sources were general merchandise, of 25%, and non-prescription drugs, of 12%, respectively.
An Acquisition to Create the Global Pharmaceutical Retailing Empire
Walgreen has expanded its business in Europe and several emerging markets through an acquisition of Alliance Boots GmbH to own a piece of the retailer operating in 11 countries, with more than 3,330 health and beauty retail stores, including pharmacies in more than 3,200 stores. In August, 45% of Alliance Boots belonged to Walgreen with the price of $6.7 billion; in addition, Walgreen had a call option to purchase the rest of 55% in 6-month period from February 2015. 
Interestingly, Mr. Stefano Pessina mentioned that he would not take any money out of the deal, but instead would own 8% of Walgreen. That signals his belief in the future of Walgreen after the deal. Indeed, the deal would give Walgreen the strong foundation of Alliance Boots’ experience in emerging markets such as Latin America and China. The purchase of Alliance Boots has created the largest global pharmacy business ever with 11,000 stores in 12 countries, nearly 50% higher than the store count of its rival CVS Caremark (NYSE: CVS), with around 7,400 retail stores, and more than two times higher than the store count of Rite Aid NYSE: RAD), with around 4,600 stores.
Because the stake in Alliance Boots was booked into Walgreen’s financial statement in the form of equity method (one-line reporting), thus, only the net income and the total equity would reflected the 45% of Alliance Boots’ net income and total equity. Because of the equity method accounting, we would expect in the near future, Walgreen’s net margin will improve because of higher net income on the same level of sales. 
Cheap Valuation and Highest Yield
Among the three peers including Walgreen, CVS and Rite Aid, CVS seems to have the strongest performance in the stock performance year-to-date, with 18.5% gain, whereas Walgreen ranks the second, with 12.6% gain. Rite Aid experienced a loss of nearly 20% in the market value. Rite Aid is the smallest company in terms of market capitalization, of nearly $940 million. It hasn’t paid any dividends in the last 10 years, whereas the dividend yield of Walgreen is 2.7%. Even after the dividend increase to 90 cents per share, CVS yield would only be around 1.83%, lower than that of Walgreen. At the current price, Walgreen is valued at 8.3x EV/EBITDA, CVS is valued at a comparable valuation, of 8.21x EV multiples, Rite Aid is the most expensive, with 10.72x EV/EBITDA.
My Foolish Take
With a decent valuation, highest dividend yield among its peers, and the global market leading position in the pharmaceutical retailing business, Walgreen is the stock of choice for long-term value and income investors. Investors might feel more confident when those investment gurus showed their bullish attitude towards the stock recently.

Buy These Large-Cap Stocks for Sustainable Income

Following the recent article relating to the search for large cap dividend stocks, which have a record of paying sustainable dividends with decent yields, this article will unveil three more stocks with the similar screening criteria but a bit lower standard in terms of growth and yield. The screen has been run with five main criteria: (1) a minimum 10 years of historical dividends, (2) market cap more than $10 billion, (3) dividend yield is at least 3%, (4) payout ratio is at maximum 50%, and (5) the 10-year dividend growth is at least 5%. We have discovered Intel, Lockheed Martin and AstraZeneca in the previous posts, and we will discover three more in this article. Interestingly, those 3 companies are based outside of the US.
Bank of Montreal (NYSE: BMO), or BMO Financial Group, has nearly two centuries of operation in the financial services area. It is considered to be the second largest Canadian bank in terms of number of branches in North America. As of fourth quarter 2012, BMO had a total $532 billion in total assets and $328.3 billion in total deposits, with 1,571 branches. The majority of BMO’s net income was from personal and commercial banking, of $3.92 billion, accounting for 61% of the total net income. BMO is reported to have the longest dividend payment record in any company in Canada, of 184 years. In the last 10 years, the dividend payment has grown from $1.33 in 2003 to $2.86 in 2011, marking annualized growth of nearly 8% for the last 10 years. Currently, BMO is trading at $60.86 per share, with a total market capitalization of more than $39.6 billion. The current dividend yield is 4.6%, with the payout ratio of nearly 46%.
Royal Bank of Canada (NYSE: RY) is the largest bank in Canada with operations in 51 countries and 15 million clients worldwide. As of fourth quarter 2012, the bank had around $836 billion in assets and nearly $515 billion in deposits. Like BMO, the majority of its earnings were from personal and commercial banking, accounting for 56% of total earnings in 2012. The bank has reported that it has a target of payout ratio in the range of 40%-50%. Since 2010, it has had a payout ratio of less than 50%. The dividend has grown from $0.85 in 2003 to $2.31 in 2012, marking a growth of more than 10.5%. Currently, Royal Bank of Canada is trading at $59.82 per share, with the total market capitalization of $86.46 billion. The dividend yield is 3.8%, with the current payout ratio of 46%.
Total SA (NYSE: TOT) is a French oil and gas corporation with the operation in more than 130 countries, including the exploration and production operations in more than 40 countries. Total SA is considered to be the fifth largest publicly traded oil and gas company globally, with nearly $243 billion in revenue in 2011. As of December 2011, Total SA reported to have 11.4 billion BOE in its proved reserves. For the last 10 years, Total SA has paid consistent dividends, from $1 per share in 2002 to $2.51 per share in 2011, marking 10-year annualized growth of more than 9.6%. The current payout ratio is only 40.9%. The company is trading at $50.86 per share, with a total market capitalization of $114.82 billion. The dividend yield is quite decent at 5%.
Foolish Bottom Line
All those three companies mentioned above are having market-leading positions in the field they are operating in. In addition, they are paying sustainable dividends with reasonable payout ratios and decent yields to shareholders. Income investors might choose all three to be in their long-term income portfolios.

Following John Malone Into Liberty Global

There are normally two ways for a corporation to return cash to shareholders: dividend and share repurchase. The dividend is more straightforward as the corporation just paid out a portion of the cash to shareholders, the cash will be in the shareholders' accounts right away, but they will get taxed on the dividends they received.  In share repurchase, the number of shares outstanding will be reduced, so each shareholder will have a bigger percentage ownership of the firm. Thus, the announcement of dividend payment or share repurchase program always excites investors. 
Share Purchase and Different Share Classes
Recently, Liberty Global (NASDAQ: LBTYA) just announced that the board has authorized a new $1 billion stock buyback program during the next year. The company has had a consistent history of repurchasing its shares via open market transaction or via private negotiations. From the beginning of the year to the middle of December, it has bought back around $925 million. The total share repurchase since its establishment in 2005 is already more than $9 billion. It said that this program was mainly to acquire Series A and Series C common shares.
In the capital structure of Liberty Global, there are three classes of common stocks: Series A, Series B and Series C. Series B has the most voting power, with 10 votes per share, whereas Series A entitles holders to one vote per share, and Series C carries no voting rights at all. It is normally the structure that John Malone, Chairman of the Board, has been applying to most of his company for him to control the company. In the most recent proxy filing, it was reported that John Malone owned 85.9% of Series B, and had 36% voting power in the company. Bill Gates, BlackRock, and Tiger Global Management, owned significant voting power through Series A and Series C, of 4.4%, 3.8% and 3.8%, respectively.
John Malone Is famous for corporate action activities
John Malone has been quite famous with his frequent spin offs and other corporate actions, which open investors to many investment opportunities. In the third quarter this year, hisLiberty Interactive Corp (NASDAQ: LINTA) split its shares into two tracking stocks, Liberty Interactive and Liberty Ventures. Liberty Interactive would include its interest in QVC, the home shopping services and HSN, whereas Liberty Ventures, which focuses mainly ininvestment, comprise of interests in several corporations such as Expedia, Time Warner, AOL, etc. In addition, John Malone, via Liberty Media (NASDAQ: LMCA) has made a fortune by giving Sirius XM Radio (NASDAQ: SIRI) a $530 million loan to get it out of bankruptcy with high interest, of 15% and then converted it into a majority stake in the company. The recent decision to pay out a special dividend and share buyback program of Sirius will bring a lot of value to John Malone as well.
Penetration into European and Chilean Broadband Communications
Owning Liberty Global shares gives investors exposure to the operation of broadband internet, telephony service industry and direct-to-home satellite in 13 countries in Europe and Chile, serving around 19.5 million customers. In 2011, the majority of its revenue came from the Broadband Division, with $6.14 billion out of a total $9.5 billion in revenue. The main concentration in the Broadband Division is in three Western countries including Germany, The Netherlands and Switzerland. The second highest revenue contribution is Telenet in Belgium, with more than $1.9 billion in revenue in 2011. Compared to 2010, Liberty Global experienced an organic increase in every single segment, with a total increase of 4.6%, whereas the increase (including acquisitions) was 13.7%. 
With the operation mainly overseas, the currency fluctuation poses risk to the company. Indeed, in the last 2 years, it has recorded $237 million and $572 million in losses in 2010 and 2011 respectively due to foreign currency transaction losses. Over the last 3 years, Liberty Global had consistently positive operating income, but it consistently had losses in net income. The majority of the losses were due to the company’s high interest expense.
As expected in the broadband communication and cable television services with the growing acquisition strategy, Liberty Global had high goodwill, and high long-term debt, which resulted in high interest expense. As of September 2012, Liberty Global had more than $26 billion in long-term debt and capital lease obligations, and nearly $16 billion in goodwill and intangibles, whereas the total stockholders equity was only $2.85 billion. Currently, Liberty Global is trading at $60.31 per share, with an enterprise value/EBITDA of nearly 9x.
Bottom Line
For the record, investors might not go wrong following John Malone into the company he is controlling. The share buyback in 2013 would represent a significant benefit to shareholders, and John Malone as well as he owns the controlling stake of the company. It is a really win-win situation. 

3 Sustainable Large Cap Dividend Stocks

I love dividend stocks, as consistent dividends flow into my brokerage account on the constant basis, making me feel safe. However, dividends should be sustainable with decent payout ratio so that companies could use some of the profits to reinvest back in the business, to grow the future earnings, and in turn create larger future dividends for shareholders. This time, I set the screen solely for income investors, with the following criteria: (1) minimum 10 years of paying dividends historically, (2) annualized dividend growth is at least 14%, (3) dividend yield is at least 4%, (4) payout ratio is at most 50%, and (5) the market capitalization is larger than $10 billion. Here are the top 3 results:
Intel (NASDAQ: INTC) is the world’s market leader in the semiconductor business, with around 60% of the global market share. Currently, many investors are torn about whether they should buy Intel or not. Some say it is a value stock, with the market leading position in the global market, a big company, and a nice constant dividend to shareholders. Some might argue that as nearly a third of its 2011 revenue derived from PC Client Group, the weakening PC industry will keep hurting Intel’s revenue and its bottom line.
Currently, Intel is trading at $20.53 per share, with a total market capitalization of $102.14 billion. Intel has a terrific record of paying consistent and growing dividends in the past 10 years, from $0.08 per share in 2002 to $0.78 per share in 2011, marking a 25.6% annualized growth. Currently, the payout ratio is only 37.4%, and the dividend yield is 4.2%. At the current trading price, Intel seems to be quite cheap, at 9.8x forward P/E and 2.1 P/B valuation.
Lockheed Martin (NYSE: LMT) is considered to be the leading global aerospace and security company in the field of defense, space, intelligence, and cyber security, with the majority of its products and services sold to the U.S. Government. Out of $46.5 billion, 82% of that was generated from sales to the US Government, whereas the remaining 17% were from military sales internationally.
Lockheed Martin is also a great example of consistent and growing dividend payment. In 2002, the dividend was $0.44 per share, and it has grown to $3.25 per share in 2011, marking a 10-year annualized growth of 22.1%. Trailing twelve months, the payout ratio is quite decent, at 45.7%. Currently, Lockheed Martin is trading at $88.96 per share, with the total market capitalization of $28.79 billion. The dividend yield is as high as 4.7%. The market is valuing the company at 10.2x forward earnings and 11.8x P/B.
AstraZeneca (NYSE: AZN) is one of the largest global pharmaceutical companies, developing medicines for six healthcare areas with operations in more than 100 countries. In the last 10 years, AstraZeneca has been consistently paying sustainable and growing dividends. It paid out $0.70 dividend per share in 2002, and by 2011 the dividend grew to $2.70 per share. Thus, the 10-year annualized dividend growth is 14.5%. In 2011, the dividend payout ratio was 37%. Currently, AstraZeneca is trading at $47.46 per share, with the total market capitalization of $59.09 billion. The dividend yield is as high as 6%. At the current price, AstraZeneca is valued at 8.1x forward P/E and 2.7x P/B.
Foolish Bottom Line
With consistent and growing dividends for the last 10 years, the decent payout ratios, and nice dividend yields, the three dividend stocks above should be considered to be in the income portfolios of long-term investors. 

Coffee Will Be Tastier After George Howell's Comeback

One of the four filters that Warren Buffett and Charlie Munger often seek for investment opportunities is “able and trustworthy managers.” Indeed, I think having a great chief would be extremely beneficial, and more often than not, a great leader can turn around a sinking ship. Investors might get very rich by just “following the entrepreneur,” investing in the company that an entrepreneur with a proven record of success is leading. 
George Howell, who is considered to be a specialty coffee pioneer and the expert on single-origin coffee, has decided to come back to the coffee business. George Howell is actually the founder of The Coffee Connection, the high-end coffee retailer located in the Boston area that became the first acquisition of Starbucks (NASDAQ: SBUX) back in 1994 for $23 million. At that time, Coffee Connection had around 22 stores in 3 different states. The purchase of Coffee Connection would allow the 300-stores Starbucks had at that time to expand in the East Coast market. From talking to customers, Starbucks found out that when Coffee Connection got acquired and its name was changed into Starbucks, the Coffee Connection roast would disappear. In addition, Starbucks had a right on “Frappuccino” trademark, which was originally developed and sold by Coffee Connection and George Howell.
Actually at that time, Howell didn’t like Howard Schlutz. Joe Caruso, an advisor to Howell, commented that the main reason for the acquisition of Coffee Connection was the real estate and merchandise; it was not about coffee. Thus, Schlutz offered the deal but got rejected twice.  The Boston Magazine quoted John Rapinchunk, Coffee Connection’s board member:“He got smart, and told George that he wanted the respect and the name and the quality.”  It was said that Schlutz promised to keep the Coffee Connection name and kept Howell as a coffee consultant. Gradually, the recipe of the Frappuccino was changed.
After spending the time with the United Nations and waiting for his noncompeting agreement with Starbucks to expire in 2001, he was back in the game, opening George Howell’s Terroir Cafe after that. According to Boston Magazine, after 8 years of operating his roastery, he was quite ready for the coffee battle as the business became profitable last year. According to IBISWorld, in 2011 Starbucks had quite a meaningful share in the US market, about 32.6%. The second biggest player in the Coffee and Snack Shops industry was Dunkin Brands(NASDAQ: DNKN), with a 16.1% market share. Other major players owned a much smaller share of the market, including Krispy Kreme Doughnuts (NYSE: KKD) with only 3%, andEinstein Noah Restaurant Group (NASDAQ: BAGL), with 2.5%.
Year-to-date, Starbucks has not been the best performer, as it only delivered nearly 20% total gain to its shareholders.
SBUX Total Return Price data by YCharts
Krispy Creme Doughnuts and Dunkin Brands are the two best performers, giving investors total gains of 40.8% and 30.5%, respectively. However, looking at a 5-year horizon, Starbucks is the best performer, with more than 50% total gain, as Starbucks has the most consistently profitable operations with the market leading position. Thus, the market is giving Starbucks quite a generous valuation, of nearly 30x P/E. But Dunkin Brands is the most expensive with 78x P/E. Krispy Creme Doughnuts is the cheapest, with only 4.1x earnings valuation. Einstein Noah is in between, with 17.1x P/E.
Foolish Bottom Line
Indeed, the competition in the industry is fierce and will be fiercer going forward. With the comeback of George Howell, there will definitely a lot of changes in the coffee industry. If and when his new business IPO's, and if its price is reasonable, I am willing to be in for the long run. 

The Risk Ahead with this Nutrition Company

USANA Health Sciences (NYSE: USNA) has experienced quite a bit of volatility over the last year. In the beginning of 2011 the company was selling for around $43 per share, but then it plunged to $23.60 four months later. Afterwards, it shot up to nearly $49 in September 2012, and it is currently trading at around $39.
Actually, USANA was in the portfolio of Joel Greenblatt in the first quarter in 2011. The main thesis for buying USANA at that time was the superb return on equity, low leverage, significant discount valuation compared to its peers, and insider buying.  However, just recently, the stock tanked by more than 8% within a day due to the management shake up. In addition, negative research about the company has been released, along with the risk of a multi-level marketing model. It is time to look at USANA to see whether investors should come in and wait for more price depression, or just walk away from the stock. 
Management Shakeup
Roy Truett, the COO of USANA, has had his resignation accepted by the company, and Jim Brown, the Chief Production Officer, will come ahead to manage the operations of the company. Roy is still young at 44 years old, and he has worked at the company since 2003. In addition, the young executive Doug Hekking, only 42, will step down from the CFO position to return to support the groups of finance and operation, due to family health matters.
USANA is still led by its founder, Dr. Myron Wentz, the current chairman. As of fiscal 2011, Myron Wentz is the largest controlling shareholder in the company. He effectively holds 52% of USANA, including the stakes held by his 100%-owned Gull Holdings. However, in the last few months, Wentz and Gull Holdings have kept selling out the company’s shares in the open market. Since December, the founder has sold 464,050 shares, with the total transaction value more than $20 million. Not a good signal.
Recent Negative Research on USANA
Citron Research just released a report on the company’s activity in China. Citron mentioned that USANA was operating a multilevel marketing in China; thus, the claim of double-digit top and bottom line growth was not sustainable. Citron has a similar research on Nu Skin Enterprises (NYSE: NUS), revealing the company’s operation MLM in China, the “apparent violation of FDA and/or FTC regulator law in the US,” and questioning the scientific research with Stanford University for the company's AgeLOC products. 
USANA has disclosed in their 2011 10-K filing that over the last 3 years Greater China has become the largest revenue source for the company. In 2011, China brought nearly $205 million in revenue, accounting for 35.2% of the total sales, whereas the second ranked US generated around $148 million, or 25.4%, of total sales. For Nu Skin, China only accounted for 20% of their sales in 2011. The biggest portion of its revenue has come from Northern Asia, accounting for up to 43% of its total revenue, with the concentration in Japan (27% of revenue) and South Korea (16% of revenue).
The General Risk of This Business Model
I have covered a topic on the risk of the direct selling model, which investors should care about before investing in those companies. David Einhorn has looked into this field as well, by showing up at the Herbalife earnings conference to ask for more details. He was curious about the sales the company made outside its network, the sales percentage among three main distributor groups including self consumers, small retailers and potential sales leaders; and the incentive difference between direct selling the product and recruiting new distributors. He hasn’t made any move in the stock, long or short, but his appearance in the earnings callsent shares plunging that day.
Foolish Bottom Line
Even Zacks ranked the company in its Aggressive Growth Portfolio as a Zacks #1 Rank (Strong Buy). However, with all the recent glitches and the huge insider sells, investors should be careful about initiating a position now.

Five Opportunistic Stocks for 2013 (Part II)

Following the first part of 2013 opportunistic stocks, this article will uncover two more stocks with the potential to enjoy the nice run in the next year. Investors might expect that 2013 would be quite an interesting year, especially with the declining trends in the global PC market, the chipmaker for the mobile industry, and the potential of the streaming business.
4. Intel
Due to the downward spiral of the overall global PC market, the PC chipmakers followed the path as well. Intel (NASDAQ: INTC) has been the world’s biggest chipmaker, along with the invention of x86 processor. Intel currently holds around 60% of the total global microprocessor market, leaving its next competitor Advanced Micro Devices (NYSE: AMD) further away, with only 25% share. In addition, AMD’s total market cap of $1.7 billion only accounted for 1.6% of Intel’s, a very small percentage.
Intel has been struggling along with the weak PC industry, as around 66% of its revenue came from PC Client Group, with the two biggest customers, Hewlett-Packard and Dell. Currently, Intel is trading at $20.53 per share, with the total market capitalization of $102.14 billion. It has seen its market value lost more than 16% year-to-date, pushing its dividend yield up to 4.2%. However, I think 2013 is the year of opportunity for Intel. Many experts thought that Intel had the right ingredients for the new generation of mobile chips. Apple (NASDAQ:AAPL) has relied on Samsung to build the chips it designs, and for sure, its relationship would not last for long. Apple has been talking to Intel to take that role instead of Samsung. Intel has enough expertise and cash to make the move.
5. Netflix
2011 and 2012 were two bad years for Netflix (NASDAQ: NFLX) with all the surprising internal events. The stock experienced a significant drop from nearly $130 per share to nearly $53.80 per share in September. However, the drop is not as fatal as in the second and the third quarter of 2011, when it plunged from $295 to around $63.80 per share. The cause for the huge drop was due to two reasons: first was because the CEO Reed Hasting changed the fee structure to separate DVD by mail service from the Internet streaming service, which frustrated subscribers. Second, Starz and Netflix partnership officially ended in the beginning of this year, so Netflix lost more than 1,000 film movies including famous ones such as “Toy Story 3,” “Young Frankenstein” and “Beetlejuice.”
However, Netflix just recently took a major step for its long-term future by signing the exclusive deal with Walt Disney. Starting in 2016, only Netflix’s subscribers can watch Disney’s new releases from Marvel, Pixar, and other Disney’s channels, taking away Starz’s licensing deal with Disney. In addition, Netflix enjoyed the exclusive rights to stream future Disney’s movies 8 months after they are shown in the theater.
In this year, activist investor Carl Icahn built positions in Netflix up to nearly 10%, with the expectation that Netflix would get acquired. He said: “I believe that there is going to be great consolidation between Netflix and, everybody's read about it, Amazon (NASDAQ: AMZN)or Microsoft or Verizon or Google, there are so many possible combinations.” Netflix indeed has a good subscriber base, of nearly 32 million subscribers, with nearly 80% of them streaming in the US. The number of Netflix’s subscribers is far more than that of Amazon and Hulu. Amazon with its Amazon Prime Service has approximately 9 million, nearly one third of Netflix’s, whereas Hulu is much less with only 2 million. In the next year, along with the new Disney deal, Netflix can welcome more and more subscriptions, and the stock might enjoy the nice run up.
Foolish Bottom Line
With the market leading position and the opportunities that lie ahead, both Intel and Netflix might enjoy a good year in 2013. Investors should take advantage of the volatility to buy at lower prices. 
Disclosure: Long AAPL

Three Opportunistic Stocks for 2013 (Part I)

We are coming to the close of 2012 with all of its ups and downs, bears and bulls, sorrow and happiness in both daily life and investing. Many might wonder what 2013 will bring, and what to focus on catching 2013’s opportunities, especially when it comes to investment. Thus, I come up with the idea of writing article series to select stocks for 2013 in three investment themes: opportunistic, value and growth plays.  This article will be the first one in the series, it is the part I with 3 stocks for opportunistic plays for the next year. Why opportunistic? Because those stocks have been beaten down significantly in 2012, but they either have a fantastic operating record, or are still market leaders in their respective fields.
1. Hewlett-Packard (NYSE: HPQ)
It made the top of the list for opportunistic plays for many reasons. It was hit significantly both internally and externally. Externally, the overall PC industry slowdown has hit the company quite hard. According to IDC, HP was still leading in the third quarter of 2012 shipments with 13,946 units, accounting for 15.9% share of the total global PC market. Lenovo was getting quite close, with only 20 basis points lower in the global market. In addition, HP also experienced the worst plunge, 16.4% year-over-year, whereas the average declines for all vendors were 8.6%. Misfortunes never come alone. Internally, HP had to write off as much as $8.8 billion, accounting for more than 80% of the $11 billion price tag it paid to acquire Autonomy. Out of that, $5 billion was due to accounting improprieties, disclosure failure and misrepresentation of Autonomy. Year-to-date, HP has shed nearly 45% from its market capitalization.
Since Nov. 20, HP’s share price began to rise again, from $11.71 to $14.75 currently. Looking forward, 2013 could be an interesting year for HP. Meg Whitman declared the restructuring of the business. She mentioned that the real recovery could not be seen until 2014, and warned investors to expect a significant fall in earnings in 2013. The volatility in HP's share price in 2013 could present some excitng opportunities to pick up shares on the cheap.
2. Groupon (NASDAQ: GRPN)
Here's another exciting opportunistic play. The stock has experienced a lot of volatility in 2012. Since its IPO in November 2011, it has lost more than 80% of its market value. The stock hit rock bottom at around $2.63 per share in Nov. 13, and suddenly jumped to $4.54 just two weeks later, due to the news that Chase Coleman took 9.9% ownership in the company. Then it was rumored that its CEO would be fired, but then he stayed to lead the company, the stock dropped right away. Following Yipit’s data, Groupon was still the leading player in the discount marketplace, with a 53% market share. The second player, LivingSocial, was far behind, with 22% share. With the market leading position in an increasingly competitive industry, I think Groupon will have an interesting year ahead in 2013 with expected volatility.
3. Facebook (NASDAQ: FB)
The company emerged to be the biggest IPO in history with an initial price that valued this social network at as much as $100 billion in May this year. This pegged the less than 10 year old start-up in a group with the likes of Intel, Cisco, and British American Tobacco in terms of market cap. After the IPO, the market valued Facebook in the downward trend, to $17.73 in the beginning of September. In the same month, it reported to have one seventh of the world population, reaching 1 billion active monthly users. The lock-up expiry date for insiders to sell the shares, has created a lot of volatility for the stock. The biggest batch lock-up had already expired in Nov. 14, with 749 million shares.  Currently Facebook is trading at $26.81 per share, the market is valuing the company at as high as 45x forward P/E.
Foolish Bottom Line
Among the three stocks above, Groupon seems to have the most potential to rise ahead due to its plunge in the stock market this year and its market leading position. All of the threestocks could be considered opportunistic; all will be volatile, and I expect these three to have a nice run in the coming year. In the next article, I will uncover two more opportunistic stocks for investors in 2013.