Thursday, January 31, 2013

Stocks with Over 100 Years of Uninterrupted Dividends (Part I)

In the current volatile market, investors should remember two important investing rules, which have been mentioned over and over again by the world’s most successful investor, Warren Buffett. The first rule was not to lose money, and the second rule was not to forget the first rule. Investors would feel much safer after parking their money in businesses that  have delivered terrific operating performances, especially companies with a great history of dividend payment over a long period of time. I am quite excited with corporations that have returned cash to shareholders via uninterrupted dividends for more than a century, includingColgate Palmolive (NYSE: CL)Johnson Controls (NYSE: JCI) and Church & Dwight(NYSE: CHD).
Colgate Palmolive, founded in 1806, has been one of the leading global consumer goods companies, with operations in more than 200 countries. It had two main product segments: Oral, Personal and Home Care; and Pet Nutrition. Actually, Colgate reminds consumers around the world of the most trusted brands of toothpaste and toothbrush. Thus, Oral Care is the company’s main business in Greater Asia/Africa, with sales accounting for 73% of total region’s sales. In addition, via Hill’s, the Pet Nutrition segment is also the global leader in specialty pet nutrition for dogs and cats, with products in more than 95 countries, representing 13% of the total company’s sales in 2011.
Colgate has been paying uninterrupted dividends since 1895. In the last 10 years, the dividend has kept increasing, from $0.72 per share in 2002 to $2.27 per share in 2011. The current dividend yield is 2.4%. During the same time, it also delivered a high return on invested capital consistently, in the range of 28.18% to 39.32%. Trailing twelve months, its ROIC was 32.47%. Currently, Colgate Palmolive is trading at $104.04 per share, with the total market capitalization of $49.16 billion. The market is valuing Colgate at 17.5x forward earnings, and 19.6x book value.
Johnson Controls, incorporated in 1885, is considered to be the world’s leader in energy optimization and operational efficiencies for customers in more than 150 countries. Johnson Controls has three main businesses: Building Efficiency, Automotive Experience, and Power Solutions. The majority of its revenue ($21.33 billion) came from the Automotive Experience segment,  accounting for 50.8% of the total revenue. The second biggest segment belongs to Building Efficiency, with $14.7 billion in revenue, accounting for 35% of total 2011 sales.
Johnson Controls has paid uninterrupted dividends since 1887. It also has raised its dividends continuously for the last 10 years, from $0.24 per share in 2003 to $0.72 per share in 2012. The current dividend yield is 2.4%. Trailing twelve months, it generated a 7.25% return on invested capital. At the current trading price of $30.11 per share, the total market capitalization is $20.6 billion. The market is valuing the company at 9.5x forward P/E and 1.8x book value.
Church & Dwight, founded in 1846, is the household personal care manufacturer with its 8 power brands including ARM & HAMMER, TROJAN condoms, XTRA laundry detergent, etc. The majority of its revenue was derived from the sales of household products, accounting for 47% of the company’s total sales, whereas personal care products represented around 25% of the total revenue in 2011. The largest customer has been Wal-Mart, with 23% of total consolidated sales.
Church & Dwight began to pay uninterrupted dividends in 1901. The current dividend yield is 1.8%. At the current price of $53.42 per share, the total market capitalization is $7.46 billion. The market is valuing the company at relatively high valuations: 18.9x forward earnings, 3.6x book value. 
Foolish Bottom Line
Among the three, Colgate delivered the highest return on invested capital, and the highvaluation in terms of book value was due to its leveraged capital structure. Johnson Controlsseems to be the cheapest, with single digit forward earnings valuation. Church & Dwight seems a bit expensive, but its 5-year average earnings valuation was also high, at 20x. However, with a strong history of paying uninterrupted dividends, the three stocks mentioned above definitely make investors feel safe in their long-term income portfolios.

A Closer Look at a Financial Advisory's Buyout

Duff & Phelps (NYSE: DUF) rose as much as 20% in only one trading day, from $13.05 to $15.62 per share, due to its acquisition by a Consortium of private companies including The Carlyle Group, Stone Point Capital, Pictet & Cie, and Edmond de Rothschild Group. The Consortium agreed to pay $15.55 per share, which valued the whole company at around $665.5 million. Duff & Phelps could still seek competing offers by Feb. 8, 2013. Does this price represent a fair value for the company? Could the company receive a superior offer from third parties?
Business with the Increasing EPS
Duff & Phelps, founded in 1932, is an independent financial advisory and investment banking services provider, with more than 1,000 employees in around 25 offices globally.  The majority of the company’s revenue was generated from the Financial Advisory business segment, including Valuation Advisory, Tax Services, and Dispute & Legal Management Consulting business units. This represented around 66% of the company's total revenue in 2011. The other two business segments, Alternative Asset Advisory and Investment Banking, accounted for 14% and 20% of the total revenue, respectively. The top ten customers took between 11.8% and 15.9% of the total company’s sales in the last 3 years, and no single client represented more than 4.4% of total revenue in 2011. Since 2008, the company’s bottom line has kept rising gradually. The net income rose from $5 million to $19 million in 2011, and the EPS followed the same trend, increasing from $0.39 per share in 2008 to $0.63 per share in 2011. The firm began to pay dividends in 2009, from $0.10 per share to $0.32 per share in 2011.
Fair Value and Competing Bids?
With a total value of $665.5 million, the EV/EBITDA valuation for the company would be around 7.45x. The law firm Levi & Korsinsky, LLP announced that it would investigate if the offer price was fair, as at least one analyst had a target price of $24 per share, much higher than the offering price. Several people thought that it could receive the possible competing bids from other peers, such as FTI Consulting (NYSE: FCN) and Navigant Consulting(NYSE: NCI). FTI is operating in four main regions, including 43 offices in the US, 2 offices in Canada, 5 offices in Latin America, 14 offices in Asia-Pacific, and 24 offices in Europe, Middle East and Africa, as of the 2011 fiscal year. FTI is more diverse in terms of revenue sources. The biggest revenue source was from Corporate Finance/Restructuring, with $427.8 million, whereas the second biggest segment was Forensic and Litigation Consulting, with $365.3 million in revenue. In the last quarter 2012, FTI acquired Australian-based KordaMentha (Qld), which was a better fit in terms of turnaround, restructuring and corporate advisory services. Navigant also announced it would acquire Easton Associates to add to the strategy development, due diligence, and product planning business with the long-term relationship with large pharmaceutical companies.
As Duff & Phelps’ business was mainly comparable and competing with big audit firms, including Deloitte, KPMG, E&Y, and PwC, which are private and much larger businesses. Thus, it seems that the strategy is to acquire the company, and later bring it back to the market in a more competitive position with those audit firms. Because of a bit different business segment focus, I personally don’t think the competing bids would be from FTI and Navigant.
Foolish Bottom Line
The valuation seems to be relatively reasonable, as FTI and Navigant are valued at the comparative valuations of around 7.57x and 7x EV/EBITDA, respectively. Duff & Phelps’ investors could tender their shares in the market now, at an even higher price than the offering, with reasonable valuation and unlikely competing bids. 

Stocks with Over 100 Years of Uninterrupted Dividends (Last Part)

Investors should get excited about businesses that have consistently paid uninterrupted dividends for more than a century. Those businesses have weathered all the ups and downs of many catastrophic events, including World War I, World War II, the Great Depression, Oil Shock, etc. They still survived, prospered, and returned cash to shareholders in the form of dividends. In the two previous articles, I have featured five stocks that have consistently been paying dividends for more than 100 years, including Colgate Palmolive, Johnson Controls, Church & Dwight, Consolidated Edison and PPG Industries. In this last part, I will write about two more stocks with 100+ years of dividend payments.
Global Largest Oil/Gas Player
Exxon Mobil (NYSE: XOM) used to be the largest publicly traded corporation in the world, before being outpaced by Apple.  However, Exxon Mobil is still considered to be the biggest publicly traded oil and gas corporation, with 36 refineries in 20 countries. The total proved reserves were 24.9 billion BOE, including its oil sand stakes via Imperial Oil, as of Dec 2011. ExxonMobil’s proved reserves were much larger than those of BP’s (NYSE: BP) 17.75 billion BOE, and Chevron’s (NYSE: CVS) 11.2 billion BOE. Exxon Mobil has also become the biggest natural gas player in the US, via its acquisition of XTO Energy for as much as $26 billion more than 2 years ago. Thus, the low price of natural gas might have some short-term negative impact on the company’s returns, but the long-term perspective for this oil/gas giant is terrific. 
Exxon Mobil has been consistently returning cash to shareholders for more than a century. It first paid a dividend in 1882, marking an incredible 130 years of uninterrupted dividend payments. Exxon Mobil has raised its dividends over the last 10 years, from $0.92 per share in 2002 to $1.85 per share in 2011. Currently, the dividend yield is 2.5%, whereas BP is paying its shareholders a 4.8% dividend yield, and Chevron’s dividend yield is 3.3%. At the current price of $86.55 per share, the total market capitalization is $394.61 billion. The market is valuing the company at 10.1x forward P/E and 2.4x P/B.
Global Leader in Hand and Power Tools
Stanley Black & Decker (NYSE: SWK), founded in 1843, has been paying dividends since 1877, or more than 135 years. It was known as Stanley Works before the 2012 merger with Black & Decker Corporation. The combination between Stanley Works and Black & Decker has made the merged company the global leader in the hand and power tools industry, as well as hardware, which could brings a lot of value to shareholders and customers worldwide.
It had three main business segments: Construction & Do-It-Yourself, Security, and Industrial. The majority of its revenue came from the first business segment, nearly $5.24 billion, accounting for 50.5% of the total 2011 revenue. The other two segments brought similar revenue: $2.64 billion for the Security segment and $2.5 billion for the Industrial segment. Stanley Black & Decker has also increased its dividend payments consistently for the last 10 years, from $0.99 per share in 2002 to $1.64 per share in 2011. The current dividend yield is 2.5%. At the current trading price of $73.97 per share, the total market capitalization is $12.49 billion. The market is valuing the company at 12x forward P/E and 1.7x book value.
Foolish Bottom Line
I have covered 7 businesses that have paid uninterrupted dividends for more than 100 years. What a wonderful record for long time shareholders! Thus, the wealth of the investors would be compounded gradually over time with those sustainable and consistently increasing dividends. All of those 7 businesses could fit well within the income portfolios of long-term investors.

Stocks with Over 100 Years of Uninterrupted Dividends (Part II)

In addition to capital gains, a dividend is an important source of income for investors. There are several businesses that have long histories of dividend payments that are worthwhile for investors to hold for a very long time. Following my recent article featuring three such businesses, which have been paying uninterrupted dividends for more than a century, I will unveil two more stocks with similar characteristics.
Utility Company, A Great Income Stock
Consolidated Edison (NYSE: ED) is an energy provider holding company with different services including electricity, natural gas, and steam delivery in New York City, Westchester County, northern New Jersey, northeastern Pennsylvania, and other areas. In the utility business, investors would expect that it produced stable earnings and cash flow over time. Thus, the company could be in a good position to leverage on its predictable business, and the dividend would be quite sustainable.
Consolidated Edison has paid dividends continuously since 1885, meaning that the dividends have been uninterrupted for the last 127 years. In the last 10 years, it has consistently and gradually raised its dividend, from $2.22 per share in 2002 to $2.40 per share in 2011. The current dividend yield is high, at 4.4%. It seems that the company has a large amount of debt, but the capital structure is quite reasonable. As of September 2012, it had more than $11.4 billion in stockholders’ equity, more than $11 billion in total debts, short-term and long-term, and $3.24 billion cash. At the current price of $55.54 per share, the total market capitalization is $16.27 billion. The market is valuing the company at 12.1x forward earnings, and 1.4x book value.
A Global Coatings Company, Too
PPG Industries (NYSE: PPG) is another candidate for the 100+ years uninterrupted dividend stock list. It was incorporated in 1883 and is considered to be the global leader in protective and decorative coatings provider. The two major revenue sources for the company were Performance Coatings and Industrial Coatings, bringing in $4.63 billion and $4.16 billion, respectively. Those two segments also brought the majority of income back to PPG Industries, with Performance Coatings taking in $673 million and Industrial Coatings making $438 million.
...And Growing Bigger
Recently, with the purchase of North American Decorative Paint business from Azko Nobel(NASDAQOTH: AKZOY), PPG became the world’s leading in coating maker, thanks to the additional 600 AkzoNobel paint stores and 1,000 stores in the North American network. It seems that PPG was getting the bargain, as it only paid $1.05 billion, at a valuation of only 0.7x P/S. PPG used a bit of leverage in its operations.
As of September 2012, it had $3.86 billion in total stockholders’ equity, $3.37 billion in long-term debt, $636 million in short-term debt, and more than $2 billion in cash. In addition, it also booked more than $2.2 billion in pensions and other benefits, pushing its total liabilities up to nearly $11.745 billion. However, the interest coverage is still quite comfortable at 11.6x, thus, the operating income is more than enough to cover its interest expenses.
PPG has paid dividends uninterruptedly since 1899, making a record of 113 years. The current dividend yield is 1.7%. In the last 10 years, long-term shareholders also enjoyed the consistently growing dividends, from $1.70 per share in 2012 to $2.26 per share in 2011. PPG Industries is trading at $135.35 per share, with the total market capitalization of $20.76 billion. The market seems to price PPG Industries at a bit expensive valuation, at 17.2x forward earnings and 5.4x book value.
My Foolish Take
Consolidated Edison and PPG Industries, with their long histories of dividend payments, continue to return cash to shareholders via increasing dividends over time. Those two stocks should be in an income portfolio of patient investors. In the next part, I will talk about two more stocks that also paid uninterrupted dividends for a century. 

Cheap, Quickly Growing Stocks for 2013 (Last Part)

This is the last article in my 3 part series about a growth portfolio with high return but cheaply valued stocks in 2013. I have talked about 4 stocks, each of which fits perfectly our four criteria: (1) more than 25% EPS growth, (2) more than 25% return on investment, (3) no long-term debt, and (4) below 1x Price-to-Earnings Growth ratio. Those already-covered stocks areApple, American Public Education, Baidu, and Questcor Pharmaceuticals. In this article, I will unveil two more growing stocks that investors might consider for their growth portfolio in 2013. One is in the specialty retail industry, and the other is in the business of manufacturing drugs.
Fast Followers and Broad and Shallow Merchandising Strategy
Many investors and shoppers have heard of Francesca’s Holdings (NASDAQ: FRAN). It is the upscale boutique for young and middle-aged female shoppers in the range of 18-35 years old, with around 51% of the total net sales derived from apparel. Even though no vendors represented more than 15% of the retailer’s total merchandise purchases, the two largest vendors belonged to Francesca’s founders’ relatives.
Francesca’s is known for its broad and shallow merchandising strategy, meaning that it had a lot of selections for customers, but only several items in the inventory for each style. If it was sold out, shoppers might not have the chance to buy that item again. Thus, it always offered unique, refreshing merchandise for customers. Indeed, in its conference call, John De Meritt, Francesca’s President and CEO, believed in the company’s ability to chase fashion trends, describing the company as “fast followers.” He said:
As fast followers, we identify mainstream trends versus emerging trends, which is one distinction. We then source these trends from hundreds of domestic vendors and deliver it to our boutiques in a relatively short timeframe. We also typically buy merchandise for delivery no more than 90 days out. This gives us the unique ability to source merchandise on a practical real-time basis. So as trends become mainstream, we use our available near-term open-to-buy to follow these trends.
In addition, the low inventory for each style helps the retailer turn over its inventory quickly, resulting in low fashion risk.
Fast Growing With Cheapest PEG
In the last 3 years, Francesca’s has grown EPS from -$1.99 to $0.52 per share. Trailing twelve months, its EPS has reached $0.91 per share. It also delivered quite a high return on invested capital. Over the last 12 months, its ROIC was 82.83%. Currently, the retailer is debt-free. As of October 2012, it had $56 million in total stockholders’ equity, no debt, and $13 million in cash. It is trading at $24.92 per share, with a total market capitalization of nearly $1.1 billion. The market is valuing it at 27.5x P/E (seems pricey?), but only 0.7x PEG. It is still cheaper than Urban Outfitters (NASDAQ: URBN), which is trading at 28.7x earnings and 1x PEG. Its other peer, Ann (NYSE: ANN), is trading at a lower trailing earnings multiple of 15.5x, but higher valuation in terms of growth, at 1.2x PEG.
Volatile Growing Drug Manufacturer
POZEN (NASDAQ: POZN) has the smallest market capitalization of the 6 growth stocks for 2013. It is trading at $4.98 per share, with a total market cap of only $150.94 million. Since 2010 it has consistently generated very high return on invested capital; trailing twelve months, its ROIC was 63.76%. POZEN is in the business of in-house drug developing and manufacturing, while other strong commercial partners market its products. The company said that it had received the FDA’s approval of its two self-invented products in two years. It currently has three licensed products, including Treximet, an acute treatment for migraine attacks, MT 400, for migraine headaches, and VIMOVO, for relief the symptoms of osteoarthritis, rheumatoid arthritis, and ankylosing spondylitis.
The company has experienced fluctuating business performance since 2007. In 2007, its EPS was $0.15; in 2011, it has grown to $1.40. However, it generated losses in 2008 and 2009. This drug developing and manufacturing company doesn’t employ debt in its operation. As of September 2012, it had $90 million in total stockholders’ equity, and $92 million in total cash and short-term investments. POZEN is valued at only 3.6x trailing earnings and only 0.4x PEG.
Foolish Bottom Line
Those two stocks conclude my growth portfolio of 6 stocks for 2013. All six stocks in these three articles have demonstrated their historically growing earnings, as well as high returns on debt-free operations. They are also quite cheaply valued if growth is factored in. However, POZEN, because of its volatile earnings, might be an opportunistic stock for investors. It is definitely not a good stock for holding in the long run at the current moment. Francesca’s Holdings, with its unique merchandising strategy, might still be a decent bet at the current PEG valuation.

Cheap, Quickly Growing Stocks for 2013 (Part I)

Many investors often pick their style as  “value” or “growth” investors, but in doing so they separate value and growth. It was Warren Buffett who thought that growth was one of the indicators of value. Thus, growth should be one of the inputs used to calculate the intrinsic value of businesses. I myself like to look for high-return companies that have experienced decent growth over the last 5 years, but are cheap in terms of the PEG ratio (the P/E ratio in which the growth is factored). More specifically, my criteria are: (1) 5-year EPS growth was higher than 25%, (2) return on Investment was greater than 25%, (3) no long-term debt, and (4) PEG ratio is less than 1x. Here are the first two stocks that meet my criteria:
Apple (NASDAQ: AAPL) has been the most famous stocks of 2012. Though it used to be the highest market cap publicly traded company in the world, Apple's value has dropped heavily since September 2012. Many investors have varying opinions about Apple; some are still bullish, and some are quite pessimistic. Since the middle of 2012 Apple has begun to pay dividends twice, to return its huge cash position to its shareholders. The dividend yield is around 1%. In the past 5 years, Apple has grown its EPS tremendously, from only $5.36 to $44.15, marking an annualized growth of 52.46%. Its wonderful record of extreme growth was the result of creative innovation in the technology field, particularly in the mobile and tablet industries.
Apple is running on its iOS system, competing head-to-head with the Android system ofGoogle (NASDAQ: GOOG) and Samsung. According to IDC, iOS is still a leading tablet operating system now, accounting for 53.8% of the market in 2012, and it is expected to remain the leader in the market into 2016, with an estimated 49.7% market share. Android still ranks second, with 42.7% of the market in 2012, and is estimated to account for 39.7% of the total tablet operating system market in 2016. Windows, from Microsoft (NASDAQ: MSFT), currently owns around 2.9% of total market share, but IDC estimated that it would experience the highest compounded annualized growth in the period of 2012-2016, around 69.2%, to take 10.3% of the tablet operating system market. 

Trailing twelve months, Apple delivered a 42.84% return on invested capital. The extremely high growth and high return on investment was generated via debt-free operations. Currently, Apple is trading at $509.59 per share, with a total market capitalization of $479.37 billion. The market is valuing Apple at only 11.5x trailing P/E and 0.5x PEG.
American Public Education (NASDAQ: APEI) is the second company that appeared in my list after my stock screener. It is the online post secondary education provider, focusing on military and public community services, via two main universities: American Public University and American Military University. Although its market capitalization is barely more than 0.1% of Apple’s, APEI is quite the high growth stock. Its EPS has grown from $0.64 to $2.23 per share, an annualized growth of nearly 28.36%. It has been a consistently growing cash flow generator. Trailing twelve months, APEI generated $57 million in operating cash flow and $17 million in free cash flow. The LTM return on invested capital was 30.57%.  Interestingly, the high return was generated from the debt-free oprations.
Currently, it is trading at $35.42 per share, with the total market capitalization of $639.84 million. The market is valuing the company at 15.2x trailing P/E and 0.9x PEG. The historical number looks great, but Jim Chanos has expressed his views on the whole industry in which APEI is operating. He thought that the business model of for-profit education was not right, as all those companies depended on taxpayer’s money to guarantee the federal loans they profit from.
Foolish Bottom Line
Personally, I think it is worth another closer look into APEI's fundamentals, as well as the macro environment of for-profit education, to determine its investment attractiveness, even though the historical numbers were quite compelling. Apple, even with a lot of recent criticism, is still valued much cheaper than boring Microsoft, with 14.4x P/E and 1.1x PEG. With the fantastic infrastructure it has built, and integrated devices including mobile phones, tablets, and PCs, Apple would serve investors well in the long run.
Disclosure: Long AAPL

Could MagicJack be a "Magic" Stock?

A lot of people often hear the saying "When you love its products, you should buy the stock." I don’t think this is a good idea. Loving the products might be the reason you dig deeper into the company to see whether it represent an investment opportunity or not. Of course, if you love the products and the stock looks so compelling, it’s a great combination. magicJackPlus, a product of magicJack VocalTec (NASDAQ: CALL), is a one such product that a lot of my friends around the world love, because it allows users to call to the US and Canada for free. Recently, the company raised its Q4 outlook. Let’s dig deeper to see whether or not magicJack could offer some “magic” to investors.
Business Snapshot
magicJack, the Israeli company, is a cloud communication company that provides VoIP, the softphone, and other magicJack products. The company said that its products and services allow users to call for free to the US and Canada. In addition, it is also the owner of different companies in related operating fields, including a microprocessor chip design company, a softphone company, an app server, and session border controller company. The majority of its revenue came from the sales of magicJack and magicJack Plus, at around $44.55 million, accounting for more than 40.3% of the total revenue in 2011. The second largest revenue source was license renewals, bringing in $36.55 million, representing around 33% of total sales. More than 90% of the total revenue derived from the US. The magicJack devices were manufactured and assembled in China.
Raising Outlook on Non-Leveraged Operation
Recently, magicJack raised its outlook for Q4 and full year 2012. It expected to deliver $0.70 per share in EPS, due to lower telecom expenses, higher revenue, and marketing and legal expenses. Interestingly, magicJack didn’t employ high leverage levels, but it had negative equity. As of September 2012, it booked negative $35 million in total stockholders’ equity, no interest-bearing debts, and $34 million in cash. The negative equity was due to the negative retained earnings and increasing treasury stock amount. In the liabilities, the biggest item was deferred revenue, at $54 million. The company also highlighted that the deferred revenue liabilities are not cash liabilities. It would require only small cash outlay, asmagicJack’s ability to generate cash is quite decent.
New Chief is a Good Sign
In addition, magicJack announced the replacement of its founder, Dan Borislow, with the new CEO Gerald Vento, effective the first day in 2013. Vento has spent quite a long time in the telecom industry. He was the founder of TeleCorp PCS, a public wireless services company, and eventually sold his company to AT&T (NYSE: T) in 2002 for a price tag of $5.7 billion. Donald Burns, who is also very experienced in the telecom industry, would be the chairman.Borislow commented: I am more of a startup and invention guy; Jerry and Don have the ability and the track record running successful public companies." Right after the event, the shares jumped more than 10% to $17.95 per share.
Cheapest Growing
Compared to its peers, including AT&T and Vonage Holdings (NYSE: VG), magicJack seems to be the most expensive, with more than 12.6x EV/EBITDA valuation. Vonage Holdings is the cheapest, with EV multiples of only 3.9x. AT&T is valued at 7.12x EV/EBITDA. However, trailing twelve months, magicJack delivered the highest operating margin of 15%, whereas the operating margins of AT&T and Vonage Holdings were 13% and 11%, respectively. Furthermore, magicJack seems to be expensive in terms of EV multiples only, but it is the cheapest when factoring in its growth. It is currently valued at only 0.54x PEG, whereas AT&T and Vonage Holdings had their PEGs of 2.18x and 1.53x, respectively.
Foolish Bottom Line
With only 0.54x P/E growth ratio, magicJack seems to be a decent growth play for investors. Its products are quite convenient and unique for users. However, in this technology VoIP field, things could change quite quickly. magicJack could be quite vulnerable to more severe direct competition in the near future.

With Strong Fundamentals, This Semiconductor is So Cheap

Cash flow is an important indicator of business operation efficiency, and it is more reliable than earnings in terms of valuing a business, as it is less manipulated. Free cash flow is the amount of cash available to the company after all necessary capital expenditures. Thus, I would be quite excited with companies trading at low Price/Free Cash Flow ratio. In addition, if the cash flow was generated without the help of high leverage and it delivered a high return on invested capital, it could be a low risk/high reward opportunity. Here is one company, with the market capitalization of larger than $500 million, that fits those three criteria: Kulicke & Soffa Industries (NASDAQ: KLIC).
Business Snapshot 
Kulicke & Soffa (K&S), incorporated in 1956, is an equipment and expendable tools provider for semiconductor device manufacturers, test providers, and other electronic manufacturers. The majority of its revenue ($727 million) was from the Equipment segment, accounting for nearly 92% of the company's total revenue. In fiscal 2012, around 98.3% of the total sales were to customer locations outside of the US.
Cash Cow with High Return
K&S experienced operating losses in 2008 and 2009 due to the negative impact of the global economic downturn. Its revenue was very low during those two years dropping from $700 million in 2007 to only $328 million in 2008, and to only $225 million in 2009. However, in 2010, sales bounced back to $763 million. Since then, K&S has consistently delivered a high return on invested capital, from 25.62% to 38.76%. In fiscal 2012, the return on invested capital was 26.35%, whereas the return on equity was 28.84%. During the same three-year period, K&S generated consistently positive operating and free cash flow. It generated $182 million in operating cash flow and $161 million in free cash flow in fiscal 2012.
Market Leader in its Products
Interestingly, in the boring semiconductor industry, K&S held the #1 position in many of its product markets, including Wire Bond, Wedge Bond, Stud Bump, and Capillaries. In 2012, it was reported to have 70% of the Wire Bond market. In the company’s recent presentation, it said that the market research forecasted that 83% of all Integrated Circuits would be Wire Bonded in 2016.  
Source: K&S Presentation
Cash Cow but Cheaply Valued
To achieve high return on invested capital, K&S employed no leverage at all. As of September 2012, it had $744 million in stockholders’ equity, no debt, and $440 million in cash. Thus, with the total market capitalization of $871.34 million, the enterprise value is much lower, at only $431 million. So the market values K&S at only 2.68x P/FCF. Its EV/EBITDA is also quite low, of 2.17x.
Among its peers, including BE Semiconductor (NASDAQOTH: BESIY) and Teradyne(NYSE: TER), K&S had the lowest valuation among the three. As mentioned above, K&S is valued at 2.17x EV/EBITDA and 5.4x P/E, whereas BE is valued at 4.89x EV/EBITDA and 11.5x P/E. The market is valuing Teradyne at a slightly higher EV multiples, at 5.15x and 10.2x P/E.
Foolish Bottom Line
It is good to see K&S had a market leader position in its Wire Bond product, along with the potential growth of its semiconductor niche. With the debt-free operation, high return on invested capital, low free cash flow, and EV multiples valuation, K&S is definitely a great value pick for investors.

This Energy Company is a Decent Asset Play

There is one independent oil and natural gas exploration and production company that several investment gurus, including T. Boone Pickens, Wallace Weitz, and Canadian Warren Buffett Prem Watsa are investing in. Right after Christmas, Prem Watsa actually added more shares into his existing holdings of this company, bringing his total to more than 59.5 million shares. This company is SandRidge Energy (NYSE: SD). Oil guru T. Boone Pickens owns more than 700,000 shares, and Wallace Weitz owns more than 9.2 million shares of the company. Should investors follow these investment gurus into SandRidge? Let’s find out.
Business with High Leverage
SandRidge, headquartered in Oklahoma, is an independent oil and natural gas located in several areas, including Oklahoma, Kansas, and west Texas. As of the end of 2011, SandRidge was estimated to have around 533 million BOE, with 91% of the total reserved in oil. For the last 3 years, the company has increased the production volume gradually, from 47.9 MBOE per day to 64.1 MBOE per day. As of September 2012, SandRidge had nearly $2.66 billion in total stockholders’ equity, $674 million in cash, and as much as $4.3 billion in long-term debt. The low equity was due to nearly $2.55 billion in treasury stocks and nearly $2.6 billion in accumulated comprehensive losses. Thus, it seemed that SandRidge was highly leveraged.
Permian Sale to Strengthen the Balance Sheet
In December, SandRidge made a move by selling its Permian basin properties for $2.6 billion in cash to Sheridan Production Partners II. The company had three motives for the sale. First, the company has seen that “oily, conventional, mature assets” had a high valuation. Second, it could have cash to reduce debt to be more flexible financially. Third, it could focus on Horizontal Mississippian assets with high rates of return with the potential of long-term growth. The intention of the Permian sale has received different opinions from shareholders. Many thought that the $2.6 billion price tag was low. However, Grew Dewey, the company’s VP, Communications and Community Relations explained that the company had two big assets but didn’t have enough cash, so it had to choose which to focus on. The company thought that the future growth of Permian’s production would be difficult. Tom Ward, SandRidge’s Chairman and CEO commented on the sale, “This is a great outcome for our shareholders. The sale of the Permian assets at this time has allowed us to capitalize on current strong valuations for mature, conventional Permian assets and generate a very strong return on our investment there." Indeed, the cash position has increased to more than $3 billion, and the company intended to use it for debt reduction and focus on “highly scalable, high return Mississippian Play.”
Proxy Battle on an Undervalued Energy Company
The company is currently facing a proxy battle between its management team and several big shareholders. TPG-Axon, a 6.7% owner, has sent the company a letter saying that the fund was filing a lawsuit, as SandRidge didn’t give shareholders enough time to vote. Mount Kellett Capital Management, a 4.5% owner, also mentioned that Tom Ward should be replaced. It thought that the company’s asset was worth around $20 per share. At the current price of $6.23 per share, SandRidge is valued at 1.1x P/B, and as high as 666x P/E, whereas its peers, including Apache Corporation (NYSE: APA) and Occidental Petroleum (NYSE:OXY) are trading at quite reasonable valuations. Apache is valued at 1x P/B and 12.4x P/E, and it is also paying a dividend yield of 0.9%. Occidental Petroleum, one of the biggest global oil/gas giants, is valued at 10.3x P/E and 1.5x P/B. Occidental Petroleum is paying the highest yield among the three, of 2.9%. 
Foolish Bottom Line
As other big shareholders have mentioned, the key to unlocking the value of SandRidge might be via strategic partners and strategic sales. The high P/E ratio is misleading, as the main value stays in the assets it owns. SandRidge owned good oil/gas assets, which could be valued at $20 per share, more than three times higher the current share price. It could be a good opportunistic stock to hold after it strengthened its balance sheet with the cash received from the Permian sale.

Is This MicroCap a Good Investment After CEO's Buy?

I often pay attention to insider trading, especially when the top executives of a particular company buy a significant amount of stock. That is quite an important signal of value, and the indicator of a potential price surge in the near future. I will cover two companies that have experienced more than $300,000 worth of insider buying since the middle of December in two articles. In this article, I'll focus on a micro cap restaurant chain, Luby’s (NYSE: LUB), with two brothers purchasing 100,000 shares just a week ago. Should investors follow their lead and invest in the company as well? Let’s find out.
Same Store Consistent Growth
Luby’s has been operating in the restaurant industry for more than half a century through several brands, including Luby’s Cafeteria, Luby’s Culinary Contract Services, Bob Lucy’s Seafood, and Fuddruckers. The company is currently operating 156 restaurants in the US, with the majority of restaurants in the Houston metro area in Texas, including 121 Fuddruckers franchise restaurants owned by 53 franchisees. Like many other restaurant operators, the main revenue source has been restaurant sales, which came to $324.5 million, accounting for 92.7% of the total revenue. In fiscal 2012, the restaurant operator reported to have a 2.6% same-store sales growth, and same-store sales have increased continuously for the last 4 quarters of fiscal 2012. Luby’s uses little debt for its operation. As of November 2011, it had $173 million in total stockholders’ equity, $2 million in cash, and only $11.5 million in long-term debt.
Decent Q1 2013 Operating Performance
On Dec. 19, Luby’s reported decent first quarter results for FY2013. The restaurant sales were $74 million, 1.1% higher than the same quarter of last year. The growth in sales was due to both the growth in same store sales, as well as the opening of 7 new restaurants since last year. Out of the 1.1% total restaurant sales, the high growth came from Fuddruckers and Koo Koo Roo’s sales growth of 1.9%, whereas Luby’s restaurants increased its sales by 0.8%. However, store profit levels declined slightly to $9.8 million, lower than the profit in Q1 2012 ($10.1 million), due to higher labor cost and higher advertising and marketing expenses. In December, Luby's announced it will pay $11 million to purchase 23 restaurants from the Cheeseburger in Paradise chain. 
Significant Insider Buys and Lowest Leverage
On Dec. 26, right after Christmas, Luby's President and CEO Christopher Pappas bought 50,000 shares of Luby’s at the cost of $6.565 per share, with the total transaction worth nearly $330,000. Harris Pappas, Christopher’s brother,  bought the same amount of shares at the same price on the same day. Collectively, those two brothers owned around 32.89% of the total company. This is indeed a very good value signal for shareholders.
At the current share price, the restaurant chain is trading at 7.19x EV/EBITDA. The valuation is a little cheaper than its peer, Denny’s Corporation (NASDAQ: DENN), which had its EV/EBITDA at around 7.7x. Denny’s EPS for the last 12 months of $0.11 was five times higher than that of Luby’s, at $0.02 per share. However, looking deeper into Denny’s balance sheet, this was due to the provision for income tax, which pushed Denny’s net income much higher. Its other peers, Einstein Noah Restaurant (NASDAQ: BAGL), seems to be the cheapest, with only 6.51x EV/EBITDA. However, Luby’s has the most conservative capital structure. Luby’s D/E is only 0.1x, whereas Denny’s D/E is as high as 324.1x, and Einstein Noah’s D/E is 0.6x.
My Foolish Take
The high level of insider ownership is a strong indicator of value. Luby’s is improving its operating performance with a conservative capital structure, which makes investors feel safe. In addition, it is quite reasonably valued. I personally think Luby’s could experience a price surge in the near future. In the next article, I will dig deeper into another stock with a recent CEO buy of over $300,000 in company stock.

These Two Retailers Are Cheap Now

The sales data just released by ShopperTrak indicates that the recent holiday sales, ended Dec. 23, were quite gloomy. ShopperTrak mentioned that traffic fell by 3.3% compared to the same week last year. The significant gain to the previous week of 39.1% was quite reasonable, as the week ended Dec. 23 was the hottest retail season of the year, right before Christmas. However, compared to the same week sales in 2011, retail sales experienced a decline of 2.5%. Right after the data was released, many retailers got hit in the stock market, including The Gap (NYSE: GPS)Aeropostale (NYSE: ARO). However, I think it could be a good chance to pick up these two decent growing retailers to own for the next year.
Gap is one of the leading apparel, accessories, and personal care products retailer in the world, with more than 3,300 stores worldwide operating different famous brands including the Gap, Old Navy, and Banana Republic. Gap has diversified its merchandise with more than 1,000 vendors in 43 countries. In 2011, no vendors accounted for more than 4% of the total company’s purchases. Gap is a seasonal retailer, as its sales reach its peak in around eight weeks during the year end holidays. The company has experienced a decline in its comparable sales in four out of the last five years. However, in November Gap reported positive comp. sales growth. The November comp. sales increased by 3%, quite positive compared to the decline of 5% in the same month last year.
Gap has been a constant cash flow generator in the last 10 years. In the last 12 months, the retailer generated $1.95 billion in operating cash flow and more than $1.35 free cash flow. Since 2004, the retailer has kept delivering double-digit return on invested capital; trailing twelve months, the ROIC was 20.8%. In addition, Gap paid out $0.45 dividend per share, with a payout ratio of 28.8%. Gap is valued at around 6.12x EV/EBITDA. 
Aeropostale is also an apparel and accessories retailer, but it mainly targets young women and men, and also kids from 4-17 years old. The main operations of Aeropostale are in North America, with 1,011 stores in 50 states and Puerto Rico, and 75 stores in Canada. Unlike Gap, Aeropostale has a concentration of suppliers. The retailer sourced around 87% of its merchandise from its top five vendors, with the majority of vendor’s sourcing offices in the US, while production was in Asia and Central America. The business is also seasonal, with the majority of sales and profits derived from the second half of the year, with back-to-school sales season in Q3 and the holiday season in Q4. The retailer experienced positive comparable sales growth in 4 out of the previous 5 years.
Interestingly, Aeropostale ended the third quarter with $184 million in cash and no debt, whereas the total stockholders’ equity was $409 million. The recent $12 million decrease in stockholders’ equity in the previous quarter was due to $40 million share buybacks. In the last 10 years, Aeropostale has experienced consistently positive EPS and free cash flow. During that period, Aeropostale delivered a double-digit return on invested capital. Trailing twelve months, its ROIC was 15.60%. At the current trading price, the retailer is valued at only 4.43x EV/EBITDA, the cheapest among its peers. Whereas Abercrombie & Fitch (NYSE: ANF) is valued at 6.65x EV/EBITDA and American Eagle Outfitters is the most expensive, at 7.1x EV/EBITDA.
My Foolish Take
The cheap EV multiples valuations are quite intriguing for value investors, especially the growing Aeropostale. Even though the market sentiment sent those two stocks down in the short-term, I think those two retailers would be quite beneficial for shareholders in the long run. 

This Stragetic Deal Could Enhance the Value of Mini-Berkshire

Recently, Markel Corporation (NYSE: MKL), which has long been considered the mini-Berkshire Hathaway, announced a big acquisition. Markel said that it would acquire Alterra Capital Holdings (NASDAQ: ALTE) for around $3.13 billion. Markel would pay Alterra’s investors $10 per share in cash and 0.4315 Markel’s shares per Alterra’s shares. The price tag of $3.13 billion would value Alterra at around $31 per share. After the deal, Markel will own 69% of the combined company, and Alterra would own the remaining 31%. Should investors be excited about the news? Are Alterra and/or Markel a buy after the deal?
Profitable P&C Insurer
Alterra, incorporated in Bermuda, is the diversified specialty insurance and reinsurance providers, with operations in the US, Europe, and Latin America. In 2011, the majority of its gross premium derived from the Reinsurance business, worth $869.7 million, accounting for 45.7% of the total gross premium written. The second highest premium source was insurance, accounting for 21.5%. In terms of geography, the main property and casualty premiums were brought from North America operations, representing 73.8% of the total gross premiums written in 2011. In the last 5 years, Alterra has managed to consistently grow its premium earned, from $817.9 million in 2007 to $1.425 billion in 2011. 
However, the firm suffered losses of $175.3 million 2008, and in 2011 brought in net income of only $65.3 million. The negative loss in 2008 was due to the losses that the firm had to take from alternative investments. The low profits in 2011 were due to much higher net losses and loss expenses compared to 2010. The losses derived from significant property catastrophe events, including Australian floods, the New Zealand earthquake, the earthquake in Japan, Hurricane Irene, etc. In the last 3 years, Alterra reported to have consistently positive underwriting profits, with the combined ratio below 100%. In 2011, the consolidated combined ratio was 98.2%. Out of its 5 insurance lines, the Insurance Segment and Reinsurance Segment are generating significant underwriting profits, whereas the U.S Specialty Segment and Aterra at Lloyd’s Segment are generating underwriting losses, with 104.8% and 135.4% combined ratios in 2011, respectively.
Mini-Berkshire Potential Advantages
Markel is a specialty insurance product provider with three main segments: Excess and Surplus Lines; Specialty Admitted; and London Insurance Market. In fiscal 2011, the majority of premiums were from two sources: Excess and Surplus Lines, with nearly $893.5 million, and London Market Insurance, with $825.3 million in gross premium. In 2011, the reported combined ratio of Markel was 102%, higher than 2010's 97% and 2009's 95%. However, with the investment yield of 4% and taxable equivalent total investment return of 7%, 2011 is still a decent year for the company. 
After the acquisition, Markel’s business would have an equal division of short and long tail insurance premiums, along with the division of 67% insurance and 33% reinsurance.  Steven Markel, Vice Chairman of Markel, said:
The addition of Alterra's reinsurance and large account insurance portfolios will serve to diversify and strengthen Markel's current book of specialty insurance business. We look forward to welcoming Alterra's talented underwriting teams to Markel – with their help and the benefit of approximately $6 billion in combined shareholders' equity, we believe we will be well positioned to take advantage of a wide range of profitable opportunities.
With the current book value of $2.92 billion, the deal would value Alterra, the company with the $7.4 billion investment portfolio, at a bit higher than its book value. Markel is trading at $430 per share, with a total market capitalization of $4.14 billion. It had an investment portfolio valued at around $7.6 billion. The market is valuing Markel is 1.1x P/B. One of Markel's peers in the insurance business, CNA Financial Corp  (NYSE: CNA), had an investment portfolio of nearly $47.79 billion, with the majority was in fixed maturity securities ($42.3 billion), whereas the market capitalization was $7.78 billion. CNA is valued at only 60% of its book value and is paying its shareholders a dividend yield of 2.1%. 
My Foolish Take
The acquisition of the profitable P&C insurance company Alterra would give Markel a lot of competitive advantages in insurance, reinsurance, float and investing profits. Alterra and Markel could still be considered a long term insurance investment, especially when investors have a chance to buy at the lower price than the offering price.  

This Apparel Maker Offers Long Term Value Amidst Short Term Headwinds

Deckers Outdoor (NASDAQ: DECK) has surprised investors one more time by the sudden daily increase of as much as 9.3% to close the most recent trading day at $38.11 per share. Standpoint’s analyst Ronnie Moas sent his bullish feeling about Deckers by noting that its sheepskin products, UGG outpaced Kindle and iPad to be the number one researched item. I have written about this shoemaker several times in the past, calling it a good stock to hold for the long run. What about now, along with the bullish sentiment and recent surge in its stock price?
Tied Closely to UGG
Many people think about Deckers as an UGG maker. Indeed, the majority of Deckers's revenues has been derived from UGG’s sales alone. In 2011, UGG generated $915.2 million in sales, accounting for nearly 66.5% of total revenues, whereas the second biggest brand, Teva, generated around $118.7 million. Over the last 5 years, UGG’s revenue has increased significantly, from only $219.9 million in 2007, to $915.2 million in 2011, sporting an annualized growth rate of 33%. The UGG brand has been positioned to be luxurious and comfortable footwear, handbags and other accessories. Thus, Deckers’ future seems to tie closely with UGG brands.
Worst Performer Last Year
Deckers is the most volatile and fragile stock, compared to its peers including Nike (NYSE:NKE) and Crocs (NASDAQ: CROX). Deckers has lost more than 50% of its total value since the beginning of last year, whereas Crocs lost nearly 10.4%. Nike was the best performing stock among the three, with an increase of nearly 7%. 
Deckers has been growing its net income and EPS over time. The net income has risen from $19 million to as high as $285 million in 2011, along with the rise in the EPS from $0.26 to $5.07.
Sluggish Q3 Results
However, the recent third quarter earnings results disappointed investors, with a 10% decrease in revenue, which missed the analysts’ estimates. In addition, its third quarter net income declined significantly by 47% year-over-year, to only $43.06 million. Deckers also expected a year-over-year drop of 14% in EPS for the fourth quarter. Angel Martinez, the company’s Chairman and CEO said that the 80% increase in sheepskin and raw material costs impact had been mitigated by price rises. In addition, the warmer weather has also impacted negatively on UGG boot sales, as UGG was fashionable mainly in the winter time.  Thus, it’s all about the weather. On the conference call, the CEO commented on the Q3 conference call:
“If we're sitting here in mid-November, early December, and it's 75 degrees in New York City, we're going to be over-inventoried in the channel, I can guarantee you that. So I think retailer have brought in the appropriate amount of inventory based on last year, which was not a good year for weather. So we're kind of just sitting here waiting on cold weather. I mean I hate the -- that's what drives me nuts, it's just sitting here with this, watching the weather report everyday." 
Indeed, the inventory level of Deckers has risen from $357 million in the third quarter 2011 to $486 million in the third quarter 2012. Valuation-wise, Deckers is valued at a bit more than 6x EV multiples. Crocs is the cheapest at only 4.88x EV/EBITDA, and Nike is the most expensive at 12.56x EV/EBITDA.
Foolish Bottom Line
Weather, weather, weather! The cold weather is the best condition for UGG boots to bepopular. In addition, Deckers might have other options to diversify into other fashion lines, rather than just focusing solely on UGG. That would make the company less volatile. However, UGG is still considered the highest quality luxury brand compared to Bear Paw and Emu. The fur on UGG is thought to be much softer and warmer. With the low valuation, I think Deckers will offers a lot of value for shareholders in the long run. 

Safest Income Stocks for 2013 (Final Part)

n the 3-article series “Safest Income Stocks for 2013,” I laid out 6 stocks that I think are the safest income stocks for the next year. Each article covers two stocks in different industries, including quick service restaurants and technology, as well as fast moving consumer goods and tobacco. In this article, I will uncover two final safe stocks that could pay investors sustainable dividends on their growing business fundamentals in the next year. One is in the banking industry, and the other is in the wholesale/retail industry.
Wells Fargo (NYSE: WFC) is one of the most well managed banks in the US, with the stamp of confidence from the most successful investor of our time, Warren Buffett. Indeed, Buffett has considered Wells Fargo to be one of his long-term holdings. He started buying Wells Fargo when the whole banking industry was in crisis in 2008. Berkshire Hathaway came in to buy a 10% interest in the bank for only $290 million, which was valued at less than 5x after-tax earnings at that time.
Buffett wrote in 1990,
Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings. The exception was Wells Fargo, a superbly managed, high-return banking operation in which we increased our ownership to just under 10%, the most we can own without the approval of the Federal Reserve Board. About one-sixth of our position was bought in 1989, the rest in 1990.
As of September 2012, Wells Fargo was the second biggest position in Berkshire Hathaway’s portfolio, with more than 422.5 million shares and a total value of nearly $15 billion. 
In the last 10 years, Wells Fargo has paid consistent dividends, although the dividend payment was fluctuating. Trailing twelve months, it paid out $0.68 dividend per share, with a decent payout ratio of 21.3%. Wells Fargo has the best net interest margin compared to its peers, including Citigroup (NYSE: C) and Bank of America (NYSE: BAC). Wells Fargo’s net interest margin for the third quarter was 3.66%, much higher than Citigroup’s of 2.8% and Bank of America's 2.21%. Valuation-wise, Wells Fargo is trading at 10.8x P/E and 1.3x P/B. Bank of America seems to be more expensive with 31.3x P/E, but cheaper with a 0.6x P/B. Citigroup is valued at 16.2x earnings and 0.6x book value. Wells Fargo is paying the highest dividend yield among the three (2.3%), whereas Bank of America and Citigroup are paying 0.4% and 0.1%, respectively.
Costco (NASDAQ: COST) is the final stock in my list of 6 safest income stocks for 2013. It has quite an interesting business model. People pay for their memberships to get into Costco and buy merchandise for very low prices. In turn, Costco focuses on generating high sales volume with low prices and increasing inventory turnover. Charlie Munger is a big fan of Costco. When he was asked about his favorite company in addition to Berkshire Hathaway, he automatically mentioned Costco. He said about the long-term vision of Costco:
It has a frantic desire to serve customers a little better every year. When other companies find ways to save money, they turn it into profit. Sinegal passes it on to customers. It's almost a religious duty. He's sacrificing short-term profits for long-term success.
Costco has been generating consistently increasing profits and dividends. Its EPS has increased from $1.85 in fiscal 2004 to $3.89 in fiscal 2012. In the same period, Costco’s dividend payment has risen from $0.20 per share to $1.03 per share. In December, Costco paid special dividends of $7 per share, financed by newly issued senior notes of as much as $3 billion. I considered it an advantageous move for shareholders, as Costco had conservative capital structure. By issuing new debts, Costco could take advantage of the low interest rate to pay dividends.
Foolish Bottom Line
Wells Fargo and Costco have superb operations that are generating high margins and returns for shareholders. I think investors could sleep well at night betting on those stocks for a long run. This is the last article in the three articles covering 6 Safest Income Stocks for the next year. At the end of 2013, we will come back to see how well we will be doing with an income portfolio consisting of these 6 stocks.

Is This Carmaker a Good Stock After a $1 Billion Settlement?

Toyota Motor Corporation (NYSE: TM) has agreed to pay $1.1 billion to settle the US class action lawsuit arising from the automobile recalls in 2009-2010, which came about because of the unintended acceleration in Toyota’s vehicles. Around 16 million vehicles with different brands, including Toyota, Lexus, and Scion, got safety updates and payments. Including the 2010 recall costs and decrease in sales, the total cost of this debacle is up more than $3.1 billion, including this settlement. How will the event affect this carmaker’s earnings? Shouldinvestors consider Toyota a possible investment after this all this?
Top Global Market Position
Toyota has emerged as one of the largest global automobile manufacturers. Its automotive products have been sold in around 170 countries and regions, with the majority of cars sold in Japan (more than 2 million units in fiscal 2012), generating revenue of nearly ¥7.3 trillion ($85.14 billion). The second biggest consumption area was North America, where more than 1.87 million were units sold, generating nearly ¥4.65 trillion ($54.23 billion) in sales. Asia is next on the list, with more than 1.32 million units sold, bringing to Toyota nearly ¥3.2 trillion ($37.32 billion) in revenue. In the first nine months of 2012, Toyota has kept its status as the world’s highest selling car maker, with sales of 7.4 million vehicles. General Motors (NYSE:GM) has sold more than 6.95 million vehicles during the same time. The third position belonged to Volkswagen Group (NASDAQOTH: VLKAY), with around 6.2 million units sold.
“Strong” Business Profile
In November 2012, S&P rated Toyota as having a “strong” business profile for several reasons. First, the company has a strong market position thanks to consistently reducing costs by around ¥300 billion ($3.5 billion) per year. Even with the Japanese earthquake in Mach 2011, it successfully sold 7.35 million vehicles globally in that year, along with the recovery in inventory and production levels. S&P expected that Toyota could regain market share in several key markets. Second, Toyota had “a strong capital structure and exceptional liquidity,” thus the financial risk was quite remote.
Decent Balance Sheet and Valued Most Expensive
Toyota had a decently leveraged balance sheet. As of September 2012, it got nearly ¥10.74 trillion ($125.26 billion) in total stockholders’ equity, more than ¥11.7 trillion ($136.5 billion) in both long and short term debt, and ¥3 trillion ($35 billion) in cash. In fiscal 2012, Toyota generated nearly ¥284 billion ($3.31 billion). This Japanese automaker forecasted its net income to ¥780 billion ($9.1 billion). According to Toyota, the $1.1 billion will be charged to this quarterly earnings; thus the expected net income would be around $8 billion, more or less. With the current share price of $91.84, the total value of Toyota is around $145.42 billion. This means that the net income of $8 billion, after the settlement charges, would put the earnings valuation to 17.8x forward P/E. Toyota is valued as more expensive than GM and Volkswagen. GM is currently valued at only 7.1x forward earnings, and Volkswagen is valued at 6.61x forward P/E.
Interestingly, many investment gurus have been buying Toyota in the second and third quarter of this year, including John Rogers, Bill Gates, Donald Smith, and Ken Fisher. Ken Fisher is holding nearly 4.75 million shares in the company, Bill Gates owns 153,300 shares, Donald Smith and John Rogers holds 369,197 and 2,950 Toyota shares, respectively.
Foolish Bottom Line
I think Toyota is regaining its top global carmaker position, surpassing GM and Volkswagen, even with the recent recall and settlement. This might be the reason why it received a much higher valuation in the stock market compared to its peers. However, I have pointed outpreviously that GM seemed to be the low risk bet with good potential, and Volkswagen is poised to benefit shareholders in the long run as well.