Wednesday, February 13, 2013

A Potential 50% Premium Takeover Candidate

In the 2013 Barron’s Roundtable, Mario Gabelli discussed many of his investment ideas, including Hillshire Brands and Post Holdings. He was also bullish on a leading water and wastewater treatment equipment business called Xylem (NYSE: XYL). He considered Xylem a potential takeover candidate with a 50% premium to the current stock price within two years. Let’s dig deeper to see whether or not we should follow Gabelli into Xylem.
Business Snapshot
Xylem was spun off from ITT Corporation in 2011. It is a global leading provider of highly engineered technologies for the water industry, with several brands such as Flygt, Wedeco, AC Fire, Standard and Bell & Gossett. It has two main business segments: Water Infrastructure and Applied Water. The majority of revenue, $2.4 billion, or 63% of the total revenue, was generated from the Water Infrastructure segment. Applied Water contributed nearly $1.45 billion in revenue in 2011. Xylem has a diverse customer base, as no individual customer represented more than 10% of the total revenue in 2011. In terms of geography, the United States and Europe accounted for 36% and 37% of the total sales, respectivley.
High Potential Growth
As of September 2012, Xylem had more than $2 billion in total stockholders’ equity, $424 million in cash, and nearly $1.2 billion in long-term debt. The goodwill and intangible assets, around $1.1 billion, seemed to be high.  In the last 5 years Xylem has managed to generate consistent positive net income. The net income has been fluctuating in the range of $219 million--$329 million. In 2011, Xylem generated more than $3.8 billion in revenue, and Mario Gabelli expects the revenue to increase to $4.6 billion by 2016. EBITDA could reach $800 million by that time, and EPS might rise from $1.80 to $2.50. At the current price of $28 per share, the total market capitalization is $5.2 billion. The market is valuing Xylem at 9.72x EV/EBITDA.
50% Potential Premium on Takeover
Xylem has a quite diversified end market. Industrial and public utility customers accounted for 40% and 36% of the total revenue, respectively. The industrial market is considered to be less cyclical than the commercial market, and public utility is non-cyclical. Thus, customers from those two markets could be considered sticky. In addition, because only Xylem can produce the replacement parts for its equipment, the customer switching cost is high. Gabelli commented: This is a yummy for a large corporation that wants to have distribution and products in water industry.” He thought that the company might be acquired at a 50% premium to the current price within the next two years. 
Cheapest Among Peers
Xylem looks cheap in comparison to its peers, including Danaher (NYSE: DHR) andFranklin Electric (NASDAQ: FELE). With a total market capitalization of $41.6 billion, Danaher is valued at 11.4x EV/EBITDA.  Franklin Electric is the smallest company among the three, with only a $1.56 billion market cap. Franklin Electric has the highest valuation, at 12x EV/EBITDA. Both Xylem and Franklin Electric had a 13% operating margin over the last 12 months. Danaher’s operating margin, 17%, is the highest among the three. Currently, Xylem is paying a 1.4% dividend yield to investors, while Danaher and Franklin Electric are paying only 0.2% and 0.9% yields, respectively. 
My Foolish Take
Indeed, Xylem has the strong advantages of technical expertise and a market-leading position in the water treatment industry. A high switching cost creates loyal customers and fuels Xylem’s future growth. Investors might consider Xylem as a long-term stock in their portfolios.

Why I Like This Cereal Business

Mario Gabelli, a famous investment manager, has beaten the S&P 500 by 2% per year for more than 25 years. In the Barron’s Roundtable this year, Mario Gabelli has discussed several stocks that he likes, including Hillshire Brands, a leader in meat-centric food solutions. In this article, I would talk about one more business that he recommended in the Roundtable: Post Holdings (NYSE: POST)
Third largest player in the US cereal market
Post is the manufacturer and distributor of ready-to-eat cereals in the US and Canada with several brands, including Post Selects, Great Grains, Honey Bunches of Oats, etc. Post reported to be the third largest company in ready-to-eat cereals in the US market, with a 10.4% share of retail sales. The products were divided into three different categories: Balanced, Sweet, and Unsweetened. Post said that it had a long and stable relationship with key customers in all distribution channels, including retail chains, grocery wholesalers, drug stores, and Foodservice distributors. In fiscal 2012, the ten largest customers accounted for around 55% of the total gross sales. Wal-Mart, the largest customer, represented around 21% of net sales. Actually, Post is the spin-off from Ralcorp Holdings. Interestingly, William Stiritz, the chairman and CEO of Post, was the chairman of Ralcorp for nearly 30 years. 
The CEO with $1 base salary
If the executives were rewarded based on long-term business performance, investors would be better off in the long run. In a three-year employment agreement between Postand Stiritz, Stiritz would receive a base salary of only $1 per year. The majority of the payment would be in the form of stock options. In the 2012 proxy filing, the company wrote:
In May 2012, the Compensation Committee granted Mr. Stiritz 1,550,000 non-qualified stock options, at an exercise price of $31.25 per share, the closing price of our stock on the date of grant, which generally vest in equal installments on the first, second and third anniversary dates of grant. These options are intended to constitute substantially all of Mr.Stiritz’s compensation for his service as Chief Executive Officer of the Company during the three-year term of his employment agreement, absent special circumstances.” 
I personally like this compensation arrangement because his benefits will be aligned with shareholders’ interests. Even with a $1 base salary, Stiritz’s total compensation was nearly $22.7 million in 2012, including $9.76 million in stock awards and $12.85 million in option awards. Mario Gabelli liked Stiritz. He said that Stiritz was a proven money maker.
Earnings expected to grow in near future
As of September 2012, Post reported to have $1.23 billion in total stockholders’ equity, $930 billion in long-term debt, and $58 million in cash. It booked a huge amount of goodwill--nearly $1.4 billion. The intangible asset amount was also high, at nearly $740 million. In 2011, Post lost nearly $425 million. The loss was due to a $566 million impairment of goodwill and intangible assets. The operating cash flow has been positive for the last 4 years. In 2012, it generated $144 million in operating cash flow and $113 million free cash flow. At the current price of $37.95 per share, Post is worth $1.24 billion in the market. It is valued at nearly 9.9x EV/EBITDA. Mario Gabelli expected that Post would earn $1.50 per share in this year. The earnings might even grow to $3 per share in the next 3-4 years. 
Peers comparison
Post is considered the smallest company in comparison to its peers, including General Mills (NYSE: GIS) and Kellogg (NYSE: K). General Mills is worth nearly $27.22 billion in the market, while Kellogg is worth more than $21 billion. Among the three, General Mills generated the highest operating margin of 17%. Post’s operating margin was 16%, whereas the operating margin of Kellogg was the lowest at 14%. In terms of valuation, General Mills and Post are both valued at around 9.9x EV/EBITDA, while Kellogg is considered the most expensive company with 12.1x EV/EBITDA. Those three companies are the three biggest players in a cereal market. Kellogg has the biggest market share at 34%, while General Mills came quite close at 33%. Post, as mentioned above, ranked third with a 10.5% market share.
My Foolish Take
As Mario Gabelli said about Post: “You want to buy cash-generating companies with pricing power that have had some sort of short-term hiccup. They must be run by CEOs who understand how to create value. The sun, moon, and stars are aligned at Post.”Personally, I would consider Post a buy at the current price. 

Two Winners and One Loser in Dan Loeb's Portfolio

Daniel Loeb, a famous hedge fund manager, has managed to deliver a 21.2% return in 2012. His three biggest positions were Yahoo! (NASDAQ: YHOO)American International Group (NYSE: AIG), and Apple (NASDAQ: AAPL). The first two positions were the two top winners in the fund, whereas Apple ranked as one of the top losers in 2012. Let’s have a look at those three stocks to see whether or not investors should follow Dan Loeb into those holdings.
Yahoo! A Past Greedy Move
In the third quarter 2012, Yahoo! was the biggest position in Dan Loeb’s portfolio. He owned more than 73 million shares in the company, accounting for 23% of his total portfolio at that time. In 2008, Microsoft offered to buy Yahoo! at $31 per share, valuing the whole company at $45 billion. However, at that time founder Jerry Yang rejected the offer, as he and Yahoo!’s board thought the offer undervalued the company. The rejection seems to have been a bad move, as Yahoo!’s share price has been fluctuating in the range of $11.30-$20 since 2009. 
More of an Opportunistic Play with Poor Corporate Governance
In May 2012, Dan Loeb issued a letter to the board of Yahoo! indicating the company’s poor corporate governance by pointing out the false credentials of its previous CEO, Scott Thompson. Dan Loeb urged the company to fire Thompson and to appoint an interim CEO. In July 2012, Yahoo! hired Marissa Mayer to replace Scott Thompson as CEO. The new CEO has acknowledged that the company was facing challenges in monetizing its mobile segment, as it had zero revenue coming from mobile advertisements. It was said that the company might focus on several other segments, including Sports, Finance, and Entertainment to drive up revenue. At the current price of $19.78 per share, Yahoo! is valued at 6x trailing P/E, but the forward P/E is high at 17.35x, indicating the expected earnings drop this year. However, Zacks ranked Yahoo! as a Buy due to 7 straight positive earnings surprises and impressive third quarter results.
Apple Continues to Drop
Apple was the third biggest position Dan Loeb was holding as of September 2012. It was also one of the top biggest losers for him. After Apple released its first quarter earnings results, investors rushed to sell its shares. The share price dropped to $450. However, the first quarter earnings results were not bad at all. It had $54.5 billion in revenue and $13.1 billion in quarterly profit. The EPS was $13.81, higher than analysts’ estimates of $13.48. In addition, Apple generated $23 billion in operating cash flow in the first quarter, bringing the total cash level to $137 billion. With the total market capitalization of $422.4 billion, Apple is valued at 8.8x forward P/E. Investors would get the forward dividend yield of 2.8% if they buy Apple at the current price.
A Value Insurance Play  
AIG was the second biggest position of Dan Loeb in the third quarter 2012. He owned 23.5 million shares, accounting for 15.2% of his total portfolio. In the last 12 months, AIG has experienced a nearly 56% gain. The global insurance giant has repaid a $182 billion funding from the US government in full. AIG has been a popular holding for several famous hedge fund managers, including George Soros, David Tepper, and Leon Cooperman. Recently, AIG has decided to focus on its core business. It sold out its 90% stake in the airplane leasing global leader for around $5.28 billion. Previously, it also sold AIA business, a big Asian life insurer and American Life Insurance Company. AIG no doubt is still the leader in the global property and casualty insurance market. It is also the biggest US life insurance and retirement service provider with more than 86 million customers worldwide. At the current trading price of $36.18 per share, AIG is valued at 9.2x forward P/E and 0.5x P/B.
Foolish Bottom Line
AIG looks cheap now. With its refocus on its core operations, the near term future looks decent, while it is valued cheaply in the market. Apple also looks cheap with its huge cash balance and a strong technology base. Both AIG and Apple are definitely value plays.  Yahoo! is more of an opportunistic play on its turnaround efforts. If it can leverage on its current customer base and its existing assets, it could deliver a decent return in the future. 

Two Bad Acquisitions With a Huge Writedown

Rio Tinto (NYSE: RIO) just announced that it expected to have a huge impairment charge of as much as $14 billion in its full year 2012 results. Following the non-cash impairment charge, the company’s CEO, Tom Albanese, resigned and was replaced by Iron Ore’s chief executive Sam Walsh. The news seemed to be quite negative for this UK mining giant. Should investors be bearish about Rio Tinto?
Business Snapshot
Rio Tinto is considered one of the largest mineral corporation in the world, with different product groups including aluminum, copper, diamonds, iron ore, etc. The majority of Rio Tinto’s earnings were generated from the iron ore segment, more than $12.85 billion, accounting for 82.6% of the total group underlying earnings in 2011. The second biggest earnings source was copper, with $1.93 billion in earnings, representing 12.4% of the total 2011 earnings. In the last 10 years, Rio Tinto has managed to generate consistently positive operating cash flow and free cash flow. The operating cash flow has increased from $2.72 billion in 2002 to more than $20 billion in 2011. The free cash flow has fluctuated in the range of $535 million to $13.69 billion for the last 10 years. Rio Tinto had quite a strong balance sheet.  As of June 2012, it had nearly $55.68 billion in total stockholders’ equity, nearly $7.3 billion in cash, $1.77 billion in short-term debt and $19.4 billion in long-term debt. The debt/equity ratio was only 0.3x and the interest coverage was quite high at 27.6x. 
Two Huge Bad Acquisitions
Rio Tinto would recognize $14 billion in non-cash impairment charge in fiscal 2012, including $3 billion relating to Mozambique Coal and $10 billion - $11 billion decrease in its aluminum assets’ carrying value. The company also expected several write-downs of $500 million. The total $14 billion impairment charges related to two bad acquisitions. The $3 billion write-down has nearly wiped out the total acquisition cost of $3.7 billion, which Rio Tinto has paid to acquire the coal assets in Mozambique. The $10-$11 billion charges has increased the total write-down on Alcan’s acquisition to nearly $30 billion, representing 80% of the total purchase price of $38.1 billion in 2007.  Jan du Plessis, Rio Tinto’s chairman said:
The Rio Tinto Board fully acknowledges that a write-down of this scale in relation to the relatively recent Mozambique acquisition is unacceptable. We are also deeply disappointed to have to take a further substantial write-down in our aluminum businesses, albeit in an industry that continues to experience significant adverse changes globally.”
In 2010, Rio Tinto’s net income was the highest in the last 10 years, at $14.3 billion. In 2011, it earned only $5.8 billion. The huge non-impairment charges might drag Rio Tinto’s full year 2012 earnings into negative figures. 
Potential Near Term Price Drop?
At the current trading price of $55.85 per share, Rio Tinto is worth $103.15 billion in the market. The market is valuing Rio Tinto at 25.55x trailing P/E and 1.82x P/B. The $14 billion non-cash charges would be equal to 13.6% of the company’s total market capitalization. If we assumed that Rio Tinto is fairly valued in the market, I would expect the equivalent drop in its market price. Otherwise, Rio Tinto would look more expensive with the higher price/book valuation.
Compared to its peers, including BHP Billiton (NYSE: BHP) and Vale (NYSE: VALE), Rio Tinto seemed to be the most expensive mining giant. BHP, with $76.87 per share, is worth $205.5 billion in the market. It is valued at only 13.33x trailing P/E. Vale’s share price is currently $20.02 per share, with a total market capitalization of $103.17 billion. The market is valuing Vale at 8.8x P/E. Currently, BHP and Rio Tinto are paying the same dividend yield of 2.9%, whereas Vale is paying 1.6%. Among the three, Rio Tinto had the highest amount of goodwill and intangible assets at $16.3 billion on its balance sheet. BHP and Vale were much more conservative with relatively smaller goodwill and intangible asset amounts. BHP had more than $1.6 billion in intangible assets and no goodwill, while Vale had nearly $3 billion in goodwill and $1 billion in intangible assets. Thus, the likelihood of write-down for both BHP and Vale were much smaller than for Rio Tinto.
My Foolish Take
Investors should always remember two things. First, the values of mineral companies are moving closely with the commodity market prices. Second, the giant and expensive acquisition would turn sour for the company’s market price and its shareholders in the long run. Be careful when the big becomes bigger but not more efficient.

The Best Stock in the Vehicle Remarketing Industry

Copart (NASDAQ: CPRT) had a great year in 2012. Over the last 12 months the share price has increased 31.6%, much higher than S&P 500’s return of nearly 13.8%. Currently, it is trading at its 52-week high at $31.67 per share. At its 52-week high, its CEO Jayson Adair sold 57,520 shares at the average price of $30.40 per share, cashing out nearly $1.75 million. Is it a bearish sign? Let’s dig deeper.
Leader in Salvaged Vehicles Processing and Sale Service
Copart is considered to be the leading online auction and vehicle marketing service provider company in the US, the UK, and Canada. The salvaged vehicles that the company processes and sells have been obtained from insurance company suppliers. The business revenue includes fees from sales transactions, transportation, and otherremarketing services. The majority of its revenue was generated from services, nearly $760 million, accounting for 82% of the total revenue in fiscal 2012. The remaining 18% of sales came from vehicle sales. No customer represented more than 10% of its revenue for the last 3 years.
Cash Cow With a Strong Balance Sheet
In the last 5 years Copart has consistently generated increasing operating cash flow and free cash flow. The operating cash flow has grown from $194 million in 2008 to $230 million in 2012. The free cash flow increased from $81 million to $175 million in the same period. Since 2003, Copart has managed to deliver double-digit returns. Trailing twelve months its ROIC was 17.88%, with the net margin of 19.93%. Those high returns were generated on a debt-free operation. As of October 2012, Copart had nearly $610 million in total stockholders’ equity, $131 million in cash, and little debt.
High Insider Ownership
Since October 2012, insiders, including the CEO, the COO, and the General Counsel, have been selling their positions. As mentioned above, CEO Jayson Adair sold more than 57,500 shares at the beginning of this year. However, he and his related family members still own more than 5.5 million shares, accounting for 4.4% of the total company. The largest insider owner is Willis Johnson, who owned more than 14 million shares, representing 11.1% of the total shares outstanding. 
More Superior Performance
Compared to the company’s peers, including AutoZone (NYSE:AZO) and CarMax (NYSE: KMX), Copart has been the most performing stock over the past year. 
Copart has gained 31.6%, whereas AutoZone and CarMax’s share prices have increased 0.36% and 15.63%, respectively. Copart indeed deserves the rally due to its superior performance compared to the other two companies. Its operating margin was 31.1%, whereas the operating margin of CarMax and AutoZone were only 6.6% and 18.2%, respectively. Copart was also the least leveraged among the three, with 0.6x D/E. CarMax’s D/E was 1.8x, while AutoZone had a negative book value.
With the current trading price of $31.67 per share, Copart is worth $3.95 billion in the stock market. The market is valuing Copart at 17.4x forward earnings and 12.34x EV/EBITDA. Copart’s valuation surprisingly is still cheaper than CarMax’s. CarMax is valued at 18.3x forward P/E and more than 17x EV/EBITDA. AutoZone seems to be the cheapest, with 11.12x forward earnings and 8.72x EV/EBITDA.
Looking Forward
Since 2012, Copart has expanded its business overseas. In August, it acquired Ride Safely Middle East Auction in Dubai, UAE. In September, it announced the opening of its new facility in New Hampshire to address growing demand volume in the New England region. In November, the business was expanded to Germany via the acquisition of WOM Wreck Online Marketing Aktiengesellschaft.  EPS is estimated to grow to $1.82 next year. Personally, I think in a few years time, Copart would keep expanding its business overseas using its sustainable cash flow from operations. Thus, its EPS would be on the rise.
Foolish Bottom Line
Although the CEO is selling out at its 52-week high, he and his related family members are still holding significant stakes in Copart. The superior margin and return seem to be quite attractive. However, the double digit EV multiples have resisted me from initiating a long position in Copart at the moment. 

Warren Buffett is Confident About US Banks

According to Bloomberg, Warren Buffett has guaranteed that the US banks would not get the country in trouble. He also mentioned that he liked US banks because “the capital ratios are huge, the excesses on the asset have been largely cleared out.” With Buffett’s endorsement, investors should feel more confident about US banks. I personally think US banks are attractive investment opportunities at the moment.
Attractive Global Franchise
Citigroup (NYSE: C) just released its FY 2012 results. The revenue grew 3% to $55.8 billion, while the net income was $12.5 billion, up 6% from $11.8 billion in 2011. Citigroup has become a much safer bank with the increasing tangible common equity and Basel I Tier 1 Common Stock. The tangible common equity was $154.5 billion, with the tangible book value of $52.69 per share. The Tier 1 common equity ratio stayed at 12.7%. In the third quarter 2012, Citigroup had nearly $955 billion in deposits, an 11% growth compared to the third quarter last year. The net interest margin was 2.86%. Citigroup is trading at $42.34 per share; the total market capitalization is $124.16 billion. The market is valuing Citigroup at 8.1x forward earnings and 0.7x book value.
Highest Net Interest Margin
Wells Fargo (NYSE: WFC) is Warren Buffett’s favorite long-term bank stock.  He owns more than 422.5 million shares, accounting for more than 8% of the bank and more than 19.4% of Buffett’s portfolio. The net interest margin was 3.56%, the highest among big US banks. Its Tier 1 common equity ratio was 10.12%. Wells Fargo has also managed to increase its core deposits over time, from $864.9 billion in 2011 to $928.8 billion in 2012. In the full year 2012, Wells Fargo has experienced a 19% growth to $18.9 billion in net income. The EPS also rose by 19% to $3.36. Currently, Wells Fargo is trading at $34.68 per share, with a total market capitalization of $181.85 billion. The market is valuing Wells Fargo at 8.8x P/E and 1.3x book value.
Largest Deposit Base
Bank of America (NYSE: BAC) has the largest deposit base among the three US banks. For 4 years, the bank has managed to grow the deposits from $992 billion in 2009 to more than $1 trillion in 2012. The Basel I Tier 1 common capital has reached $155.4 billion, with the Tier I common capital ratio of 11.06%. Full year 2012, the net income came in at 2.76 billion, much higher than 2011 net income of $85 million. The increase in net income was mainly due to the lower provision for credit losses. Indeed, Bank of America's earnings power had been hidden by the large loan loss provision. Gradually, this provision will be released to the bottom line, which would increase the bank's net income.  In the fourth quarter of 2012, net interest margin was the lowest among the three, at 2.35%. Currently, Bank of America is trading at $11.44 per share, with a total market capitalization of $123.25 billion. The market is valuing Bank of America at 9.7x forward earnings and only 0.6x book value. 
Foolish Bottom Line
Investors would feel confident about large US banks with Warren Buffett’s endorsement. Wells Fargo has an efficient operation with the highest interest margin. Citigroup has the top global banking franchise, while Bank of America has the largest deposit base.  Over the long run, all of these three US banking giants will prosper with the improvement of the US economy. 

High Short Float but Cheaply Valued

Be fearful when others are greedy, be greedy when others are fearful” 
Warren Buffett
That is the key to wealth. When good stocks with high insider ownership are on sale, investors should bet on them. In order to find such opportunities, I create a simple stock screen with four main criteria: (1) market capitalization is greater than $100 million, (2) short float is more than 25%, (3) insider ownership is greater than 20% and (4) EV/EBITDA is less than 5x. Here are the only two results:
USANA Health Sciences (NYSE: USNA) is the multilevel marketing company promoting nutritional and personal products. USANA generated nearly 75% of total sales outside the US. In fiscal 2011, more than 35% of the total revenue was generated from Greater China, whereas 19.2% was from Southeast Asia/Pacific. The company reported that sales were made mainly to independent Associates and Preferred Customers. The company had a diverse customer base, as no single customer represented 10% of net sales in 2011. In the past 10 years, USANA has consistently generated more than 30% return on invested capital. The trailing twelve months ROIC was 34.3%. 
USANA has a high insider ownership. According to the recent 14A filing, the founder and chairman of the Board, Myron Wentz, owned 52% of the total shares outstanding. David Wentz, Myron Wentz’s son and the CEO, owned a 4.7% stake in the company.  Currently, the short float ratio of the company is quite high, at more than 55%. At the current price of $37 per share, the total market capitalization is around $463 million.
The market is valuing USANA at 4.68x EV/EBITDA. USANA has the cheapest valuation in comparison with other multilevel marketing companies, including Herbalife (NYSE: HLF)and Nu Skin Enterprises (NYSE: NUS). Herbalife is valued at 6.9x EV/EBITDA, while Nu Skin has 6.9x EV multiples. Herbalife has been in a hot seat recently. Activist investor Bill Ackman said Herbalife was a pyramid scheme, and he set a $0 price target for Herbalife. In contrast, Dan Loeb, another hedge fund manager, has considered Herbalife as a great investment opportunity. He thought Herbalife was worth $55 - $68 per share. The short float of Herbalife is nearly 35%, lower than the short float of USANA. Among the three, Nu Skin has the lowest short float of 17.04%. 
Blyth (NYSE: BTH) is the direct to consumer business focusing on fragrance products, decorative accessories, nutrition supplements and energy drinks. The majority of the company’s revenue was generated from the Direct Selling segment, which accounted for 78% of the total revenue in 2011. The Catalog & Internet segment ranked second, accounting for 15% of the total revenue. In the past 4 years sales have been decreasing, from $955.8 million in 2008 to $796.6 million in 2011. The principal Direct Selling segments are PartyLife and ViSalus. In 2011, the Direct Selling segment’s net sales increased $141.4 million, which was attributable to a $192.6 million increase in ViSalus’ net sales and offset by a $50.3 million decrease in PartyLife’s net sales. Blyth reported that the growth in ViSalus’ sales was due to an increase in promoters from 8,000 last year to more than 59,000 this year.
Blyth has a high short float at nearly 45%. It also had a high insider ownership. Robert Goergen, CEO and Chairman, owned more than 3 million shares, which accounts for 35.2% of the total shares outstanding. Pamela Georgen, the Chairman’s wife and Director, holds an 8.2% stake in the company. Robert Georgen Jr, the Chairman’s son, holds a 9.6% stake. At the current trading price of nearly $15 per share, Blyth’s market capitalization is $257.5 million. The company has quite a cheap valuation of only 1.6x EV/EBITDA.
Foolish Bottom Line
Both USANA and Blyth seem to be good stocks for value investors. Even though USANA had a higher valuation, it has consistently generated quite a high return on invested capital. Nevertheless, multilevel marketing companies generally have to face with a lot of potential legal risks. Investors need to look closer to find a suitable for their own portfolios.

A Profitable and High Yielding Food Company

Mario Gabelli, the Chairman and CEO of GAMCO Investors, is famous for his long-term investment track record. Since 1986, he has beaten the S&P 500 by more than 2% per year. He also has grown the assets under management to over $30 billion. In a recent2013 Barron’s Roundtable, Mario Gabelli talked about several stocks that he felt confident about. Let’s look closer into his thesis to determine their attractiveness.  In this article, we will look at Hillshire Brands (NYSE: HSH).
Business snapshot
Hillshire is considered to be the leading meat-centric food solutions provider for foodservice and retail markets. The company is operating with three main business segments: Retail, Foodservice, and Australian Bakery. In the retail business, Hillshire markets packaged meat and frozen bakery products such as hot dogs, breakfast sausages, and breakfast sandwiches to retail customers in North America. The foodservice business sells meat and bakery products to restaurants, hospitals, and other institutions, while Australian Bakery sells frozen dessert, ice cream, and savory products mainly in Australia and New Zealand. The retail business generated 71% of the total revenue in fiscal year 2012, whereas the Foodservice segment ranked second, with 26% of the total revenue. The company’s biggest customer was Wal-Mart, which accounted for 25% of net sales.
$35 - $50 range in two years
Mario Gabelli thought there was a high probability that Hillshire would be acquired. The company was estimated to generate $4.1 billion in revenue in the fiscal year ending June 30. The EPS would be around $1.60-$1.65, and in 2017 EPS could even increase by 45% to $2.40. Gabelli mentioned that Hillshire was the leader in all of its three business categories, including breakfast sausages, lunch meat, and hot dog. In addition, the company has kept reducing its debt level. As of September 2012, it had $311 million in total stockholders’ equity, $253 million in cash, and $942 million in long-term debt. To focus on its core meat business, Hillshire has recently announced it will sell 100% of its Australian Bakery business to McCain Foods for $85 million. At the current trading price of $30.50 per share, Hillshire’s total market capitalization is $3.73 billion. The market is valuing Hillshire at 19x forward earnings. If Hillshire could earn $2.40 per share as Gabelli estimated, the 15x P/E would translate into a $35 stock price. For 20x earnings, Hillshire might reach $48 in 2014. Thus, Gabelli said shares could reach $35 - $50 in around two years. 
Most profitable with highest dividend yields
In comparison with its peers, including Hormel Foods (NYSE: HRL) and Tyson Foods(NYSE: TSN), Hillshire is the smallest company. Hillshire, with 9,500 employees, has more than $3.7 billion in market capitalization. Hormel Foods has 19,700 employees and its market capitalization is $9.23 billion. Tyson, with 115,000 employees, is worth more than $8 billion in the market. 

Operating margin (%)
ROIC (%)
Div yield (%)
Among the three, Tyson has the lowest operating margin and return on invested capital. Hormel and Hillshire had the same operating margin of 9%. Hillshire enjoyed the extremely high return on invested capital, 117%, while the ROIC of Hormel and Tyson were 16.45% and 4.44%, respectively. Hillshire is also paying investors the highest dividend yield, at 2.7%. In terms of valuation, Hormel has the highest valuation at  10.36x EV/EBITDA. Tyson is the cheapest with a 5.35x EV/EBITDA, while Hillshire’s valuation stands in between at nearly 8x EV/EBITDA. 
My Foolish Take
With the leading market position, high ROIC and dividend yield, Hillshire seems to be a good stock to hold for the long-term. I personally think that if Hillshire was acquired, the buyout price might value Hillshire at double digit EV multiples. 

Which is the Best Discount Retailers?

Family Dollar Stores (NYSE: FDO) has faced a significant drop of nearly 13% after its first quarter earnings announcement. Since December, the share price has decreased continuously from $71 per share to $58.50 per share. Some people believed that when the economy got better, consumers would trade out of the discount channel. That apparently had negative impacts on discount retailers. Zacks also downgraded Family Dollar Stores from “outperform” to “underperform.”  Should investors stay away, or consider the share price decline as an investment opportunity?
What happened?
Family Dollar Stores has just released its 2013 first quarter earnings results. The revenue growth was quite decent, but the earnings fell short of Wall Street’s expectation. The net sales were more than $2.4 billion, a 12.7% growth compared to the same period last year. The revenue of $2.42 billion was higher than the analysts’ expectation of just $2.38 billion. The net income was nearly $80.3 million, somewhat lower than the $80.35 million of Q1 2012. The EPS of the first quarter was $0.69, much lower than analysts’ expectation of $0.74.
Positive Signs of Fundamental Growth
With a closer look, Family Dollar Stores’ business fundamentals are still growing. The consumables category has experienced the strongest sales growth of 18.5%, due to the strong growth in tobacco, health and beauty aids, and food items. Because of the increasing traffic and average customer transaction value, its comparable store sales in the first quarter rose by 6.6%. The December comparable store sales have also increased by 2.5%, and was also driven by the consumables category.
Howard Levine, the company’s Chairman and CEO, has commented that the company had been driving more traffic to the stores and increasing its market share. Firmly believing in the long-term business fundamentals, he said:
While the near-term economic environment remains difficult to predict, I continue to be excited about the long-term opportunity for our business. We are seeing tangible benefits from our margin-enhancing investments in global sourcing and private brands, and as we work to drive further benefit from the investments we are making to expand profitability, I remain confident that our efforts will deliver stronger results as we progress through fiscal 2013 and beyond.” 
The comparable store sales are expected to grow by 4%-6% in fiscal year 2013, with 500 new stores opening and 70-90 stores closing. The company estimated to spend $600 - $650 million opening new stores, renovating existing stores, and expanding supply chains.
Peers Comparison
Compared to Dollar General (NYSE: DG) and Dollar Tree (NASDAQ: DLTR), Family Dollar is the smallest company, with $6.8 billion in market capitalization, while Dollar General and Dollar Tree are worth $15.4 billion and $9.33 billion, respectively. Among the three, Dollar Tree was the most profitable with 32.8% ROIC and 12% operating margin over the last twelve months. Dollar General had 11.17% ROIC and 10% operating margin, while the ROIC and operating margin of Family Dollar were 21.2% and 7%, respectively. In terms of valuation, Family Dollar is valued the cheapest among the three, with 8.07x EV/EBITDA. At the same time, Dollar General is valued at 9.45x EV/EBITDA, while the EV multiple of Dollar Tree is 9.08x EV/EBITDA
Foolish Bottom Line
Among the three, Dollar Tree stands out with the highest returns and the most profitable operations. Its net margin and return on invested capital were far superior to those of its peers. From the perspective of an investor, I would prefer Dollar Tree for its more impressive business performance.  

Unilever is Getting Ahead

When I was working for Unilever (NYSE: UL) 5 years ago, I was told about the fierce competition between the company and Procter & Gamble (NYSE: PG). Those two companies are the largest global fast moving consumer goods businesses. They made a variety of consumer products, including detergents, shampoos, and soap. Although Unilever is the smaller company, with around $114 billion in market capitalization, it seems that the company is becoming more efficient than P&G, especially in emerging markets.
Fantastic Growth
Recently, Unilever reported strong full year 2012 results. Sales grew 10.5% to €51.3 billion, while operating profit reached €7 billion, 9% higher than the operating profit last year. The diluted EPS increased by 5% to €5.14. Since 2009, Unilever has experienced consistent revenue growth, from €40 billion in 2009 to €51 billion in 2012. It reported that the growth occurred in every sector, including the Americas, Europe, and the Asia/AMET/RUB region, and in every category, including Personal Care, Foods, Refreshment and Home Care. Asia/AMER/RUB was the fastest growing cluster, with 10.6%, whereas Americas and Europe had the growth of 7.9% and 0.8% respectively. Home Care was the fastest growing category, with 10.3% growth in sales, while Personal Care ranked second with 10% growth. In 2012, its core operating margin was up 30 basis points, including 10 basis points in gross margin and 20 basis points in business restructuring. The core EPS increased from €1.41 to €1.57, mainly due to a €0.16 increase in operational performance.
Brand Portfolio Restructuring
In order to achieve that, Unilever has also successfully restructured its brand portfolio under Paul Poleman’s leadership. The company sold its North America Frozen Foods business for $267 million to ConAgra Foods. In addition, it sold Skippy peanut butter, the number two peanut butter brand in the US, for $700 million in cash to Hormel Foods. Along with the ongoing attempt to exit the frozen food business, Unilever shifted its focus to Beauty & Personal care in emerging markets. In the first half of 2012 it completed the acquisition of Concern Kalina, the Russia maker of Black Pearl facial products and SilkyHands creams, for $694 million.
More Efficient Than P&G
Unilever derived the majority of its revenue from emerging markets. Around 55% of Unilever’s turnover was generated in emerging markets, whereas P&G’s sales in emerging markets accounted for only 37% of the total revenue.
As P&G had more sales in developed markets, which have been facing an economic slowdown, P&G got hit hard. In the current weak economic environment, consumers tended to be more price-sensitive, and the decision to raise some of its prices might lead to market share loss for P&G. In addition, Unilever’s business structure was more decentralized than that of P&G. Thus, Unilever could cater quickly to local tastes and demands, while P&G was slower to adapt its products to local markets with more centralized operations.
Peer Comparison
Among the three big consumer products giants, including Unilever, P&G, and ColgatePalmolive (NYSE: CL), Unilever seems to be the cheapest company on the market. 

Operating margin (%)
Dividend yield (%)
The market is valuing Unilever at 11.68x EV/EBITDA, whereas the EV multiples of both Colgate-Palmolive and P&G are much higher, of 12.96x and 12.15x, respectively. However, Unilever had the lowest operating margin at 14%. P&G’s operating margin is higher at 19%. Colgate-Palmolive seems to generate the highest profit with a 23% operating margin. All three companies are paying a decent dividend yield to shareholders. P&G is paying the highest, with a 3.1% dividend yield, while Unilever and Colgate-Palmolive are paying 3% and 2.2% dividend yields, respectively.
Foolish Bottom Line
The race between Unilever and P&G will never end. It is all about the right strategy at the right time with the right execution. They are both fighting for global market shares in home care and personal care products. Colgate Palmolive is a bit different, as it has long established its global leading position in the toothpaste market. With the decent dividend yields, all three companies could fit well in investors long-term income portfolios. 

An Opportunistic Play on an Improving US Housing Market

Carl Icahn, the famous activist investor, once offered to acquire Oshkosh Corporation(NYSE: OSK) at $32.50 per share, with a total deal value of $3 billion. However, the company’s board rejected the offer, as they thought the offer undervalued the company. Indeed, after reporting strong 2013 first quarter earnings results, Oshkosh’s share price just surged by nearly 19% in one trading day to more than $41 per share, 26% higher thanIcahn’s offer.
A Growing First Quarter
In the first quarter 2013, Oshkosh generated $1.76 billion in revenue, 6.1% lower than the first quarter last year. The decline in revenue was due to the decrease in defense segment sales. The net income was $46.2 million, an 18.8% year-over-year growth compared to $38.9 million in the first quarter last year. EPS has grown from $0.43 last year to $0.51 this year. The largest operating income contributor was the Defense segment with $60.9 million. The Access Equipment segment ranked second, with $48.9 million in operating income. In the first quarter 2013, Oshkosh generated $39 million in free cash flow. The company spent more than $125 million repurchasing around 4.25 million of its own shares in the market. This recent share buyback was part of the plan to repurchase $300 million of the company’s common stock in the period of 12 – 18 months.  Charlie Szews, Oshkosh’s CEO, said: “We started the year strong with results that exceeded our expectations as we continued to execute our MOVE strategy. MOVE provides a clear roadmap and targets for delivering shareholder value, and the Oshkosh team is working diligently to deliver against that roadmap.” He confidently raised the full-year outlook for adjusted diluted EPS to a range of $2.80 - $3.05. At the current trading price of $41 per share, the market is valuing Oshkosh at 13.4x – 14.6x forward P/E.
Unlock Oshkosh’s Hidden Value
Carl Icahn saw the hidden value of Oshkosh in its lifting equipment subsidiary, JLG. Seven years ago, Oshkosh acquired JLG for $3.1 billion in cash. Recently, JLG generated $716 million in fourth quarter revenue and $60 million in operating profits. JLG’s revenue for the full year reached $2.92 billion. Thus, the $3 billion for Oshkosh including JLG seemed to be a quite sweet deal for Carl Icahn. He thought that the company’s hidden value would be unlocked by spinning off JLG and selling the military-truck business. As the US government cut spending, the military business would face a sales decline in the coming years. However, Oshkosh reported that it was awarded around $800 million worth of Defense Department contracts in the first quarter. JLG business, which was tied to construction activity, was quite cyclical in nature. The improvement in the overall US housing market would benefit the business in the near term.
Cheapest Among Peers
Even with the recent significant rise in the share price, Oshkosh is still the cheapest company among its peers, including Federal Signal Corp (NYSE: FSS) and Terex Corporation (NYSE: TEX). Oshkosh is trading at around $41 per share, with a total market capitalization of $3.76 billion. The market is valuing the company at nearly 8.5x EV/EBITDA. Terex’s share price has also increased by 12.7% to $32.05 per share in one trading day. With $3.54 billion in market cap, Terex is valued at 8.8x EV/EBITDA.  Federal Signal, the smallest company among the three, has the most expensive valuation. At the current trading price of $8 per share, Federal Signal has a total market capitalization of nearly $504 million. The market is valuing it at 10.23x EV/EBITDA.
Foolish Takeaway
The improvement in the US housing environment might benefit Oshkosh in the near future. Thus, Oshkosh might be considered an opportunistic play on the US housing market. It shouldn’t be a long-term holding, as both the military truck and lifting equipment business are cyclical in nature.

A Challenge Ahead for This World's Biggest Franchise Chain

McDonald’s (NYSE: MCD), the world’s biggest quick service restaurant, did not have a smooth year in 2012. The share price dropped from $100 in January to only around $84 in November, and gradually climbed to $93.70 currently. Along with the share price drop, in October McDonald’s experienced the first decline in comparable store sales growth in the past 10 years. It is also expected to have negative comparable store sales growth in January 2013. Should we be bearish on McDonald’s outlook? 
A Move That Helps Growing Comparable Store Sales Growth
In October 2012, McDonald’s experienced a 1.8% drop in comparable store sales, with the US down 2.2% and Europe down 2.2%. The decline in the US comparable store sales was due to increased competition and low consumer demand. The company said that it would remain concentrated on balancing the everyday value menu with affordable premium menu options. However, the comparable store sales came back positive in both November and December. In November, the global comparable store sales increased 2.4%, with 2.5% in the US and 1.4% in Europe. In the US, the comparable store sales growth was due to the popularity of the McDonald’s breakfast, everyday value offerings, and options for premium menus. Indeed, the increase in November sales was due to the refocus on its famous “Dollar Menu.” In December, many people had been expecting a 1.8% drop in the US comparable store sales. Surprisingly, McDonald’s posted a 0.9% gain instead.
In the full year 2012, McDonald’s enjoyed a 3.3% rise in its global comparable store sales growth, with the US up 3.3% and Europe up 4%. McDonald’s generated nearly $27.6 billion in revenue, 2% higher than 2011 revenue of $27 billion. Net income came in at $5.46 billion, small growth compared to the $5.5 billion in net income last year. In the fourth quarter, McDonald’s successfully fixed the US business to help the operating performance in November and December. It delayed the annual McRib limited offering to December, shifted the business focus to the “Dollar Menu,” and persuaded restaurants to stay open on Christmas Day.
Tough Competition Ahead
The refocus on the “Dollar Menu” seems to be working. Nevertheless, McDonald’s will have to face increasing competition in the quick service restaurant market, as well as increasing ingredient costs. The issue with the “Dollar Menu” was that it encouraged people to spend less, not to buy more.  Yum! Brands’ (NYSE: YUM) Mexican fast food chain Taco Bell has been quite creative with a “$1 Craving Menu,” with five different cravings. Christ Brandt, the vice president of marketing for Taco Bell, said that diners felt that they were “forced to eat off the value menu/.” The Wendy’s Company (NASDAQ:WEN) has recently replaced its 99-cent value menu with “Right Price Right Size” with the item cost in the range of $0.99 to $1.99. Wendy’s also passed on the increased ingredient costs to consumers, by both increasing the price of several items and reducing the quantity of food offered. Burger King Worldwide (NYSE: BKW) has reportedly attracted consumers away from McDonald’s with its more family friendly foods. It has kept consumers feeling fresh with a stream of new food items, including popcorn chicken, an Italian basil chicken wrap, and a raspberry smoothie. According to Datassential, a food researcher, Burger King had around 20 new test items in the third quarter last year, whereas McDonald’s offered only 9 items.
Along with the decent fourth quarter and annual earnings result, McDonald’s has risen to more than $93.70 per share, bringing the total market capitalization to $94.1 billion. The market is valuing McDonald’s at 9.34x EV/EBITDA. Burger King is the most expensive, with more than 14x EV multiples. Wendy’s is the cheapest, with around 9x EV/EBITDA, whereas the market values YUM! at 11.3x EV multiples.
Foolish Bottom Line
McDonald’s warned investors about the comparable store sales drop in January. It might continue to experience a decline in comparable store sales growth until it is more creative with the new food offering to gain back its customers from other competitors.

A $25 Billion Price Tag is Low for Dell

Dell’s (NASDAQ: DELL) shareholders must've been happy when the stock price increased from $10 per share to $13 per share, a 30% return in a month. In addition, its founder and CEO, Michael Dell, and Silver Lake Partners have been talking about a leveraged buyout for around $25 billion, or $14 per share. Is $14 a reasonable price for Dell? Let’s see.
Decent 10-Year Operating Performance
Dell seems to be quite vulnerable to the overall declining PC sales environment. It has three main business segments: Large Enterprise, Public, Small and Medium Business, and Consumer. In 2011, the majority of revenue was generated from Mobility Client products; $19.1 billion, accounting for 31% of the total revenue. Desktop PC's ranked second, with $14.1 billion in revenue, accounting for 23% of the total revenue. Software and peripherals represented around 17% of the total sales. In the past 10 years, Dell has generated consistently positive net income and cash flow. The 10-year average net income was nearly $2.7 billion, whereas the 10-year average operating cash flow and free cash flow were $4 billion and $3.5 billion, respectively.
Notably, in the past 10 years, Dell has managed to deliver a consistent double-digit return on invested capital.
Net margin
The net margin has been fluctuating. In 2009, its net margin was only 2.71%. However, the margin has already improved in the last two years, with 4.29% in 2010 and 5.63% in 2011. Trailing twelve months, the net margin was 4.44% and the ROIC was 13.11%.  The operating cash flow and free cash flow came in at $3.68 billion and $3.13 billion, respectively. 
A Buyout at Low Valuation
As of October 2012, Dell had $10.1 billion in total stockholders’ equity, $9 billion in both long and short-term debt, and $14.2 billion in cash, most of which was held overseas. So Dell had net cash of around $5 billion. Taking the cash out of the offer amount, the real price would be $20 billion. A $20 billion price tag would value Dell at around 7.4x average 10-year earnings and 5.7x average 10-year free cash flow. Dell was estimated to earn around $1.70 per share in 2012 and around $1.66 per share in 2013. Thus, the deal valued Dell at nearly 6.8x forward earnings, after subtracting the net cash position. Andrew Barry of The Wall Street Journal argued that LBOs were normally done at around 15x after-tax earnings. In terms of EV multiples, the deal valued Dell at 5.63x trailing EV/EBITDA. It was a record low valuation in the past 10 years. In a study done by Akerman, the lowest EV/EBITDA was 5.9x in 2002, and the highest EV multiple was 9.5x in 2008. The 10-year average EV multiple stayed around 7.88x. Thus, a deal offer is actually quite low.
Peers Comparison
Among the PC makers, including Dell, Hewlett-Packard (NYSE: HPQ), and Lenovo Group (NASDAQOTH: LNVGY), HP has the lowest valuation. At the current trading price of $17 per share, HP is valued at only 3.43x EV/EBITDA. However, HP has recently had to take an $8.8 billion impairment charges from its big acquisition of Autonomy due to its accounting fraud. Lenovo is the most expensive, with 8.26x EV/EBITDA. Among the three, Lenovo seems to be the most active company to prepare for the industry shift from PC tosmartphones and tablets. At the 2013 International Consumer Electronics Show, Lenovo introduced its latest products, including a 27-inch PC touch tablet, IdeaCentre Hozion, and a 39-inch Table PC.
Foolish Bottom Line
Personally, I do not think the $25 billion price tag was fair to shareholders. If simply placing the average 10-year EV multiples on Dell’s trailing EBITDA, Dell should be worth around $34.6 billion, 38% higher than the current offer.