Ituran Location & Control Ltd (ITRN) is a small Israeli company that provides GPS tracking systems for cars, motorcycles, and trucks, so that you or your insurance company can locate a vehicle that is stolen. It was founded about 20 years ago, and operates in Israel, Brazil, Argentina, and the United States. It competes against companies like LoJack, Garmin, Pointer Telocation, and GM's (GM) OnStar. A significant portion of the shares are owned by the founding family, which is deeply involved in the company. It is a good company that pays significant dividends, and I have had the shares in my portfolio for more than two years. But I have decided to sell my shares for the following reasons.
But before I get to my reasons, it is important and I hope helpful to you for me to discuss why I purchased the shares in the first place. I have owned shares in this company during two distinct periods. I first discovered the company during the financial crisis and purchased shares at about $8.50/share, because it had a very clean balance sheet, and seemed like a good business that was priced for near-extinction. I was looking for small companies that were getting unfairly demolished in the markets, but that I thought could survive even a worse downturn than we were already experiencing. This was a very successful investment/trade, and I eventually sold the shares in early 2010 for about $15.50/share, a massive approximately one-year gain. The company did not leave my radar, however, and on April 14, 2011, I reinvested in it at $15.19/share.
As I look back at my original pitch for that second purchase in my trading diary (I did not pitch it on Seeking Alpha), I see that it was very story-based. I focused on the company's recovery in return on equity and return on assets. I focused, still, on the balance sheet. I focused on the fact that the stock had gone to "Nowheresville" for a year. I planned to make a follow-up purchase to complete the position, but I never did.
I also think (and this is my mistake) I was too enamored of my original success with my first investment, failed to attribute that sufficiently to generally improving markets, and because of that success, failed to perform sufficiently diligent analysis when wading back in. In particular, what I did not focus on enough was valuation. Even a great company is not worth buying if it is overvalued, and since I purchased the stock in 2011, even including dividends, it has underperformed the S&P index by about 3% points cumulatively. Not bad, but not spectacular, particularly for a small capitalization stock.
That gets me to my first and primary reason for selling. Today as part of my annual Spring reevaluation of my holdings, I did a discounted free cash flow spreadsheet, which is how I value stocks. You can view it here.
As the sheet shows, Ituran has had annualized 6.54% free cash flow growth over the past nine years. However, more recently, growth has been virtually stagnant since 2009, for three years. Moreover, because of the cyclical nature of the business, the average free cash flow over the past nine years and over the past five years is significantly lower than last year's (2012) figure. This information is all drawn from the top section of the sheet, and the numbers were obtained from Morningstar.
I always use a company's weighted average cost of capital as my discount rate when discounting future cash flows, and I calculate Ituran's at 12%. Note that calculating Ituran's WACC is difficult, because its dividend fluctuates so wildly (European style), and weighted average cost of capital incorporates cost of equity. You may arrive at a different figure. I assume an annualized free cash flow growth rate of 5% for 10 years starting from 2012's level of $23 million. This is a blend of the 6.54% annualized growth over the past nine years and the much slower recent growth over the more recent three years. As you can see, discounted free cash flow analysis is an art, not a science.
Nevertheless, this yields a valuation of about $13.02/share, which is about 22% less than the present share price. I usually sell a stock when my sheet (using the best analysis and assumptions of which I'm capable) shows it to be overvalued by more than 20%.
I think qualitative analysis backs up my numbers, too. For quite some time, Ituran has had 75% to 80% market share in its home Israeli market. That is great for the stability of its business, and indicates it has some moat there, but means growth opportunities there are limited. Its position in America, by contrast, is negligible, stagnant with only about 22,000 subscribers, per page 16 of the most recent annual report. That means it is counting on Brazil and Argentina for growth.
Argentina is a hot mess. That leaves Brazil, where Ituran is a leader, though not dominant as it is in Israel. Per the annual report, at page 28, Brazil is expected to require anti-theft devices on all new cars as of June 30, 2013. Wow, great! However, this has apparently been set and postponed since 2009, so one cannot get one's hopes up too much. Nevertheless, this represents the biggest bullish case for Ituran. It is just not enough for me, given the other factors in play. I may well be wrong to sell for this reason, and maybe growth will accelerate, but Brazil's economy is also in fairly bad shape, though some think the worst might be over. If the worst is not over in China, however, it is not over for Brazil, since Brazil's economy is so heavily tied to China's.
I suspect despite its widely variable dividends, we are seeing some yield-chasing with Ituran. I am willing to hold a company like Coke (KO), even if yield-chasing pushes up its appraised value a bit, but I'm not willing to hold a company like this, which I think has a very narrow or non-existent moat as to the 66% or so of its business that is not located in Israel.
Too Much Family
Another thing the 2012 annual report (linked to above) again makes clear is the extent to which this is a family business. My dad worked for a family business (not our family) for decades, and I think it introduces inefficiency and retards growth. Let me give you one example of what I don't like. Per page 57 of the annual report, Ituran buys its insurance from an insurance agency in Israel owned by Efraim Sheratzky, the brother of the President and the uncle of both Co-Chief Executive Officers. Actually, there are at least three things about that sentence I don't like, including the fact that (apparently for family reasons) two siblings are serving as Co-Chief Executive Officers. No small company this size needs two CEOs. And their dad is the President. So this company has three executive officers running it, all from the same immediate family It is disclosed, which is great, but it is too much. And they are buying insurance from another family member.
I was excited shortly after purchasing my shares again in 2011 to learn that legendary hedge fund manager Seth Klarman had bought a 7.2% stake in the company. It is nice when one is front-running the greats! He later increased his stake. However, as of this past February, he has since sold off more than half of his stake, and is down to $22 million worth or so. Though Ituran is still in his portfolio, it is now a much lower-conviction holding for him. He should be assumed to be a seller, not a buyer. At a minimum, he decided over the past year that he had better uses for some of that capital. That is meaningful to me as well.
So there you have it. Ituran has not been a loser for me, and I have enjoyed my dividends, but I think there are better places to park my money. Ituran is not a bad company, it has a great balance sheet, and it generates free cash flow. But it appears overpriced relative to its free cash flow, I am not wildly optimistic about its growth prospects qualitatively, there is a lot of nepotism, and a guru I highly respect already lightened his load. As an added bonus, I can now remove the money from my taxable online brokerage account and add it to my IRA, which I have not yet filled for 2013. There capital gains and dividends are not taxed, and because of my relationship with Bank of America Merrill Lynch, I get 30 free trades per month.
Ituran, I am sorry, but it is time to say goodbye.
Additional disclosure: Based on the analysis in this article, I am selling out my position upon or before publication of this article.