Stock Selection: Really Great Financial Health
This is Part 3 of A Portfolio For Mom, which explores the portfolio we're building for one of our most important clients. The series outlines our investment philosophy, centered on loss avoidance, while hopefully educating our client through a variety of case studies.
We'll introduce the philosophy, present case studies, and discuss potential stock candidates. With the help of the Seeking Alpha community, we hope to improve her investment returns.
In our last article, we looked at the math behind avoiding significant losses. In this edition, we'll introduce five companies with really great balance sheets that are candidates for A Portfolio For Mom. We'll introduce each business and why it fits with our investment philosophy.
Avoiding Excess Debt
As mentioned in Part 1, we don't like companies that are in poor financial health. We actively avoid companies with significant debt as this imposes a risk upon investors we aren't willing to accept.
The following five, however, have really good balance sheets. In fact, all have a net cash balance and annually generate more cash, which provides us with a free option on buybacks to help with our loss avoidance goal. We hope our frugal client would approve.
Jean Coutu (OTCPK:JCOUF) is Quebec's largest pharmacy with a network of more than 400 franchised stores across the province (and a few in Ontario and New Brunswick). With convenient locations and a very strong brand name, the company is an institution in the province.
However, things haven't been so great in recent years. Competition from chains such as Dollarama (OTC:DLMAF) and Costco (NASDAQ:COST) have nipped front-of-store sales forcing management to reduce prices. In addition, lower drug prices have eaten into sales growth and more regulation further threatens profit at their generic drug unit, Pro-Doc.
Why it fits
In a previous life, the company had a disastrous foray into the United States. The wounds, however, remain fresh in the minds of management. As a result, the company has maintained an ultra-conservative operating philosophy. Jean Coutu has more than $120 million in cash at the end of Q3 and no debt.
In the past year, it has financed a new head office and distribution centre with its own cash and no debt. This is akin to building a new house with cash and no mortgage! Investors have virtually begged the company to borrow cash to buy back stock but management hasn't budged. It's just not worth the risk.
Important to our philosophy is that the company has continued to grow revenue and earnings despite these regulatory headwinds. And if things go sour, the company has a growing war chest of cash to repurchase stock and protect us from experiencing a significant loss of capital.
MTY Food Group
MTY Food Group (OTC:MTYFF) is one of Canada's largest franchisor's of quick-serve restaurants (Thai Express, Mucho Burrito, Sushi Shop, etc). In recent years, the company has branched into casual brands as well as a modest expansion into the U.S. The company, led by CEO Stanley Ma, is considered one of the best "spenders of money" in Canada.
However, organic growth has also slowed. Competition from newer, faster growing chains have eaten into sales at some of their duller, legacy brands, like Country Style and Mr. Sub.
Why it fits
Unlike Jean Coutu, MTY has never bet the farm on a big U.S. expansion. Still, management has always had an ultra-conservative attitude, and despite frequent acquisitions, has more than $40 million on the balance sheet.
Despite some challenges, management hasn't burdened shareholders with significant debt. They probably could have gone after big acquisitions - and short-term investors would have cheered - but they've stuck to their knitting. It can sound a bit boring but that's why we like it.
Enghouse (OTC:EGHSF) provides software to a variety of industries including telecommunications, transportation, and call centers. The company has a great history of growing sales and earnings while maintaining good financial health. But, my gosh, doesn't that sound dull?
Unlike Jean Coutu and MTY, Enghouse hasn't really faced that many problems in recent years. Things have been running very smoothly (and, up until this year, the stock price has done well).
Why it fits
Like our previous two companies, Enghouse also has a net cash position of more than $80 million. They have a history of avoiding debt and maintaining good financial health. It is akin to spending money to renovate your house but never using a bank loan or credit card.
Like MTY, Enghouse is a bit of an anomaly in having not used debt. Most companies use it responsibly, but unfortunately, a large number use too much debt. We want to avoid those types of stocks, which is why we like Enghouse.
Winpak (OTC:WIPKF) is a packaging company based in Winnipeg. It makes a variety of plastic packaging for the food and pharmaceutical industries from shrink-wrap for cheese and meat to safety packages for pills. Even though it is a Canadian company, the majority of sales come from the United States (80%).
Why it fits
Once again, we have chosen a company with cash on hand (more than $100 million) and no debt. Consistent with our philosophy of choosing stable, profitable companies, Winpak has not lost money in recent memory. The industry, plastic packaging, might be one of the most boring you'll ever hear of.
For us, that's a good thing. Plastic packaging is increasingly being used instead of glass or tin because it is cheaper. It also helps keep food fresher for longer. You probably notice how more plastic continues to find its way into your fridge (fresh pasta) and cupboard (resealable bags). Winpak likely makes a lot of it.
Richelieu (OTC:RHUHF) is a distributor of home renovation products. These range from the wood flooring in our house to the handles on our cupboards. Faucets, hinges, doorknobs, storage systems. If it's a home renovation product, Richelieu likely distributes it to over 70,000 woodworkers, designers, and renovators across North America.
In recent years, things have been going well for Richelieu. The home renovation market in both Canada and the United States has been good and sales have increased accordingly.
Why it fits
Like Enghouse, Richelieu has grown through a variety of acquisitions funded with excess cash (and not debt). It's also maintained a history of profitability and the current cash balance is approximately $30 million.
You might wonder how has a housing-related company done so well, especially after the housing crisis of 2008. Well most of Richelieu's business is done in the renovation market and homeowners view renovations as something that improve the value of their home. As a result, sales fell just 4% in 2009. Earnings fell 12%. People keep renovating.
The exposure to housing is always a risk, especially when many pundits say Canadian housing is overvalued. However, Richelieu's history of profitability and maintaining a healthy balance sheet gives us confidence that it can withstand any downturn comfortably.
Mom Approved (Hopefully)
All five companies (hopefully) fit with our investment philosophy. Some are doing well while others are struggling with specific challenges. However, each have core similarities. They have a history of profitability, operate in relatively boring industries, and have great financial health.
With a history of avoiding substantial financial risk for shareholders, we believe these conservative companies will help prevent Mom's portfolio from experiencing a significant loss of capital and allow it to build wealth over time. We hope Mom would approve.
Here's our first five:
Up next is Part 4, where we'll go through a Case Study about the importance of good financial health in order to help Mom "buy-in" to our investment philosophy.
What do you think of our first five? What are your critiques? Do you know of any dull, stable businesses with a net cash balance that might be a candidate for A Portfolio For Mom?
Disclosure: I am/we are long JCOUF, WIPKF, RHUHF, MTYFF, EGHSF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.