Evaluating Michael Dell's Top Stock Picks

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Includes: ABG, DIN, DPZ, MIC, WEX
by: FAF Research

In 1998, Michael Dell formed MSD Capital to exclusively manage his and his family's capital. MSD Capital's team of approximately 80 people operates from the firm's offices in New York, Santa Monica and London. MSD Capital has invested in special opportunities, public and private equity, real estate as well as partnership.

In the public equity investments, according to the MSD web site, they:

...make long-term equity investments in a limited number of outstanding companies, both in the United States and abroad. We employ a disciplined, research-intensive analytic process in searching for businesses that possess sustainable long-term competitive advantages and are managed by honest, astute and shareholder-minded management teams. We firmly believe that businesses create wealth for their owners through the long-term generation of net free cash flow. Although we typically invest as a minority owner of publicly-traded companies, given the long-term perspective that we take when we make investments, we consider ourselves to be a partial owner of the businesses in which we invest. We focus on the absolute value of businesses, not their value relative to other 'peer' companies or general stock market indices.

I find it is interesting to analyze MSD Capital's Holdings so as to generate seed investment ideas for more research. I reckon that, if a stock is a top holding from an eminent manager like Dell, the firm is bound to have passed rigorous research standards. As such, I find myself increasingly interested in investing in a company of this kind.

Dine Equity Inc (NYSE:DIN)

Dine Equity is engaged in developing, franchising and operating the International House of Pancakes restaurants (IHOP) and Applebee's restaurants. Dine Equity chain of restaurants usually feature moderately-priced, high-quality food as well as beverage items, not to mention table service that is attractive and quite a comfortable atmosphere. Even though IHOPs are best known for their brand of award-winning omelets, pancakes as well as other breakfast specialties, IHOPs and Applebee's restaurants are open throughout the day and night, offering a wide array of lunch, dinner and snack items.

In terms of quarterly results, these highlights are to be listed:

Adjusted net income available to common stockholders stood at $19.1 million for the third quarter of 2011, in comparison to the $16.6 million for the same quarter of 2010. The rise in adjusted net income was mainly due to eliminating the dividend on Series A perpetual preferred stock as well as lower cash interest expense, partly offset by a lower profit due to refranchising 149 Applebee's company-operated restaurants. The adjusted EPS stood at $1.04 per diluted share for the third quarter 2011.

For the first nine months of 2011, the firm's adjusted net income available to common stockholders stood at $61.7 million, or $3.37 per diluted share, in comparison to $51.1 million, or $2.92 per diluted share, during the same period of 2010. The rise in adjusted net income was mainly due to eliminating the dividend on Series A perpetual preferred stock, a lower tax rate and a lower cash interest expense, and partly offset by a lower segment profit on account of its refranchising.

Net income available to common stockholders stood at $15.5 million, or $0.85 per diluted share, during the third quarter of 2011, in comparison to net income of $7.8 million, or $0.44 per diluted share, during the same quarter of 2010. The rise in net income was due to lower interest expense and to eliminating the dividend on Series A perpetual preferred stock by reason of having redeemed such security during the fourth quarter of 2010, partly offset by refranchising 149 restaurants.

For the first nine months in 2011, net income available to common stockholders stood at $43.4 million, or $2.38 per diluted share, in comparison to $28.0 million, or $1.60 per diluted share for the same period of 2010. The rise was due partly to a lower interest expense, eliminating the dividend on Series A preferred stock as well as a gain on the sale of 66 Applebee's company-operated restaurants in St. Louis and Washington, D.C. Such items were partly offset by some impairment and closure charges associated with the termination of the sublease contract for Applebee's restaurant support center in Lenexa, Kansas, a lower segment profit mostly driven by its refranchising as well as higher debt extinguishment charges.

The current net profit margin of DIN is 6.58, which is higher than its 2010 margin of -2.25. I prefer companies that have increased profit margins as compared other years. It is essential to know the reason why that happened. One ratio I liked to see in DIN is its Return on Invested Capital. Its average ROIC of 3.78 (2011/2012) is the higher one since 2006. Also, DIN has its higher net profit margin figure since 2006.

In terms of income and revenue growth, DIN has a 3-year average revenue growth of -12.66. Its current revenue year over year growth is -19.38, lower than its 2010 revenue growth of -5.68. I do not like it when current revenue growth is lower than the one of the past year. It shows that business is decelerating for a certain reason. In terms of valuation ratios, DIN is trading at a Price/Book of 7.85x, a Price/Sales of 0.8x and a Price/Cash Flow of 7x in comparison to its industry averages of 6.9x Book, 2.3x Sales and 14.8x Cash Flow.

Domino's Pizza (NYSE:DPZ)

Domino's Pizza is a well-known world leader in pizza delivery. By means of its mainly franchised system, Domino's operates both franchised and company-owned stores in the U.S. as well as in over 50 countries.

In terms of DPZ's quarterly results, the firm's domestic same store sales have grown by 6.8% during the fourth quarter in comparison to the year-ago period as well as by 3.5% for this full year, which reflects a continuous improvement in the firm's internal business. In addition, the international division also published healthy results with a same store sales growth of 4.7% during the quarter as well as a 6.8% rise for the full year. This quarter was the 72nd quarter (or 18th full year) of consecutive quarterly same store sales rises. The international division also enjoyed record net store growth of 413 stores in the fiscal year 2011.

Fourth quarter diluted EPS stood at 52 cents, which rose by 30% over the as-adjusted diluted EPS during the same quarter of the previous year. Diluted EPS, as adjusted, stood at $1.69 for the fiscal year 2011, which represented a rise of 25% over the as-adjusted diluted EPS in the previous year. Moreover, the firm also re-purchased and retired 1,146,263 shares of its common stock in exchange for $35.8 million in the quarter as well as re-purchased and retired 6,414,813 shares of its common stock in exchange for $165 million in the fiscal year 2011. In this regard, the firm's management has stated:

Our positive results this year provide yet more evidence that we have successfully reset the bar for Domino's Pizza. The global momentum that we are driving through our innovation, commitment to food quality and outstanding service continues to energize our franchise owners and team members and inspire their terrific performance.

The current net profit margin of DPZ is 6.38, which is higher than its 2010 margin of 5.60. I usually seek companies that have raised their profit margins in comparison to other years. Thus, I find it is vital to know why that happened.

In terms of income and revenue growth, DPZ has a 3-year average revenue growth of 5.05 and a 3-year net income average growth of 24.98. Its current revenue year over year growth is 5.18, lower than its 2010 revenue growth of 11.88. I do not like it when current revenue growth is lower than the one in the past year. Usually, what it shows is that business is decelerating for some reason or another. The current net income year over year growth is 19.84, higher than its 2010 average of 10.25. I consider it favorable it when net income growth is higher than the past.

In December 2011, KeyBanc Capital Markets initiated coverage of DPZ with a Hold Rating. Firm views Domino's near-term outlook and long-term growth potential favorably, however, they believe that shares may have limited upside potential in the near term, as investors will likely be cautious due to the fact that starting in 1Q12, the domestic system will be lapping two consecutive years of strong SSS and an impressive 260 bps improvement in operating margins, which represents peak levels.

In terms of valuation ratios, DPZ is trading at not cheap levels. It has a Price/Earnings of 21.2x, Price/Sales of 1.5x and a Price/Cash Flow of 16.1x in comparison to its industry averages of 22.3x Earnings, 6.9x Book, 2.3x Sales and 14.8x Cash Flow.

Wright Express (WXS)

Wright Express is one of the leading providers of information management and payment processing services to the American commercial as well as governmental vehicle fleet industry. The firm is engaged in marketing such services directly and through strategic partnerships. Moreover, the company offers a MasterCard-branded corporate card.

I like WXS because Wright employs its own company network to process card-transactions. Such closed loop enables it to access both the cardholder's as well as the merchant's side of every deal. Thus, the company keeps the whole value chain in each card transaction: it issues the card as well as keeps the customer relationship, thus maintaining the whole discount fee that is charged to the merchant and (in what is considered a critical differentiator for the company's niche) the firm has also access to details of the spending data, which enables its fleet customers to record and administer fuel expenditure and control the purchases of their drivers. To date, the company's card products are basically charge cards paid up each month, which means that credit losses are normally rather small and the company does not need to tie its capital up for very long.

Another factor I like about Wright is the company's potential market share. WXS has a leading market share of a bit less than 10% of all U.S. fleet vehicles. The firm's management reckons that, currently, about two thirds of the fleets do not employ a fleet card to control fuel expenditure, which does leave room for the firm's growth. Even though the company is focused on fleets of all kinds, it particularly targets small fleets, which are usually unaware of the benefits of such fleet card products.

Such a strategy is a smart one because small fleets enjoy less bargaining power than bigger and more sophisticated ones. As such, there exists less competition for small fleets. The company is capable of mustering a healthy internal growth by persuading small fleets to change from cash (or other forms of payment) to fleet cards. Also, WXS keeps innovating. Recently, the Company announced the launch of 'Octane,' its free mobile app that includes the industry's first fuel site locator with up-to-date transaction-based fuel prices and text-to-speech capabilities.

The current net profit margin of WXS is 24.16, which is higher than its 2010 margin of 22.45. I am inclined to invest in companies with higher profit margins as compared to other years. I find it fundamental to find out why that occurred. Its current return on equity is 21.07. It is higher than the 20% standard I look for in companies I invest in. It is also higher than its 2010 average return on equity of 17.52.

In terms of income and revenue growth, WXS has a 3-year average revenue growth of 12.01 and a 3-year net income average growth of 1.54. Its current revenue year over year growth is 41.67, higher than its 2010 revenue growth of 23.86. The reality that revenue rose from last year evidences that the firm is performing well. The current net income year over year growth is 52.49, higher than its 2010 average of -37.26. I prefer companies that have a net income growth higher than the past.

In terms of valuation ratios, WXS is trading at a Price/Book of 3.5x, a Price/Sales of 4.5x and a Price/Cash Flow of 49.0x in comparison to its industry averages of 2.7x Book, 1.5x Sales and 10.7x Cash Flow.

The company was saddled with considerable debt when the firm Cendant decided it spin it off. At this point, however, Wright creates enough cash flow to fulfill its obligations.

Macquarie Infra (NYSE:MIC)

Macquarie is engaged in owning, operating and investing in a diversified conglomerate of infrastructure businesses, most of which offer basic day-to-day services in the U.S. as well as other industrialized countries. The company's initial investments and businesses encompass airport-services companies (AvPorts and Atlantic), airport-parking firms (Avistar and PCAA) as well as district energy business (Northwind Aladdin and Thermal Chicago) and a UK-regulated water utility in the Macquarie Communications Infrastructure Group.

In terms of quarterly results, the following are the company's Reports, Financial Results and Highlights for its 2011 continued healthy performance by its operating businesses:

  • A dividend of $0.20 per share was declared for the Fourth Quarter of 2011.

  • A proportionately combined free cash flow of $3.16 per share has surpassed expectations.

  • Atlantic Aviation decided to exit the cash flow lockup, which was expected to distribute nearly $25 million to MIC in 2012.

  • A proportionately combined free cash flow of $3.50 - $3.60 per share is expected to take place during 2012.

Our energy-related businesses generally, and The Gas Company in Hawaii in particular, produced very good results for the fourth quarter and full year 2011," stated James Hooke, the Chief Executive Officer of MIC. "Each of these businesses performed at or above the level of our expectations.

Besides The Gas Company, MIC's energy-related companies also encompass a 50.01% (controlling) interest in the District Energy in Chicago as well as a 50% (non-consolidated) interest in the International-Matex Tank Terminals ("IMTT"), which are based in New Orleans. Furthermore, MIC also owns 100% of Atlantic Aviation, which is an aviation-related firm that is based in Plano, Texas.

Atlantic Aviation's financial performance outpaced the improvement in industry fundamentals and reflects the operational leverage that exists in that business," observed Hooke. "As a result, Atlantic Aviation's debt levels decreased to the point where we expect the business to pay distributions totaling approximately $25 million to MIC for the fourth quarter of 2011 and the first three quarters of 2012." Hooke has stated that the firm expects its businesses to generate an additional free cash flow in the next year. "The stable performance and predictable requirements of our businesses provide us with reasonable visibility into their cash generating capacity. As a result, we expect to report proportionately combined free cash flow for the full year 2012 in a range between $3.50 and $3.60 per share.

The current net profit margin of MIC is 2.77, which is lower than its 2010 margin of 10.78. I am not positive about companies with lower profit margins than previous ones. Of course, it could also be a reason to seek to understand why that came to happen. Its current return on equity is 3.92. It is lower than the 20% standard I look for in companies I invest in. It is also lower than its 2010 average return on equity of 14.28.

In terms of income and revenue growth, MIC has a 3-year average revenue growth of 0.39. Its current revenue year over year growth is 17.60, lower than its 2010 revenue growth of 18.41. I dislike companies with a current revenue growth lower than the past year. It commonly demonstrates that that business is beginning to slow down.

In terms of valuation ratios, MIC is trading at a Price/Book of 2.2x, a Price/Sales of 1.5x and a Price/Cash Flow of 16.5x in comparison to its industry averages of 4.2x Book, 1.3x Sales and 21.3x Cash Flow.

Asbury Auto Group (NYSE:ABG)

Asbury Automotive Group is among the largest automotive retailers in the United States of America. The firm is engaged in selling, servicing and financing a wide range of external and internal automobile brands.

It is interesting to see that ABG derives nearly 53% of its revenue from its new-car sales. In turn, midline and luxury imports encompass 84% of the new light-vehicle revenue. Buyers of brands like BMW and Lexus usually have a higher-than-average income and thus have the ability to afford new cars and their maintenance even during recessions. Such product mix also cuts down the firm's exposure to the Detroit Three automakers, which are facing the threat of union worker strikes.

A second reason I like this pick is that servicing and parts amounted only to nearly 14% of revenue during the third quarter of 2011, yet they managed to make up about 45% of the firm's gross profit. Such important contribution to the firm's profitability proved less volatile than that of new and used vehicle sales. It will keep mitigating the auto industry's inherent cyclical risk. Important dealers like Asbury currently enjoy a growing competitive edge for repairing work, since most of the automakers usually require a warranty work to be performed at a dealer's rather than at an independent repair shop. Moreover, the increasingly advanced technology of cars also poses a challenge for smaller repair shops, which not as able to afford the training and equipment necessary to offer a competent service.

I think that catalysts exist for near and longer-term increases in the U.S. light vehicle SAAR, and in particular the near-term inventory recovery from the Japanese automakers (60% of sales) could serve as a catalyst for the stock, though Honda, which is its primary exposure, seems furthest from full recovery. While there is likely some near-term gross profit margin headwinds across new, used and service, scale and business model improvements likely drive incremental gross profit, leverage of SG&A and earnings improvement.

The current net profit margin of ABG is 1.59, which is higher than its 2010 margin of 0.97. I choose companies that have better profit margins as compared to previous years and believe that it is necessary to ascertain why that occurred. Its current return on equity is 22.13. It is higher than the 20% standard I look for in companies I invest in. It is also higher than its 2010 average return on equity of 14.36.

In terms of income and revenue growth, ABG has a 3-year average revenue growth of -0.96. There is no information on its 3-year net income average growth. Its current revenue year over year growth is 9.74, lower than its 2010 revenue growth of 14.42. I am not attracted by a company whose current revenue growth is lower than the one in the past year, since oftentimes it goes to show that business has begun to decelerate for some reason. The current net income year over year growth is 78.22, lower than its 2010 average of 184.33. I am not pleased when current net income growth is lower than in the past year. Most of the time, I look for companies that have managed to increase both their profits and revenues.

In terms of valuation ratios, ABG is trading at a Price/Book of 2.6x, a Price/Sales of 0.2x and a Price/Cash Flow of -4.8x in comparison to its industry averages of 2.4x Book, 0.4x Sales and 23.0x Cash Flow.

The firm's operating profits had been constantly covering interest expense 2.2 to 2.3 times since the IPO in 2002, yet the ratio has fallen to 1.6 and 1.7 times during 2008 and 2009, respectively. Such ratio was enhanced to 2.8 times during 2010. Asbury has taken on a considerably larger amount of debt during 2008, partly to purchase some previously leased real estate. The company's debt/EBITDA sank to 6.5 times at the end of the year 2010 from 8.1 times during 2009. The firm's management made known in 2011 that its target ratio is 3.0 times. No large debt maturities will be due until June of the year 2013.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.