Jeff Borack's  Instablog

For anyone out there interested in following my career as well as my investment ideas, I was interviewed by Hiro Takei from Behind the Spread this weekend.  We spoke about my involvement with kaChing, my background, and my investment strategy.  For anyone not familiar with kaChing, basically I've been managing a fantasy portfolio there for about a year, and they just started allowing investors to open brokerage accounts that mirror my trades.  If you ever need to find your way back to my kaChing profile, you can always get to it by clicking "portfolio performance" at the top of my blog at harbor.typepad.com.  So far there's about $200k mirroring me!

Deckers Outdoor Corp. (DECK) has an amazing business.  Since 2001 it’s grown revenue at a CAGR of 33.5% and it continues to grow in 2008.  More importantly, it’s grown EPS at a CAGR of 55.6%.  But what’s probably the most amazing thing about this business is that it’s grown with minimal reinvestment.  A significant portion of FCF has been put in the bank each year, growing cash & investments from $3.9 million in 2002 to $175 million LTM.  This compares to total CFO over the same time period of $212.6 million.  Of course, past performance is no guarantee of future success, but it doesn’t matter because you’re not paying for it.  The stock trades today at 10x earnings.  On an EV basis, it’s about 20% cheaper.

Introduction

Eastman Kodak’s (EK) business has been in decline for a long time. Share prices peaked in the mid ‘90s and have generally been in decline since. The consumer transition away from traditional film to digital products was too overwhelming for management to deal with effectively, and probably would have been even if they read the tea leaves perfectly. However, it is no secret today that film has been in a long and permanent decline, to the market or to management. And management has been taking steps for the last decade to right-size and reorient the company, resulting in employment decline from 74,000 in 2001 to 20,400 employees today. This has been accompanied by sustained restructuring charges in the range of $600-700 million every year. If Kodak continues restructuring at this rate, they will have no employees left in three years, creating a fundamental catalyst for restructuring charges to end or at least be greatly diminished in the future.

If we try to think about Kodak moving forward, we can finally bring into focus the effects of the changes made over the past decade. By excluding the restructuring, impairment, and excessive depreciation charges that absolutely cannot continue (assets have been almost fully depreciated as well), and making some conservative estimates for the cost reduction benefits of recent restructuring efforts, we find that Kodak presents an attractive investment opportunity despite a continuing decline in demand for traditional film products.

If any of my readers are interested, Zack from New Rules of Investing interviewed me here.

I read an entire book about shipping containers in an attempt to better understand market forces in the shipping industry, and I quoted a few paragraphs of it in the introduction to my report on Pacer International (PACR).  Levinson himself describes his book as something he “stopped talking about altogether, simply to avoid the embarrassment that every mention of the topic would bring”.  My goal was to get a better understanding of the industry’s history so that I would have a clearer picture of where it’s heading in the future.  I’m still absorbing some of what I read, but what I got out of “The Box” was something else entirely.

90% of this book demonstrates is how poorly people were able to predict the effects of containerization even looking only two years out at a time.  Granted, the 60s and 70s were turbulent times for the shipping industry.  But (with the exception of a few visionaries) labor unions, the military, and industry insiders consistently got it wrong.  Even McLean, the industries most prominent visionary eventually got it wrong when he made a bet on sustained high oil prices in the early 80s, resulting in the biggest bankruptcy in U.S. history at the time.  When labor unions thought mechanization would wipe-out jobs, efficiency improvements drew volume and created jobs.  The military ignored bids to transport supplies during Vietnam until all hope was lost that the logistics could be worked out.  Many commercial docks didn’t realize the importance of container shipping until they were closed down, giving the few desperate ports willing to make investments in infrastructure a chance to become established.  And even the transport companies themselves resisted building fleets until changes in the industry were globally apparent, leading to overcapacity and the first cyclical down-swing.

This book also does an amazing job of illustrating how difficult it was for containerized shipping to get a toehold in an economy with so many inefficiencies.  From cartels to corrupt labor unions, the resistance against containers was immense despite the possible efficiency gains and benefits to consumers.

Despite how interesting and educational a story Levinson was able to piece together, the book left me wondering where the shipping industry stands today.  The final chapter of the book, titled “Just in Time” discusses global supply chains, but it fails to really bring us into the 21st century.  Maybe a part of this is because Levinson spent 263 other pages showing us how unpredictable things are.  Or maybe he reached his conclusion mid-way through the book when he said “Ship lines’ end product was basically a commodity… just like farmers and steelmakers, they would always be hostage to external forces, their prices and profit margins depending mainly on economic growth and on their competitors’ decisions to build new ships”. 

Barbie was conceived as the all-American girl.  In truth, she never was: at her inception, in 1959, Mattel Corp. arranged to make her at a factory in Japan.  A few years later it added a plant in Taiwan, along with a large cadre of Taiwanese women who sewed Barbie’s clothes in their homes.  By the middle of the 1990s, Barbie’s citizenship had become even less distinct.  Workers in China produced her statuesque figure, using molds from the United States and other machines from Japan and Europe.  Her nylon hair was Japanese, the plastic in her body from Taiwan, the pigments American, the cotton clothing from China.  Barbie, simple girl though she is, had developed her very own global supply chain.
    Supply chains like Barbie’s are a direct result of the changes wrought by the rise of container shipping.  They were unheard-of back in 1956… and in 1976 when oil prices brought sky-high freight costs that stifled the flow of world trade.  Until then, vertical integration was the norm in manufacturing; a company would obtain raw materials, sometimes from its own mines or oil wells, move them to its factories, sometimes with its own trucks or ships or railroad; and put them through a series of processes to turn them into finished products.  As freight costs plummeted starting in the late 1970s and as the rapid exchange of cargo from one transportation carrier to another became routine, manufacturers discovered that they no longer needed to do everything themselves.  They would contract with other companies for raw materials and components, locking in supplies, and then sign transportation contracts to assure that their inputs would arrive when needed.  Integrated production yielded to disintegrated production.  Each supplier, specializing in a narrow range of products, would take advantage of the latest technological developments in its industry and gain economies of scale in its particular product lines.  Low transport costs helped make it economically sensible for a factory in China to produce Barbie dolls with Japanese hair, Taiwanese plastics, and American colorants, and ship them off to eager girls all over the world.

-Marc Levinson, The Box

Introduction

Pacer International (PACR) stock is trading below intrinsic value even if we assume that a highly pessimistic scenario unfolds.  The threat of an unfavorable UNP contract renewal and the loss of business from a weak automotive sector, the two most major investor concerns, have more than fully been priced into PACR shares.  Also, the possibility of busting a leverage ratio covenant entered the picture in the first quarter of ’09.  This is entirely the result of the lenders definition of “leverage”, and only affects Pacer insofar as they may have to resort to raising capital in the equity markets.  All of these threats have been fully worked into the current share price, leaving investors with substantial room to profit from any sort of a return to normalcy.