March Ahead

March Ahead
Contributor since: 2012
Yes, I took into account all the operating assets of HHC. Owner earnings from operating assets accounted for 53% of total owner earnings for HHC in 2011.
I did NOT account for increase in owner earnings due to redevelopments (such as redevelopment of South Seaport) and development of strategic assets. The only two assets which are likely to give significant owner earnings are redeveloped South Seaport and Hawaii condo project (which is a joint venture) and both won't give more than 5-10% of the owner earnings, so the error due to not including them is not big.
The other problem in considering Net Asset Value for HHC is that its assets don't really produce regular income (like say farm land or houses do via rent). So NAV is not a good way to analyze this stock (for more details, read this quarterly letter from Marty Whitman on where NAV is applicable -
There is no doubt that the land would be worth more than the carrying value on the books. However, the land is undeveloped and hence not the same as owning lots of houses which are income producing assets.
I think DCF can still be used by using some assumptions - for example, one could assume that the sale of acreage increases 10% over the next 5 years (very positive estimate). Lets assume the price of land only increases 3% per year (land/house prices long term just keep with inflation). Let's assume that the operating assets owner earnings increases 4% an year. The amount of time needed to sell the total acreage per MPC is given in 10-K (for example Summerlin is expected to be sold by 2039) - this enables reverse calculation of increase in acreage sold per year. I use a discount rate of 9% (the highest rate of interest on long term treasuries in the last 10 years). I get the DCF value of 2.3B.
I didn't account for any income from strategic developments which are likely to yield income in the future. Even with all these assumptions, I could be wrong and so must insist on margin of safety of 30-40%.
Since I don't see the margin of safety, buying this stock does not make sense to me. I'd rather look at the risk than look at the reward.
I agree with the first two commentators. You have presented good data, but without using discounted cash flow, the valuation is meaningless.
Also, though more acres were sold at Summerlin in 2011, the price per acre dropped sharply. The 10-K report says that Vegas land sale per acre value dropped 30% in 2011 from 2010. So I don't think Summerlin is seeing a bright spot yet. However, Houston MPCs showed better results in 2011.
I think there is a need of analysis which involves DCF because the value of the land will be unlocked over long time period.
Frank: Nice find and good article.
I agree with Ron Myers' comment : Owner earnings are more important that asset value itself. Also, there is no clear way for this asset value to unlock since the assets are old and not likely to sell for much.
Some more points to think about:
1. How bad will the Return on tangible Assets look if you take asset value to be the same as replacement value?
2. If one thinks about the long term expenses, these older assets will need to be replaced. That cap ex will affect owner earnings in the future.
Thanks Craig for your excellent and detailed reply. Sorry for my late response due to travel.
I'm invested in CHK but I am re-evaluating my investment. Your reply gives me better insights to do that. For capital intensive companies, using DCF sometimes does not show great value - CHK is such a case. But based on acreage sold to other companies, the remaining CHK acreage makes CHK look undervalued. That is why I am trying to understand more and more about the business to analyze it better. Also, CHK has made it tough for investors with their complex financial operations, JVs, subsidiaries etc
Craig: Thanks for agreeing to answer my questions.
1. How do companies identify lower quality acreage based on
a.. lower IPs (do they not report these IPs to the buyer?
b. smaller EUR ( does this not meant they've already invested enough to drill several wells)
2. Flipping leases and getting cash flow is a dubious method to achieve growth. It reminds me of housing boom while rental yields were falling. If they are not able to produce gas economically at current rates and if they are using lease flipping method, it does not point to a long term, sustainable, cash flow growth method.
3. Their financial operations are very complex. I understand that they need to hedge for natural gas prices. But they have preferred shares and several JVs and convertibles. I understand having common and preferred stock separately but the other ways of financing make it complex to analyze.
Webscribe, thanks for your reply and all the information. I'll check out the conference call transcript from NOV for more details.
CHK perplexes me.
1.They seem to sell leases to other companies and if one takes these lease amounts, the value of CHK should be way higher than their market value.
2. They are a gas and oil producer, but I hear less about their production or efficiency, but more about how they flipped leases
3. They've always had negative cash flow. They always seem to want to sell their assets to other companies to meet the debt gap.
4. If they say some investors are yield hungry, why are they not giving a good dividend? Also they could just have one common stock and one preferred convertible with higher dividend.
Craig Cooper: You still didn't answer how CHK is selling lesser quality acreage? You've skirted around the issue but not answered it. I am neutral in this argument, but right now I think Investor111 is more convincing.
You've given quotes from 1920, 1960 and recently. Right now, it appears that CHK is flipping leases and making a speculative play on natural gas. However, it would be great if you could also explain on the lines below:
1. How much are these wells really making in profit when production starts on them? I am sure someone is drilling shale gas and not just playing lease flip game.
2. Technology has changed much since 1920 and 1960. Isn't that going to make getting shale gas and shale oil easier?
3. The price of oil has been increasing since the rich reserves (conventional) are depleting fast. Now it becomes economical (relatively) to explore shale oil/gas plays. Doesn't this mean that shale gas and oil now become feasible to be drilled?
Very good article. Can you provide more information on how NOV will benefit from fracking? NOV will definitely benefit from increased rig count. I also heard that they are making their own "fracking gear" (fracking pumps, chemicals etc). Do you know more on how NOV will specifically benefit from fracking activity?
Thanks for your nice comments, Red the Bear. I'm going to write the next article when I have substantially good material. I am glad for all the thoughtful commentary here which has been encouraging and has given me great thinking points.
I agree that I did not mention pipeline and gasline companies in this article. Part of the reason is that I've not analyzed them well till now. I'll try to take a look at them in a later article.
Thanks for your article, though I don't agree with your calculations.
I agree with Cerenity here. 20% discount rate is extreme, especially for a stable company like McDonald's. You are using rates almost as if you were a tech VC.
Also applying DCF calculations to earnings is probably not the way to go. Apply it to cash flow - Stern's Damodaran has some excellent slides available online wherein he talks about DCF and where to apply it.
I understand that you need to advertise your investment services. However, I asked simple questions about the article that you posted here at Seeking Alpha. I think you should answer the questions here because when you say WM is undervalued, its based on your assumptions. I asked simple questions about your assumptions for this article which you are not willing to answer.
I would have probably thought about your investment service in more positive light if you had replied to my questions here at Seeking Alpha.
You've considered operating cash flow and capital expenditure for WM. Another things to consider might be expenses for acquisitions. WM seems to spend large amounts - in FY 2010 it was 400 million. If you do the FCF calculations including this number, you can see that the FCF has been reducing since 2009, showing the cyclical nature of WM.
I had a few questions about the free cash flow projections:
1. How did you arrive at 7.2% FCF growth rate for phase I (next 5 years)?
2. Why assumption of only 1.8% FCF growth for 6-20 years?
3. Why 3% terminal growth rate?
I ask these questions because WM's free cash flow has not changed much since 2004. In fact, its lower now than in 2004.
BTW I do like WM's FCF numbers overall. I just think they are not rising and are in fact falling. I own WM shares but I don't know how to DCF valuation in the light of falling FCF numbers.
Hope you can throw some light on these issue.
Thanks again for your good article.
Gotlife: Thanks for your comments and for insightful commentary. Yes, human nature with greed and fear would be similar through ages. Also, its natural that people who are under lot of debt, try to reduce debt and the demand from them reduces (another common thing between1920 and now).
What I wrote in this article is a top-down, macroeconomic view with themes and some investment choices. You are correct in saying that rear-view mirror driving is not an accurate predictor of the coming events. However, these themes offer "hints" such as capital appreciation is not the only way to make money, that dividends are important, that buying stock at prices lesser than value is important. These things have always been important and are even more so now in deflationary environment.
I will definitely try to do a bottoms-up review of the stocks from valuation perspective (using DCF, net-net capital check, and some other valuation methods too). I look forward to your comments in the future too :)
Thanks for your nice comments, dsr70
I don't know how you arrived at the 80 USD stock price based on valuation. What method did you use to arrive at this valuation? No matter what method you - DCF/NPV model, Ben Graham's formular (based on EPS and growth rate), or some other model - how do you ever arrive at a constant price number when there are so many variables involved?
All the future food price increases need to be quantified as threat to the Future Cash flow in same way to find the effect.
TonyP4: You are correct in saying that secular bulls and bears have large cycle times (around 20 years). But within these large secular cycles, there are smaller business cycles every 3-4 years.
Winslow, its correct to say that these are predictions. Predictions have certain probabilities attached with them. When people make short term predictions (what the S&P 500 would be tomorrow or next year), its usually a wild guess. But long term performances can be gauged even if they cannot be exactly predicted. The main point of this article is not how much S&P 500 would be 10 years from now, but that there are deflationary pressures.
1. Private debt being absorbed into public debt is correct to some order. Money printing also leads to some monetization of debt.
2. Defaults are already happening. Atleast partially. The EU is already working with Greece so that Greeks could write down 50% of their debt. This would exceed the reserve requirements of some banks.
The complete breakdown of financial system is not likely though.
1. Tony P4 is right on target here. The Japanese problem is exacerbated because of lack of immigration. The US should make it easier for talent from abroad to immigrate and fulfill deficiencies here.
2. Most of developed world is facing aging demographics except India and most of Africa.
3. E.D. Hart, your suggestion for plotting on log graph for gold price is awesome. Tails in distributions or outliers become more obvious in log scale.
Gold is like insurance. People flock to it when they think paper money is losing value. Its a great insurance to have, but one needs to think of what "price" one is paying to get insured. Right now, I feel its above the mean reversion price. I'll try the log distribution to check again.
What do you mean by "bogus CPI calculations"? It might help me answer your argument on gold more clearly.
4. Globalization has had profound effects in the way things work. However, if the US consumer spending falls, some other part of the world has to compensate for it. They will be compensate but not completely. More data on why this is so is the Duetsche bank Long term asset study - link given in article)
The Fed's predictions always have some probability attached with it. In this case its based on a model (chart 2).
Its possible that the declines might be lower or higher than the ones predicted.
As you pointed, there are a lot of complex effects in play.
Earlyride, thank you for your thoughtful comments. Good points to think on.
1. Good link for the Retirement Confidence survey.from EBRI. This is insightful data since it means that significant % of retirees are likely to dip into savings for medical expenses.
You are correct in saying that the M/O ratio captures mostly consumption rate for demographics and does not include the effect of Medicare falling short or retirees dipping into savings for medical expenses.
Yes, the effects on medical stocks are quite complex - increased base of customers, but the customers have lesser savings and Medicare might fall short.
2. Hmm. The effects of commodity prices on a commodity producer are always complex. CRESY (management) has to make sure that they are able to keep their margins up when grain prices make volatile movements. Also the government has to keep the monetary environment to be conducive. I agree that the major risk here, if any, is that the government might fail the fertile and cheap lands of Argentina.
My argument for CRESY is that I buy a piece of farmland for cheaper than I can in most places of the world.
I am not the author of this article. So I raised the questions for the article of this author because the author would be in a better position to reply.
On the surface level, its seems that some companies in healthcare or which provide services to older people might benefit from boomer retirement. However, their stock performance is not that simple to predict. Along with increased revenues from aging population, the stock might also faced reduced demand at the stock market. Meaning people would prefer low P/E. So the effect on prices is caused by these opposing forces. I'll try to study more on this and post in a future article.
In a global economy, there is no justification for US farmland prices to go up that high as compared to farmland prices elsewhere. Quoting from - "There is no justification for U.S. farmland prices to be three to four times higher than land where the same crop is planted in Brazil, or 30 times the corresponding prices in Russia".
Chart of recent price rise is here -
There is no argument against the fact that farmland is valuable and its constrained resource. The question is whether the rapid recent rise in US farmland prices was brought about by credit and if this price rise is sustainable.
Good point dancing diva. Let's look at interest rate data from Japan - . It shows that interest rates haven't been high there since 1990 and yet the Nikkei graph as shown in chart 3 went down for a decade after that. So demographics did seem to play a role there. And interest rates alone did not cause low p/e there.
Japan's crisis though did start due to asset price inflation through heavy borrowing due to low interest rates.
Even if China is number 1 based on these numbers, what significance does it carry? There exist issues such as:
1. Are the Chinese numbers real? After the fraud issues from the companies from China, its tough to believe data originating from there.
2. When a country's sole aim is to increase GDP at break-neck pace by investing 50% into fixed investments, how will it pan out in long term? They seem to have blatant disregard for supply and demand.
3. What happens when trade imbalances due to artificially depressed currency cause trade-wars?
Gotlike: I can see why you think that progress made since 1920 will lead to different outcome. There are other themes playing alongside demographics and debt vs GDP ratio. Resource constraint and increased productivity through technology add more complexity to the problem. I'll try to write about these later. Especially the theme of resource constraint is complex. You might want to read Jeremy Grantham's (GMO) recent newsletters.
1. Haha. Nope the article does not say that 1920 will be repeated exactly. The private debt vs GDP comparison is one data point out of many which will help us examine the entire picture. What we can say for sure is that themes of debt de-leveraging are similar back in 1930 and today. When people have lots of debt, they try to pay it back, they spend less and there is deflationary environment.
There are differences from 1930 to now - governments are spending and converting private debt to public debt (following Keynesian theory), there is fiat currency system which allows devaluation and technology has improved productivity. All of these will make the impact different from 1930 and that's why we've not seen situation as bad as 1930 in the stock market.
2. Japan data point in terms of demographics is very current (1990 onwards). To ignore data from Japan, which had both baby boomer generation a decade before US and had housing bubble, is not prudent.
PS: Let's not have arguments about Keynesian vs Austrian school here. I am just stating that governments are following Keynesian concepts. Let the powers-that-be decide what they want to follow.