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I am a private investor building a value focused portfolio. While I do not work directly in investing, I do have a financial background and hold the CFA designation. The goal of Margin of Safety Investing is to share my investing journey as I review and analyze investing opportunities using a... More
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  • Medtronic (MDT) Quick Review: Attractive company at an attractive price

    Medtronic currently trades at $33.3 after what has been seen as disappointing performance in its first quarter. Medtronic came into my idea pipeline as it is rated by Morningstar as a 5 stars wide-moat company and it is also mentioned in the August Value Investor Insight.

     

     

    1- Business Performance Risk

    Metric

    Status

    FCF / Sales

    Last twelve months (“LTM”): 22.5%, in line with the company’s performance over the last 10 years – between 19% and 26% (except for 2006 @ 9%)

    ROE

    LTM:22.5%, in line with the company’s 5-year average of 22.6%

    ROA

    LTM: 12%, in line with the company’s 5-year average

    Revenue Growth

    MDT’s revenue growth has been fairly consistent on a 5 and 10 year basis. 5-year growth is about 9%, dropping slightly to 8% in recent years

    Cash distribution to shareholders

    MDT’s current yield is 2.5% (in line with the S&P 500) on a ~30% payout ratio.

    In addition, MDT bought back a little less than 20% of its outstanding stock over the last 5 years or a return of 4-5% p.a.

    Medtronic’s business is strong with high cash flow generation and ROE’s. ROA’s are a little on the low side but still above my personal threshold.  In addition, the company has been able to grow consistently around 8-9%.

     

    MDT’s management shows a rather good “shareholder value” discipline with a dividend payout of ~30% and consistent share buybacks over time. On the basis of an 8% growth rate (lower than analyst projections) and ROE of 22%, MDT would have to retain about 35% of its earnings.  The rest could come back to shareholders in the form of a 30% dividend payout and 35% share buybacks, leading to an attractive total return of 8% + 2.5% + 3% buyback (35% of earnings at a 11.9x P/E)

     

    2- Balance Sheet Risk

    Metric

    Status

    LT Debt / Equity

    0.5x, declining slowly from 0.6x a few years ago. MDT also has some short term debt (about a third of long term debt).

    Current Ratio

    1.9x, lower than historical but still manageable.  Excluding cash, current assets are still higher than current liabilities.

    Overall MDT’s balance sheet risk seems low with Total Debt / Equity <1.0x. Liquidity is also good with a current of 1.9x. I’d prefer for a company like MDT to maintain its current ratio at 2.0x+ but I am not concerned here.

     

    3- Valuation Risk

    Metric

    Status

    Cash Return

    8.3%

    P/E

    11.9x, lower than the market (13.7x), the industry (17.7x) and MDT’s average over the last 5 years of 20+x.

    MDT appears attractively valued with a good cash return of 8.3% and an interesting P/E of 11.9x which could leave an investor with an attractive margin of safety.

     

    Conclusion

    MDT appears to be a very strong business, with the potential of delivering good intrinsic returns when taking into account dividends, growth and buybacks. In addition MDT is conservatively financed, with little B/S and liquidity risk. Finally, MDT’s current valuation appears attractive both on a cash and earnings basis and could present an attractive investment with a reasonable margin of safety. I will perform a Company Analysis for MDT to evaluate what an interesting entry price into the stock could be.



    Disclosure: Long MDT
    Tags: MDT
    Sep 26 9:03 PM | Link | Comment!
  • Aeropostale (ARO) quick review: could be a good opportunity with a margin of safety

    Intro

    ARO is a “legacy” stock of mine which is why I want to review it. The company’s shares currently trade at  $23 .

     

    1- Business Performance Risk

    Metric

    Status

    FCF / Sales

    Last twelve months: 10% at the high end of the company’s historical performance of between 4% and 9%, except for last year when it reached 12%

    ROE

    LTM: 54%!, above the company’s average of ~40%, but in line with 3 most recent fiscal years

    ROA

    LTM: 31%, higher than historical averages of ~20%+

    Revenue Growth

    The company has not been public for 10 years yet! However, the 5-years growth rate has been about 20%, and recent years have been ~18%!

    Cash distribution to shareholders

    ARO does not pay a dividend

    Over the last 5 years, the company has bought back 22% of its stock

    Aeropostale seems to be a strong business with high cash flow generation and strong ROE/ROA’s. In recent years growth has slowed to less than 20% while returns have surged with ROE  over 50% for the last 4 years.

     ARO unfortunately does not pay a dividend but has been buying back ~4% of its shares per year over the last 5 years and has been accumulating cash on the balance sheet.  In terms of returns, even if the company’s growth was to slow down to 5-10%, it would then be in a position (ROE assumption of 40%) to use 80% of its earnings to buy back shares / increase cash balance. With a current earnings yield of 11%, ARO could buyback up to 8% of its own shares per year.


    Overall ARO appears to be a good business with one default: not paying dividends.  ARO still should be able to deliver attractive returns even at a lower growth rate as it generates a lot of cash it can use for repurchases.  To compensate for the lack of dividend I will probably be looking for a bit more margin of safety than usual.

     2- Balance Sheet Risk

    Metric

    Status

    LT Debt / Equity

    ARO does not have any debt!

    Current Ratio

    LTM: 2.3x, in line with historical average and conservative for the industry

    No debt and a high current ratio. Great!

    3- Valuation Risk

    Metric

    Status

    Cash Return

    13.1% - this is extremely high

    P/E

    9.1x, lower than the S&P, the industry (15x) and the company’s 5-year average

    ARO appears very attractive from a valuation standpoint with very high cash returns and a low P/E. This probably means that people are expecting FCF and earnings to compress in the future but such a low valuation could provide a good margin of safety

     Conclusion

    I will perform a company analysis of ARO has the company has a strong business performance, good potential intrinsic returns, a very conservative balance sheet and a valuation that appears to leave room for an attractive margin of safety

     



    Disclosure: Long ARO
    Tags: ARO
    Sep 24 6:34 PM | Link | Comment!
  • AmerisourceBergen (ABC) quick review - I'm selling!

    Intro

    ABC is one of my “legacy” stock. The company is one of 3 large pharmaceutical distributors in the US. It currently trades for ~ $30

     1- Business Performance Risk

    Metric

    Status

    FCF / Sales

    Last twelve months: 1.0%(!) in line with the company’s performance over the last 10 years, ranging between 0.8% and 1.6%

    ROE

    LTM: 22%, higher than historical performance with a 5-year average of 11.7%.  Before 2008, ABC’s ROE was between 8% and 12%

    ROA

    4.7%, higher than the average over the last 5 years of 3.3%

    Revenue Growth

    Growth on a 5 year basis (10 year being not representative for ABC due to mergers in 2001-2002) is about 6% and has been cyclical in recent years, with growth of 2% followed by growth of 8-9%

    Cash distribution to shareholders

    ABC’s dividend yield is currently 1% on a payout of about 15% of revenues. Over the last 5 years the company has retired 35% (!) of its stock.

    ABC’s business returns and cash generation are below what I usually like in a business and are probably the sign of the company having a very narrow moat if any.  Note that the company carries $2B in intangibles which make ROE and ROA look lower. Growth is also cyclical.

    In terms of intrinsic returns, in addition to a 1% yield the company (ROE of 10%) would need to reinvest 50% of its earnings to keep growing at 5%, leaving 35% for buybacks (after the 15% going to dividends) – with this amount and at current valuation, ABC could buy back 2% of its stock back.  All in all the return would be 8% which is low, especially in the light of a risky business model.

    2- Balance Sheet Risk

    Metric

    Status

    LT Debt / Equity

    0.5x, in line with recent historical level after an increase in debt in 2007

    Current Ratio

    1.1x, in line with average over the last 3 years.

    ABC’s balance sheet appears ok. Low debt levels coupled with a somewhat aggressive current ratio. However the company is in the distribution business, so managing its current ratio is core to its operations and the level is consistent with that of recent years.

     3- Valuation Risk

    Metric

    Status

    Cash Return

    8.6%

    P/E

    14.2x, above the S&P500 of 13.7x, but below the company’s 5-years average of 17.8x

    ABC’s valuation appears reasonable but not necessarily attractive enough to leave a good margin of safety.

     Conclusion

    Given the cyclicality and the low cash generation / low return of the business, I would require – if I were to invest at all – a large margin of safety. In addition, I am not convince yet of the intrinsic returns potential of the company.

     At current valuation levels I do not believe that ABC offers such a margin of safety and will rate the stock a “pass”.   I will sell the stocks in my portfolio to redeploy that capital on more attractive opportunities.  If the stock was to fall ~$23-$25 I’d be willing to look at it again.



    Disclosure: Selling my position
    Tags: ABC
    Sep 24 6:31 PM | Link | Comment!
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