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  • McDonald's: Business Model, Valuation And Minimum Wage Legislation [View article]
    Absolutely. And Wage Inflation also boosts McDonalds' Market Share!

    Wage and other inflationary costs favor McDonalds in several ways. First, wage inflation imposes higher up-front costs and thereby raises barriers to entry. This puts startups at a further disadvantage vis-à-vis established low-cost leaders like MCD. Second, a higher minimum wage creates higher fixed costs, which harm the low-volume restaurants more than high-volume shops. MCD can almost always be the highest volume player since it enjoys greater economies of scale and hence lower price points for similar items. It can therefore bear the wage increases more easily than small chains or mom and pop restaurants.

    So even MCD's franchisees, who must bear the weight of the price hike, handle it better on average than their rival franchisees and small-time competitors. This strengthens the entire system and ultimately redounds to MCD's ultimate benefit.

    But a higher minimum wage even gives MCD a leg up against its big rivals too, since the average MCD store revenue is around $2.6M, while Wendy's comes in second at only $1.48M, and Jack in the Box third, at $1.35M. Sonic is down at $1.1M. The golden arches are simply not hit as hard by the wage hike due to their superior ability to spread out costs over greater volumes. This gives MCD a chance to either increase profits or take market share, especially from small shops and minor chains. Size has its privileges. Long MCD

    H. J. Huneycutt wrote a wonderful SA article on this topic. Below is the link,


    http://seekingalpha.co...
    Feb 26, 2014. 07:38 PM | 5 Likes Like |Link to Comment
  • Coca-Cola Cheap Considering Its Real Moat: Strategic Checkmate Power [View article]
    Redarrow;

    You say KO has no coffee line contributing meaningfully to the bottom line. What contribution do you calculate from KO's Georgia Coffee, which is the leading coffee beverage in Japan (also selling in Korea, Singapore, and India) and which outsells brand Coca-Cola in Japan by a 2 to 1 margin? This is a massive line of exceptionally profitable drinks, dominating the third largest global economy. Please show us your math behind the statement that this does not meaningfully contribute.

    Regarding energy drinks, KO has Monster, Full-Throttle, NOS, Power Play and Mother. Have you precisely identified the market share of these brands in various global markets? And their relative contribution to the bottom line?

    I fail to see how KO is not up on coffee trends when they have the run-away number one coffee brand. Please explain?
    Feb 25, 2014. 06:00 PM | 3 Likes Like |Link to Comment
  • Coca-Cola Cheap Considering Its Real Moat: Strategic Checkmate Power [View article]
    Dear Sleuth;

    Thanks for the comment. I think you nearly caught me. The byline statistic is obtained only by comparing today's future earnings multiple with past years' trailing-multiples, which is unfair. First, comparing future to trailing multiples is an apples to oranges exercise. Any company with a static p/e but a positive-sloping growth line can look like a bargain when comparing its current next year to former prior years.

    My use of the future earnings p/e is simply not really fair. A future earnings p/e requires one to ask themselves "Would I be willing to own KO at a 16.5 p/e, with the proviso that delivery would not be for one year?" That starts to sound suspiciously like a p/e 17.5 price...

    Thanks so much for your comment.
    Feb 24, 2014. 04:40 PM | Likes Like |Link to Comment
  • Coca-Cola Cheap Considering Its Real Moat: Strategic Checkmate Power [View article]
    Excellent comment, Bfineprint.

    The dividend ratio is reverting to the old S&P mean, indeed, and one can certainly draw the inference you have. By way of consolation, you can be happy that the higher dividend ratio imposes greater cash-flow discipline on management. Other things can be manipulated or glossed over, but a dividend must be met with hard cash, which keeps management more 'honest' and greatly incentivizes operational cash flow. I, for one, want management to focus more on OCF than GAAP earnings. The high dividend payout ratio forces attention to this operating metric. Truth be told, though, when a company generates a 20% return on assets, I don't want management to pay out dividends. I can't put the money to better use than they can. If they can return 20% on it, they should keep the money and compound it for us. Of course, if they did, the ROA rate would most likely drift lower.

    As for shifting with the times, Coca-Cola introduced five-hundred (500) new beverages last year. (And this is from a company that had one single product until the late 1950's.) This is like putting a chip on every slot in the cultural roulette wheel and having a spin. Its almost an absurd number of new offerings. It leaves me nonplussed. It is likely, however, that one or more will prove to be another billion dollar brand.

    We shall see. Thanks for your comment!
    Feb 24, 2014. 03:56 PM | 1 Like Like |Link to Comment
  • Coca-Cola Cheap Considering Its Real Moat: Strategic Checkmate Power [View article]
    Thanks for your insight, Redarrow. You are precisely right. Coke indeed is always late!

    You point up an important element of Coca-Cola's business, namely that the company is almost always late to market, going back to 1886. Pemberton was late with fortified wine, playing catch-up to Vin Mariani. He was late to the entire nostrum business, and then he was late to the fountain soda business. There were hundreds when Coca-Cola was introduced to Atlanta. Then KO was late to see the value of bottling. Then it was late to recognize the value of Pepsi, failing to buy it not once, but twice, when it sought to be acquired for a pittance. Then KO was late to introduce large size bottles, having to follow Pepsi and bow to pressure from its own Philippine bottlers in '55-57. Next, Coke missed expanding into other flavors. KO introduced Fanta stateside to thwart the rise of Nehi and other rainbow sodas. Then, KO was late to introduce a diet version. Pepsi was first with Diet Pepsi. KO responded with Tab. Only later did it rename the drink Diet Coke. Behind, Behind, Behind. Behind in coffee, save for Japan where Georgia brand dominates. Late to energy drinks. That is the story of the entire company's history.

    Being first in innovation has never been a hallmark of the company. Rather, starting late and eventually dominating the category has defined Coca-Cola's long history.

    If one studies this curious phenomenon, the true moat of Coca-Cola emerges, and surprisingly, it has little do with a secret formula or innovation.

    Thanks for your comment! Coke really is always late...
    Feb 24, 2014. 03:39 PM | 2 Likes Like |Link to Comment
  • Consider Coca-Cola At 3.20% Yield [View article]
    Absolutely! Coca-Cola is nearing a 25-Year Low P/E!

    Shares of Coca-Cola are presently trading at a multiple of 16.5 times ValueLine’s forward EPS of $2.25, nearly the same as its average trailing-multiple during the financial meltdown. Aside from perhaps 11 months of that meltdown, KO’s valuation is now at nearly a 25-year low. This statistic says a lot, but let’s dig a bit deeper.

    KO Now a Historical Value Relative to the S&P

    Coca-Cola is in historical value territory when it trades at only a modest 7.5% premium to the S&P 500, which Birinyi & Associates estimates to be presently at 15.35 times next year’s earnings. This value proposition is particularly evident when one considers that KO’s 3% dividend is nearly 54% higher, and its .65 beta nearly one third less volatile than, the overall index. This narrow premium to the S&P is uncommon for Coca-Cola. Still, a relative value is not necessarily an absolute value. For that, we need to look ahead to KO’s future prospects.

    Better Than Buffett?

    Berkshire’s 1988 purchase represents an undisputed moment in time where KO’s shares traded at a discount to true value. How does the beverage behemoth compare today with that moment in time? In 1988, KO had a 12.5% net profit margin and an average p/e of about 14. Today, net margins are 19.5%-nearly 55% more profitable. Crucially, the return on equity, which then stood at 34%, has now fallen to 26%. Are we to draw a negative inference from this deterioration? Not at all. It represents massive future profitability. To see why, we need to look back at Coke’s long history of generating private-equity style profits from its perpetual cycle of bottler buyouts and spinoffs.

    Shake Up The Bottlers and Profits Spew Out

    Coca-Cola is higher-margin, higher cash-flow, lower leverage and lower beta business than its many bottlers. During market crashes it can therefore pounce on them with ease, refinance their debt, streamline operations, and then spin them off later when stock markets are frothy again. This is a recipe for constant cyclical profits, private-equity style, and Coca-Cola has been doing it for generations. This fix-n-flip has been part of KO’s playbook for so long it is taken for granted that a small bottler will be bought or sold annually. But in 2010, CEO Muhtar Kent used the financial crisis and 2010 credit nadir to put this plan on steroids with the biggest bottler purchase in Coke’s history, the massive acquisition of Coca-Cola Enterprises, an acquisition which has pushed down the return on equity. Temporarily, that is, until KO mercilessly wrings the inefficiencies out of CCE, launches hundreds of questionable beverages through it, loads it to the gills with debt, and then spins it off during the next bull market frenzy. The result will be a veritable money fountain. Huge capital gain on the sale, a giant lightening of KO’s debt burden, and a return to fantastic return-on-asset statistics. Now is it clear why KO’s lower return on assets is a blessing in disguise? Meanwhile, it affords a write-down of goodwill, sheltering profits from the taxman. It also entailed a tender of certain European bottling interests as part of the purchase price, which had the brilliant effect of swapping a hard-to-repatriate foreign cash flow stream for a convenient-to-use domestic one, which in 2010-2011 allowed KO greater flexibility with share repurchases and dividend payments. This helped reposition the company in expectation of a stronger dollar, reducing hedging costs too. Which brings us to another Coke trump card, the currency headwinds.

    Dollar Down, Coke Up

    Coca-Cola seems, on the surface, to suffer from a strong dollar and lose sales during emerging market downturns. This perception has taken perhaps 10% off the stock price this year as Fed tapering promises to suck money out of emerging markets and drive up the dollar. Over the short term, this is correct. But over the long term, it makes Coca-Cola’s war-chest swell in relation to foreign acquisition targets, whose businesses will be weakened by the double whammy of higher import costs, higher credit costs, and reduced sales volume. The resulting low valuations allow Coke to come in with more muscular dollars and buy crucial manufacturer, bottler and wholesale operations around the world at deep discounts. A crash in China, Japan and or India will produce this generational windfall for Coca-Cola, hidden by temporary declines in dollar-denominated sales and reduced case-volumes. The strong-dollar era of the 1980’s resulted in just this, as did the Russian devaluation and the Asian financial crisis. It is an old trick and Coke knows how to play it every time. So taper away, Janet Yellen.

    Operationally For Coke, The Strong Dollar Doesn’t Matter

    A strong Dollar strategically aids Coca-Cola, as described above. But what about operations? Ask yourself, operationally speaking, are the foreign earnings really worth intrinsically less if the Dollar goes up? Consider, Rupiahs Coke earns but needs to immediately reinvest in India lose no value when the Dollar strengthens, except in the rare case that imported U.S. goods need to be purchased. In general, a Rupiah earned still buys a Rupiah’s worth of purchases. So as for reinvested cash flow, the forex differential makes little difference. The surplus, ‘free cash flow’ Rupiahs on the other hand, could be converted into other currencies and used elsewhere. When these need to be converted to Dollars, real value is lost. But in most cases, Coca-Cola does not need to convert these into Dollars. The funds may be needed in South Korea, Mozambique, New Zealand, Norway or Peru. In these cases, the Dollar strength is irrelevant. Rather, the local currency/Rupiah pair is relevant, and some of these will have weakened, not strengthened, against the Rupiah. The real bottom line is that only the small portion of forex earnings which MUST be converted into Dollars or spent on U.S. goods are impaired by a strengthening Dollar. This turns out to be very little, and it is offset by the many cases where some local free-cash-flow strengthens against a foreign-currency investment obligation or opportunity elsewhere. This small operational impact of a strong Dollar is then further diminished by KO’s forex hedging. What is left of the currency impact? Practically nothing. The more volatile global currencies become, the more KO can simply arbitrage its free-cash flow among them.

    Cash Flow: The Real Moat

    Each of the above discussions boil down to one thing: the real long-term moat for Coke is, surprisingly, not merely its brand, nor its secret formula for cola syrup. Rather, the durable competitive advantage nowadays resides is Coca-Cola’s torrential free cash flow, combined with its low-cost leadership position in marketing, manufacturing and distribution. These are long term advantages which turn each economic upheaval to Coca-Cola’s favor vis-à-vis its bottlers and its smaller competitors, generation after generation, in one market after another. Because of these advantages, the worse things get in some country, or some currency, the better positioned Coke gets there, because it is axiomatically less distressed than the local competitors and bottlers, advertisers and even governments. In this way, Coca-Cola makes its biggest strides in times and places of crisis. It is always the most flush company when cash becomes king, and management is therefore to be judged not by how the current marketing campaign is doing, or whether brand Coca Cola products are lagging, but rather how various crises are being strategically and tactically exploited for maximum long term advantage. A financial panic in America? Buy out all the American bottlers. Voila. An entire generation of new profits virtually guaranteed. That is my kind of management. A hard landing in China next year? We should only pray for it. Just thinking of the over-leveraged leading brands of Chinese beverages which will fall like a ripe harvest into Coke’s hands makes a long-term shareholder drool.

    Coke’s Cash Flow Secret Formula…Hint: It’s 70% Water

    If torrential free cash flow is the moat, what drives the moat? Mainly the high margins inherent in being both the lowest-cost operator and highest price seller in the business of…selling water. KO primarily sells water, or sells additives which then sell water. Water is the main ingredient of orange juice, tea, coffee, soda, and of course, bottled water. Whatever beverage is primarily water, the former advantage comes from operational and distribution scale, the latter comes from the brand and marketing scale. Can KO continue to find profitable ways to sell water over the next investing lifetime? Of course. By adding sugar syrup? Maybe but maybe not. It doesn’t matter. Coca-Cola is in the water business and will sell it more efficiently at better prices than nearly anyone else whatever the additive, for an investing lifetime.

    KO Shares Probably a Buy at 16.5 Times Forward Earnings

    Would an investor be willing to pay an 8% premium to the S&P for this kind of durable competitive advantage? Oh, and there’s also the brand. The question almost answers itself. That’s why I’m long KO and am accumulating more. Go Muhtar Kent. Go Go Pemberton. On Candler, On Goizueta, On Buffet and Woodruff. Long, and Long live, Coca-Cola.
    Feb 20, 2014. 02:35 PM | 6 Likes Like |Link to Comment
  • Does Coke Even Know That These Are The Good Years - And The Worst Is Yet To Come? [View article]
    I respectfully disagree, because KO primarily sells water, not soda. It is a buy now, especially as it approaches a 25-Year Low P/E... below is my reasoning.

    Shares of Coca-Cola are presently trading at a multiple of 16.5 times ValueLine’s forward EPS of $2.25, nearly the same as its average trailing-multiple during the financial meltdown. Aside from perhaps 11 months of that meltdown, KO’s valuation is now at nearly a 25-year low. This statistic says a lot, but let’s dig a bit deeper.

    KO Now a Historical Value Relative to the S&P

    Coca-Cola is in historical value territory when it trades at only a modest 7.5% premium to the S&P 500, which Birinyi & Associates estimates to be presently at 15.35 times next year’s earnings. This value proposition is particularly evident when one considers that KO’s 3% dividend is nearly 54% higher, and its .65 beta nearly one third less volatile than, the overall index. This narrow premium to the S&P is uncommon for Coca-Cola. Still, a relative value is not necessarily an absolute value. For that, we need to look ahead to KO’s future prospects.

    Better Than Buffett?

    Berkshire’s 1988 purchase represents an undisputed moment in time where KO’s shares traded at a discount to true value. How does the beverage behemoth compare today with that moment in time? In 1988, KO had a 12.5% net profit margin and an average p/e of about 14. Today, net margins are 19.5%-nearly 55% more profitable. Crucially, the return on equity, which then stood at 34%, has now fallen to 26%. Are we to draw a negative inference from this deterioration? Not at all. It represents massive future profitability. To see why, we need to look back at Coke’s long history of generating private-equity style profits from its perpetual cycle of bottler buyouts and spinoffs.

    Shake Up The Bottlers and Profits Spew Out

    Coca-Cola is higher-margin, higher cash-flow, lower leverage and lower beta business than its many bottlers. During market crashes it can therefore pounce on them with ease, refinance their debt, streamline operations, and then spin them off later when stock markets are frothy again. This is a recipe for constant cyclical profits, private-equity style, and Coca-Cola has been doing it for generations. This fix-n-flip has been part of KO’s playbook for so long it is taken for granted that a small bottler will be bought or sold annually. But in 2010, CEO Muhtar Kent used the financial crisis and 2010 credit nadir to put this plan on steroids with the biggest bottler purchase in Coke’s history, the massive acquisition of Coca-Cola Enterprises, an acquisition which has pushed down the return on equity. Temporarily, that is, until KO mercilessly wrings the inefficiencies out of CCE, launches hundreds of questionable beverages through it, loads it to the gills with debt, and then spins it off during the next bull market frenzy. The result will be a veritable money fountain. Huge capital gain on the sale, a giant lightening of KO’s debt burden, and a return to fantastic return-on-asset statistics. Now is it clear why KO’s lower return on assets is a blessing in disguise? Meanwhile, it affords a write-down of goodwill, sheltering profits from the taxman. It also entailed a tender of certain European bottling interests as part of the purchase price, which had the brilliant effect of swapping a hard-to-repatriate foreign cash flow stream for a convenient-to-use domestic one, which in 2010-2011 allowed KO greater flexibility with share repurchases and dividend payments. This helped reposition the company in expectation of a stronger dollar, reducing hedging costs too. Which brings us to another Coke trump card, the currency headwinds.

    Dollar Down, Coke Up

    Coca-Cola seems, on the surface, to suffer from a strong dollar and lose sales during emerging market downturns. This perception has taken perhaps 10% off the stock price this year as Fed tapering promises to suck money out of emerging markets and drive up the dollar. Over the short term, this is correct. But over the long term, it makes Coca-Cola’s war-chest swell in relation to foreign acquisition targets, whose businesses will be weakened by the double whammy of higher import costs, higher credit costs, and reduced sales volume. The resulting low valuations allow Coke to come in with more muscular dollars and buy crucial manufacturer, bottler and wholesale operations around the world at deep discounts. A crash in China, Japan and or India will produce this generational windfall for Coca-Cola, hidden by temporary declines in dollar-denominated sales and reduced case-volumes. The strong-dollar era of the 1980’s resulted in just this, as did the Russian devaluation and the Asian financial crisis. It is an old trick and Coke knows how to play it every time. So taper away, Janet Yellen.

    Operationally For Coke, The Strong Dollar Doesn’t Matter

    A strong Dollar strategically aids Coca-Cola, as described above. But what about operations? Ask yourself, operationally speaking, are the foreign earnings really worth intrinsically less if the Dollar goes up? Consider, Rupiahs Coke earns but needs to immediately reinvest in India lose no value when the Dollar strengthens, except in the rare case that imported U.S. goods need to be purchased. In general, a Rupiah earned still buys a Rupiah’s worth of purchases. So as for reinvested cash flow, the forex differential makes little difference. The surplus, ‘free cash flow’ Rupiahs on the other hand, could be converted into other currencies and used elsewhere. When these need to be converted to Dollars, real value is lost. But in most cases, Coca-Cola does not need to convert these into Dollars. The funds may be needed in South Korea, Mozambique, New Zealand, Norway or Peru. In these cases, the Dollar strength is irrelevant. Rather, the local currency/Rupiah pair is relevant, and some of these will have weakened, not strengthened, against the Rupiah. The real bottom line is that only the small portion of forex earnings which MUST be converted into Dollars or spent on U.S. goods are impaired by a strengthening Dollar. This turns out to be very little, and it is offset by the many cases where some local free-cash-flow strengthens against a foreign-currency investment obligation or opportunity elsewhere. This small operational impact of a strong Dollar is then further diminished by KO’s forex hedging. What is left of the currency impact? Practically nothing. The more volatile global currencies become, the more KO can simply arbitrage its free-cash flow among them.

    Cash Flow: The Real Moat

    Each of the above discussions boil down to one thing: the real long-term moat for Coke is, surprisingly, not merely its brand, nor its secret formula for cola syrup. Rather, the durable competitive advantage nowadays resides is Coca-Cola’s torrential free cash flow, combined with its low-cost leadership position in marketing, manufacturing and distribution. These are long term advantages which turn each economic upheaval to Coca-Cola’s favor vis-à-vis its bottlers and its smaller competitors, generation after generation, in one market after another. Because of these advantages, the worse things get in some country, or some currency, the better positioned Coke gets there, because it is axiomatically less distressed than the local competitors and bottlers, advertisers and even governments. In this way, Coca-Cola makes its biggest strides in times and places of crisis. It is always the most flush company when cash becomes king, and management is therefore to be judged not by how the current marketing campaign is doing, or whether brand Coca Cola products are lagging, but rather how various crises are being strategically and tactically exploited for maximum long term advantage. A financial panic in America? Buy out all the American bottlers. Voila. An entire generation of new profits virtually guaranteed. That is my kind of management. A hard landing in China next year? We should only pray for it. Just thinking of the over-leveraged leading brands of Chinese beverages which will fall like a ripe harvest into Coke’s hands makes a long-term shareholder drool.

    Coke’s Cash Flow Secret Formula…Hint: It’s 70% Water

    If torrential free cash flow is the moat, what drives the moat? Mainly the high margins inherent in being both the lowest-cost operator and highest price seller in the business of…selling water. KO primarily sells water, or sells additives which then sell water. Water is the main ingredient of orange juice, tea, coffee, soda, and of course, bottled water. Whatever beverage is primarily water, the former advantage comes from operational and distribution scale, the latter comes from the brand and marketing scale. Can KO continue to find profitable ways to sell water over the next investing lifetime? Of course. By adding sugar syrup? Maybe but maybe not. It doesn’t matter. Coca-Cola is in the water business and will sell it more efficiently at better prices than nearly anyone else whatever the additive, for an investing lifetime.

    KO Shares Probably a Buy at 16.5 Times Forward Earnings

    Would an investor be willing to pay an 8% premium to the S&P for this kind of durable competitive advantage? Oh, and there’s also the brand. The question almost answers itself. That’s why I’m long KO and am accumulating more. Go Muhtar Kent. Go Go Pemberton. On Candler, On Goizueta, On Buffet and Woodruff. Long, and Long live, Coca-Cola.
    Feb 20, 2014. 02:32 PM | 9 Likes Like |Link to Comment
  • The Road To Omaha: Sighting The Duck As An Elephant [View article]
    Duck's Letter to Buffett

    Mr. Warren E. Buffett
    Chairman
    Berkshire Hathaway, Inc.
    3555 Farnam Street # 1440
    Omaha, NE 68131-3378

    December, 2011

    Re: Please do not buy Aflac…

    Dear Mr. Buffett:

    My name is Louis the Swan. Being impecunious, I have to make every investment count, and with only my web feet to count on, I get six in one lifetime. So let’s get down to business.

    Allow me to persuade you not to buy Aflac. You see, it is only through Aflac that I can compound my investment at anything like 20% annually over the next decade or more, and really only Berkshire can take this away. As you will see, my fears are well founded.

    I am worried that you might read Aflac’s annual report and notice that Aflac now has around $93 billion of float (we swans love float)…which Berkshire could have for fearfully little cost at the moment and invest at far greater return than Aflac does. I fear you will spot the portfolio full of bonds you would be itching to reinvest otherwise, or notice that Aflac is by far the low-cost operator in Japan, being free from its competitors' costs of in-house, inefficient sales forces or negative-spread policy obligations from years gone by. You may even read how Aflac’s policy maintenance costs are only 1/4th of those of its largest four competitors, or how Aflac services 5,300 policies per administrative employee, while its largest competitors service around 900.

    Knowing that you favor companies with wide moats, I shudder that you will see how Aflac is the only company allowed to sell third-sector insurance through the Japan Post Office, which unfair monopolistic situation I wish to conceal from you; or how Aflac’s low cost operation enables it to sell policies with both higher commissions and lower premiums than its competitors, at the same time, so low that when banks were finally permitted to compete in the third sector insurance business, they all eventually gave up and became Aflac agents. I do not want you to know that Aflac’s policies are now sold through 90% of the banks in Japan.

    I am paranoid that others may also spill the beans to you about Aflac’s competitor’s double-gearing disadvantage, how many are forced to make portfolio investments in the distasteful equities of their quasi-related banks and then take the money back as subordinated credit and surplus notes…or other sister-kissing acts, like investing in these banks’ hopeless real estate projects. They might even show you how badly the competitors are still suffering from the bubble-burst and Asian financial crisis, to say nothing of the deflationary annihilation of their portfolio real estate holdings. Somebody might tell you about their Japanese equities positions. You would note that Aflac’s competitors were in no shape to increase the supply of insurance and surely would be more inclined to steal my one true love. I have no doubt you might try to ‘goose’ your profits this way.

    Last time I flew over Omaha, I noticed your collection of Valueline reports goes back far enough to enable you to pick up on Aflac’s 20 year average premium growth rate of 10%, or its annual underwriting profit, now over 5%, or its commanding 70% share of the supplemental cancer insurance market in Japan, Luckily, Valueline won’t disclose Aflac’s 95% persistency rate, or the fact that Aflac’s lapse/surrender rate is 25% lower than the industry average.

    Dreadfully, (and this might really do me in), you would note that Aflac’s operations could remain in the capable hands of Daniel Amos and the Amos family, whose 20% voting power you might be tempted to leave in place to arrive at that awful 80% ownership threshold you cherish so much. I cringe as I imagine your next annual letter, gloating on and on about his family’s long history of loving management and my beloved duck prancing around the Qwest center. I have this recurring nightmare where you bring Lou Simpson back to invest Aflac’s float. Don’t worry, I’m in therapy.

    Lastly, and I don’t mean to hurt your feelings, but I presume you are jealous of Aflac and the unfair advantage they enjoy. That’s right, I said it. Jealous.

    After all, they, the write cancer and supplemental health in the country of the healthiest people on earth, and suffer no “social inflation”, since Japan also has the lowest fraud rate on the planet and litigates nothing. Let’s admit it. It gets to you that Aflac has the number one brand in a brand- obsessed country and is able to price and sell insurance as a ‘brand item’ instead of a commodity, and that Aflac is the largest insurer by policies issued in that nation.

    It would be natural for you to resent their habit of buying back shares during 14 of the last 17 years, or hiking the dividend 28 years in a row…a dividend I know you are itching to eliminate, I can just feel it. I know you want that all-bond portfolio, too, having no real estate or equities in it whatsoever, total virgin funds for investment. Oh, I can’t go on.

    Still, I shiver that you would like earning money in yen and counting it in dollars, as the one rises while the other falls, in political predestination. You may get a childish delight out of policies which put all inflation risk on the holders through lump sum payments, while mild deflation lowers your own wages, rentals and other operating costs. For shame.

    You might cast a jealous eye upon Aflac’s grandfathered and cozy relationship with regulators in Japan, who are not likely to change much, considering the annual collapse of the Japanese cabinet and 'twisted' diet. And I am not sure you could be relied upon to act gentlemanly when realizing that Aflac Japan has only one set of insurance regulators to worry about, instead of 50 in the U.S.

    I therefore need to hide from you entirely the fact that Aflac stands to gain policy holders in waves as Japan's indebted government trims coverage under its National Health Insurance. To further dissuade you from buying Aflac, I would want you to ignore the fact that Aflac has evolved one of the most highly recognized trademarks in Japan, the so-called maneki-neko duck, or that its commercials have long been and remain number one in that country.

    Now I can trust most people to be perfectly generous and obliging when it comes to stocks. Take for example this year, when they sold Aflac to me at 20% off during a cancer scare…even though Aflac sells more cancer insurance during and after cancer scares. And again, selling me more at nearly 50% off when Aflac’s bond portfolio was suspected of containing European-style salad-oil. But I can’t trust you. No sir.

    Therefore, I will resort to positive dissuasion. I’ll insinuate that Aflac’s pricing and reserving could be real risks…and try to unhinge you with flashbacks of ‘70’s GEICO days. But then again, you would probably point out that Aflac operates in a short-tail environment with little re-insurance, which makes it far more likely that the company is pricing its policies right and reserving adequately. I will also spook you with predictions of yen hyperinflation and Japan Government Bond selloffs, in hopes that you forget how easy it is to hedge these things.

    Lastly, and I know it isn’t gentlemanly; I am forced to beg. You see, if I can’t strike it rich with Aflac I may be forced to enroll myself in…god help me…fractional ownership through NetJets. So I am counting on you to do the right thing.

    Very truly yours,


    Louis the Swan
    Apr 23, 2013. 06:48 PM | 11 Likes Like |Link to Comment
  • The Road To Omaha: Sighting The Duck As An Elephant [View article]
    AbeNomics....GULP!

    As wonderful as are Aflac's underwriting business and competitive moat, Buffett is no longer likely to buy the company at present, since it would entail the purchase of over $30 billion of Japan Government Bonds (JGB's) and other Japanese corporate bonds, which are mortally endangered by the new Bank of Japan and Ministry of Finance programs to inflate the economy and yen, known loosely as Abe-nomics, in honor of Shinzo Abe, the new Prime Minister.

    In the past, Warren has only bought into large insurance businesses when he was satisfied with the investment portfolio integrity or when, like with GEICO, he was able to buy up the franchise without paying full price for the investment portfolio.

    Timing is Everything...

    A yen/JGB crash will decimate Aflac's shares and its portfolio, after which Aflac's franchise would be available for a song, or a 'quack' so to speak. Berkshire could then make the acquisition, recapitalize the business and ride the duck all the way back to health.

    Cost is No Object...

    Berkshire would only buy 80% of Aflac, if it were to purchase the company, both because that triggers the most advantageous tax treatment of subsequent earnings and distributions, and because the Amos family's 20% stake would need to be preserved. Dan and Chris (Amos and Kloninger) would remain at the helm, of course... This kind of money is well within Berkshire's budget at the moment, so cost would not be the barrier to a BRK-AFL deal.

    Tomorrow Never Knows...

    OK, so AFL reports tomorrow, and again we will see higher sales, a tightening of margins, rising new money yields, and a twist out of JGB's in favor of hedged U.S. muni bonds, (god bless you, Eric Kirsch). But we will not see a company in trouble, or one which needs to pick up the phone and call Omaha...unless the Amos family wants out, and that would rob Aflac of so much value...

    (long AFL, BRKA)
    Apr 23, 2013. 06:36 PM | 1 Like Like |Link to Comment
  • IBM: Too High To Buy? [View article]
    IBM's moat IS "Big Data"...

    ...and this moat is nowhere near priced into the shares.

    IBM isn't just the leader in big data solutions...it is the leading USER of them, and that allows it to kill competition, ensnare customers, patent-up its positions, sniff out high-margin new businesses easily and exit from sunset operations timely. The huge irony, which hits like a ton of bricks when one notices it, is that Big data is itself IBM's competitive advantage, not just one of its main products. It uses big data to sell big data, exploit and dominate markets.

    Brother, Can I Lend You A Dime?

    A perfect example is IBM's financing division. This department knows more about its borrowers than any bank on the planet knows about theirs. Why? IBM has the big data on these firms' operations. How? IBM usually created their big data gathering and processing infrastructure. So IBM often knows as much about the company as that company knows about itself. And IBM possibly knows even more about their customers' industry, since IBM has the big data on other companies in that industry too. This means IBM can offer better financing rates, which translates into low-cost leadership and fewer non-performing accounts. IBM has, as a result, some of the best receivables in the business.

    Talk to the patent, buddy.

    IBM uses big data to patent off and protect its positions in big data. Its legendary 20 year record for most patent awards is not just an honor. It is a competitive shield against thousands of potential avenues of competition, and the thrust of patent activities are guided by IBM's superior knowledge of what might best advance its interests or gum up those of its competitors...knowledge gained from, you guessed it, big data.

    Knowledge is Power.

    IBM is in a unique position, to know the 'mostest the soonest' about its own markets, customers and competitors, by using and exploiting its own mastery of big data systems. It is hard to have a better competitive moat than that...

    Yours for a p/e of around 14. Unbelievable. Thank you investment gods.

    (Long IBM)
    Apr 6, 2013. 07:32 PM | 1 Like Like |Link to Comment
  • Warren Buffett Violates His 'Ham Sandwich' Principle With Goldman Deal [View article]
    Find Businesses That Don't Need To Reinvent Themselves.

    Buffett hunts firms that will do the same thing in 20 years as now. Coke will still make cola syrup. Burlington will still move freight. Heinz will still sell ketchup, IBM will still do tech services, P&G will still sell razors and soaps. And Goldman Sachs will still do investment banking and stockbroking.

    This is all Buffett means by the ham-sandwich quote. Avoid 'hard businesses', which need to be right every year or few years. Fashion is a hard business. Specialty retailers need to be on their game each and every season, and 'get it right' every time. Consumer electronics firms need to invent new products every few years or face extinction. But Colgate Palmolive will be doing toothpaste for an investing lifetime.

    This differentiates Buffett from FIsher, who looked for strong innovation potential companies in his famous Common Stocks and Uncommon Profits.
    Mar 27, 2013. 01:58 PM | 1 Like Like |Link to Comment
  • McDonald's, I'm Not Lovin' Its Zero U.S. Sales Growth [View article]
    MCD has an ideal crisis going on...which makes it an ideal investment. This is very rare and extremely valuable situation.

    As legendary investor John Templeton stressed, outperforming the market requires buying not what everyone else is buying but, crucially, what they are avoiding, which means you must essentially go looking for trouble...You must find companies beset by problems which have repulsed investors but do not really harm the company over the long haul. This is a 'perfect problem', and the more you can find, the wealthier you will become.

    So what is an ideal problem? One which suggests a stock might stagnate for a year and a half. This kind of problem does little real harm but still drives out speculators and institutional investors, people who absolutely need to show quarterly or annual profits (about 80% of Wall Street) ...

    McDonald's has perfect problem, from an investment point of view, one that does gentle harm to the company over an 18 month period of time and then evaporates. Europe will not always be in recession. but over the next 18 months..probably. New store openings will not always be inconsequential to growth, but over the next year or so they may be. And comps will not always be flat, but coming off a string of comp growth, those old record comps will be tough to beat.

    Moments like this are not to be missed. McDonald's is solid and its inevitable long term success is, compared to most companies, beyond question. Growth is easy for MCD, remember that there are still more McDonald's in Ohio than India, none in Vietnam, and the first went into Africa as recently as 1992. Surprisingly, most of the global quick-serve market is still relatively untapped by MCD. So when an 18 month-er hits and drives down the price, that's an ideal problem and an ideal opportunity.

    You must go looking for trouble if you want to outperform--the prefect kind of trouble. Here it is. Would you like fries with that?

    (Long MCD)
    Mar 27, 2013. 12:47 PM | 1 Like Like |Link to Comment
  • McDonald's: Today's Price Will Look Cheap 5 Years From Now [View article]
    MCD: You Deserve A Break (from Inflation) Today!

    Future Inflation Makes McDonald's an EVEN Better Investment...

    Allow me to add to your wonderful article. For those of us worried about inflation, McDonald’s wonderfully beats inflation in three fundamental ways. First, as you mention, over 80% of McDonald’s 34,000 locations are franchise units from which McDonald’s takes a royalty on gross sales. Hence, rises in the price level, if successfully passed on to consumers, boost MCD’s royalties in tandem with inflation. To the extent price level increases cannot be passed on to consumers, they reduce the profits of the franchisee but do not reduce McDonald’s sales royalties. In essence, the franchisees bear the risks of inflation. Second, inflation impacts less economical, more capital intensive restaurants far more than it does McDonald’s, which operates at a very high efficiency rate, as witnessed by their 20% net profit margin and 23% return on assets. Finally, in most countries McDonald’s owns the underlying land and building, which is a strong defense against inflation, particularly since real estate itself is part of the basic calculation involved in the definition of consumer price inflation. Thus, McDonald’s earns income from the inflation protected gross sales of franchisees and enjoys capital appreciation from the inflation protected real estate. This gives them a basic immunity to much of the damage generally caused by inflation. In addition, McDonald’s has no receivables, as it collects payment at the point of sale (Receivables are damaged by inflation as payments are received later in weaker dollars.) Then there is the debt on McDonald’s balance sheet. 45% of the capital structure is debt, with more than half due after five years. Inflation whittles down the burden of interest payments on this debt. Moreover, the debt is presently held at historically low rates and can be employed to grow the company at approximately the 23% return on asset rate.

    Turning to growth, we must acknowledge that growth is another element of a good inflation hedge. Most presume wrongly that McDonald’s has already saturated the global market and has little room to grow. In truth, they have hardly scratched the surface. Last year, there were still more McDonald’s in Ohio than India, for example. MCD’s first store in Africa was not built until 1992, in Casablanca. In many ways, they are still in the early stages of international growth. Additionally, McDonald’s management has self-consciously tried to grow more slowly than in decades past in order to focus on same-store economics. Growth is therefore available to the company whenever it chooses, and in amounts large enough to be meaningful even to a behemoth like the golden arches. Plus, its format has been proven successful in most countries and cultures. Other generally attractive things about McDonald’s include:
    • China is a big opportunity, but failure there involves little downside
    • They can raise capital in four continents if necessary. Liquidity is not a problem.
    • McDonald’s survived the high inflation of the early ‘80s and grew throughout the time.
    • MCD has thrived against endless competition over the years.
    • 50% of revenues are foreign, making it less vulnerable to U.S. inflation.
    • MCD has a lock on the best potential franchisee pool of any operation.
    • MCD has better incentivized mid-managers than most firms…as franchisees, their lives depend on profit and hard work.
    • Wars and other catastrophes do not present fatal risks to McDonald’s.
    • MCD owns some of the most desirable commercial property on the planet.
    • Real estate holdings permit MCD to borrow more easily than most businesses.
    • Foreign market penetration is easier for MCD than most companies, as the franchise model gives them powerful local partners and minimizes capital outlays, while the brand power gives them a decisive advantage over franchised rivals.
    • MCD can move easily into capital-starved markets, where loans are nil, as it can serve as the lender in many respects if it chooses.
    • MCD could spin off its real estate into a REIT someday, although I don’t expect it.
    • Warren Buffett loved the company back when its economics were poorer they are today and badly regretted selling his stake, according to his shareholder letter.
    • MCD has a 3% dividend yield, which gives us cash flow and wards off short-sellers.
    • MCD has repurchased nearly 30% of its float over the past 16 years, nearly 2% per year.
    • Economic downturns boost McDonald’s customer flow. It is a good defensive play.
    • MCD has a return on equity of 40%, making it a real compounding machine.

    Warren Buffett eventually learned to 'pay up for great companies'. As the above author points out, MCD's share price today will look very cheap in the future, and especially so if inflation takes off!

    (Long MCD, of course.)
    Feb 19, 2013. 02:33 PM | 4 Likes Like |Link to Comment
  • Helen Of Troy Is Trading At Bargain Basement Levels [View article]
    HELE: A Best-In-Breed Now at Historic Low Price

    Excellent article. Let me add some operating details to underscore this wonderful company's moat and its durable profit-making power. First, take its management. Gerald Rubin runs this company as a true founder/owner, a man who understands thoroughly every inch of the business he has built. The importance of this cannot be overestimated, and it shows up in the company's statistics, as I will get to below. But first, the business moat.

    Oddly, Helen of Troy is most profitably understood as a best-in-breed wholesaler, not as a manufacturer; it owns no factories and uses whatever Asian makers suit its needs. Hele can thereby move production quickly to capitalize on labor, currency, transport and political conditions, unlike most manufacturers. Therefore, instead of considering Hele a true manufacturer, they are more akin to a wholesaler. This means they spend little on cap-ex (typically only 10% of cash flow).

    Now for the best-in-breed part...wholesalers typically make thin margins, say 3-5% on high volumes. Hele makes a fat margin, around 8-10%, much like a manufacturer's profit, but as explained, without the inflexibility and sunk costs of a factory. It is fab-less as they say in the semiconductor world. Hele can make this by licensing and adding brand names like Revlon and Vidal Sassoon to the Asian-made items. In this way, HELE substantially free-rides on the enormous marketing budgets of these giants, saving itself the costs of brand advertising. Additionally, Hele sells to chain stores, who advertise on Hele's behalf as well. So Hele has picked out the juiciest, most profitable way to bring these goods to market. It avoids most of the risks and costs of both manufacturing and advertising. Wonderful.

    Killing the Competition

    Hele's power can be seen in its 10 year earnings growth rate of 12% per year, accomplished without excessive debt or dilution...available to you now on a 30% pullback, at a p/e of only 9! A hidden advantage can also be seen in its main competitor's time-bomb balance sheet...Jarden...17 years of earnings worth of debt. Someday interest rates will climb and Jarden will sink under its debt load, leaving Hele a wide open market. But there are many other things to like about Hele...such as...

    -Chances women stop styling their hair = Zero (0)
    -It is immune to dividend tax hikes under Obama 2.0.
    -Its selling near book value
    -No pension plan
    -No preferred ahead of the common
    -Capitalizing on green trend via Pur acquisition
    -It can coat-tail Wal-Mart's growth...it goes where they go
    -Chains prefer buying from Hele since discounts and one-stop shopping make Hele a more economical vendor for them than new entrants or smaller rivals
    -Respectable 14% return on equity
    -Sells via Amazon, so no competitive threat there
    -Housing recovery play to some extent, esp. the Kaz acquisition
    -highly predictable earnings stream (Valueline ranks it 80%)
    -Zero dividend policy makes sense, considering ROA/ROE & growth
    -Balance Sheet debt is manageable and will benefit from future inflation
    -Efficiencies of scale from Kaz and Pur acquisitions
    -Infusium acquisition copycats Unilever's successful shift towards hair/beauty care.
    -Cheap debt conditions & good cash flow make its growth-via-acquisition strategy very timely and profitable
    -U.S. economy turnaround play...77%of sales are U.S.A.
    -Hele perfected free-riding P&G's Sassoon spending for years, its now a core competency
    -Good play on free trade and TPP talks...import tariff reductions can be part captured by Hele.

    So, Helen of Troy is a favorite value play at the moment. They do a lot of warehousing, and increase profits by capturing I.P. and manufacturing margins without taking the related risks of either. Wonderful business, wonderful management. Wonderful world.
    Nov 30, 2012. 06:41 PM | Likes Like |Link to Comment
  • For-Profit Education: 3 Longs And 2 Shorts [View article]
    Strayer 40% more attractive than last week...

    Nobody enjoys the kind of kidney punch like Strayer took on Friday. Especially investors like me with a huge loss on the books. It calls for real soul-searching. Is the market right?

    First, what happened: Management lost students, killed the dividend and nixed all new campuses. On the surface, it looks horrendous. A deeper analysis begs the opposite conclusion.

    Management admitted it killed the dividend because of the election. This is a very prudent and accretive move. Why throw away money via higher taxes when it can instead be used to buy back shares tax free? This alone boosts shareholder value by the amount of taxes saved, the so-called "tax leakage". It is important to note that the decision was tax-driven, rather than the result of constrained cash-flow. Now, these funds will pile up in the company's retained earnings account, pushing up the book value year after year until deployed in share buybacks.

    Double-Whammy Value Creation

    Transforming the dividend into share buybacks gives an instant 20% effective hike in the value of our nominal dividend amount, given that we were going to simply re-invest the dividend anyway. But what is the effect when the dividend cut drives the stock price down 20% also? Yes, that's right. Effectively it is a 40% increase in the value of the erstwhile dividend, since we save 20% in tax and get a 20% discount on the shares repurchased hereafter at the new lower price.

    Now how foolish does management look? They look pretty darn good. They knew the shares would plummet and permit them to buyback at a deep discount. That's my kind of management. They just boosted my shares' intrinsic value drastically.

    Next, a halt to new campuses. Management grounded this decision upon fiscal cliff uncertainty. Again, I applaud them. This piles up even more cash in the coffers while we await a better time for growth. There isn't much student growth at the moment, why on earth build campuses just now? Any other decision would have been alarming. This decision is right on the money. Thanks, Strayer, for pushing up our book value per share even more.

    Then there is the student shrinkage. How did management react? By reminding that student populations naturally grow and shrink from time to time, as they did in 1907, 1931, 1942, 1973, etc. etc. Growth at all times and at apparently all costs is what analysts were demanding. Thank goodness Strayer's management is not willing to comply with such nonsense.

    The Growing Warchest

    The only question is what Strayer will do with all this cash piling up? I like high-quality problems like this when a high quality management is making the decision. An acquisition at this time would be most opportune. ESI is presently selling at a p/e of around one and a half, cash-adjusted. Lets say that again, p/e 1.5. Or Strayer can simply acquire Strayer, a business management is familiar with.

    STRA management Brilliance on Display.

    Now, Strayer is not only recognized as best-in-breed by Congress, but its management has shown real guts. One has to sit back in awe with respect for this team, willing to do something totally unpopular and nevertheless entirely correct. The idiocy of Wall Street is on full display selling off Strayer, and the wonder of value investing is shining in plain view.

    Disclosure: Will be buying lots of STRA next week, of course.
    Nov 10, 2012. 04:02 PM | Likes Like |Link to Comment
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