Mcwillifloor

Long only, deep value, value, growth at reasonable price
Mcwillifloor
Long only, deep value, value, growth at reasonable price
Contributor since: 2014
You da man Erik! From mike Williams in Denver. Ganbatte yo!
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...
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?
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.
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!
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...
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.
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.
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
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)
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)
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.
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)
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.)
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.
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.
Solid Job, Excellent Analysis...I completely concur. Allow me to post my lengthy reasons in support.
Western Union Is Deeply Undervalued and its Business Healthy

Shares of Western Union (WU) are presently offering investors an earnings yield of over 16% on the share price and a dividend of nearly 4%, after shares fell nearly a third following the recent disappointing earnings call and chorus of downgrades. The major headlines appeared scary enough; 40% of the company's Mexican agent locations were shuttered over compliance issues, and new discounting programs were needed to head off mounting competition. Ironically, neither is bad news for Western Union.
Both developments underscore rather Western Union's extreme dominance of the industry and the undiminished power of its long term earnings moat. The Mexican agent loss is at heart a retrofit designed to comply with new CFPB regulations which grossly favor Western Union over its competitors. The discounting is the inevitable method used by all low-cost leaders to scrub away periodic buildups of inefficient competition. Let's consider these items separately in light of WU's unmatched operating margins.
The Low-Cost Provider...It's Good to be the King
First, Western Union has a wide moat: it is essentially the low cost leader in what can be considered a commodity business, even though management often refers to itself as a premium provider. Sending small sums to recipients who require cash on the other end is a business which requires huge scale, and WU has far greater scale than others. Its scale enables WU to enjoy operating margins double those of its nearest competitor, quadruple those of its next nearest. This means that WU can always discount its competitors into oblivion when advantageous. It may charge more, but it doesn't have to. It also means that any industry-wide increase in fixed costs damages competitors and favors WU, as such costs eat into slimmer profit margins across the industry. The Consumer Financial Protection Bureau (CFPB) regulated WU's industry in February, imposing new compliance obligations and costs on everyone, a competitive victory for Western Union and a death sentence for the micro players in the industry and hapless newcomers.
Montezuma's Revenge, Western Union Style.
Now, Western Union must rebuild its Mexican agent base to comply and take advantage of the new CFPB regulations. How hard is this for WU? Quite easy, actually. Building agent networks is a core competency for Western Union and poses no problem. Mexico is very familiar territory to boot, where the brand is powerful enough to permit rapid reestablishment of the entire agent system. Competitors will have a much harder time however, meeting essentially the same burden. Western Union's Mexican refit demonstrates a Western Union regulatory triumph over competitors. Analysts have factored this in as a permanent loss of earnings power. Nothing could be further from the truth.
Discounting: The Nuclear Option.
Next, the overblown fear of discounting. Analysts worry that Western Union's discounting diminishes profitability. Over the short run this is correct, but no sane businessperson would want to be WU's competitor under such circumstances. Nobody can win a price war against Western Union; hence, any company which invests assets in a country-pair or money-transfer 'corridor' Western Union desires to dominate can be wiped out, at WU's discretion. This tried-and-true strategy, one which the company has employed many times throughout its colorful history, is virtually certain to succeed, after which the coast will be clear for resumed margin expansion and higher profits. It is a fine business plan for an international low-cost leader: milk high margins until competitors crop up, discount them out of business, then raise prices again, wash, rinse, repeat. Unless antitrust authorities intercede in a coordinated international manner, it works eternally, and Western Union's management is wise to deploy this strategy.
Long Term Forecast is Bright
Finally, there is the future. Western Union stands to make vastly greater profits when the U.S. labor and housing markets turn around, as construction jobs and other entry level employment attracts migrant labor and generates higher and higher paycheck repatriation and money transfer business. Moreover, global total use of cash has increased in every major economic zone for decades and will likely increase far into the future, even as use of credit increases. So long as both increase, WU has generates more business. Digital competition may make marginal inroads, but if somebody wants cash at the other end, this business requires ever increasing compliance and global scale, where Western Union cannot be beaten or challenged.
Lame Duck Competitors
Western Union's largest competitor, Moneygram International (MGI) nicely demonstrates WU's advantages. Setting aside the fact that MGI nearly put itself out of business during the financial crisis, they must contend with a competitor who can out-price them every day if desired, and they must ward off regulators who are intent upon eating into their already endangered profit margins, or in MGI's usual case, slim or negative profit margins. Every WU discount and every new regulation pushes MGI farther against the wall. MGI investors should carefully consider why they would want to be in such a business.
Other Happy Thoughts
Western Union has authorization now to repurchase up to 9% of its outstanding shares. As it has repurchased shares in each of the last seven years, odds are that the new 30% discount will generate serious buyback activity, making these shares even more valuable as time goes on. Meanwhile, the new 4% dividend in today's rate-starved environment puts a significant floor under WU's share prices.
Distant Inflation is No Worry for WU
For those worried about inflation, Western Union stands to gain from inflation, in fact, quite a bit. Inflation will immediately benefit WU by diminishing the real weight of WU's significant but manageable balance sheet debt, while eventually raising the general level of wages, which is a primary determinant of WU's cash transfer business volume. Since WU is paid by volume, WU revenues rise along with price inflation without any increase in capital spending, receivables, or any other metric. It is hard to find businesses more inflation-resistant than WU.
To summarize, Western Union is a wide-moat business using its moat to good effect. The company will almost certainly be doing far more business in 5 to 10 years as the world economy rebounds, and Mr. Market has handed savvy investors a significant opportunity to own shares in this great company at a very good price.
Disclosure: I am long WU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am adding to this position.
(permit me to add to your excellent article...)
Yes; Western Union Deeply Undervalued; Business Healthy

Shares of Western Union (WU) are presently offering investors an earnings yield of over 16% on the share price and a dividend of nearly 4%, after shares fell nearly a third following the recent disappointing earnings call and chorus of downgrades. The major headlines appeared scary enough; 40% of the company's Mexican agent locations were shuttered over compliance issues, and new discounting programs were needed to head off mounting competition. Ironically, neither is bad news for Western Union.
Both developments underscore rather Western Union's extreme dominance of the industry and the undiminished power of its long term earnings moat. The Mexican agent loss is at heart a retrofit designed to comply with new CFPB regulations which grossly favor Western Union over its competitors. The discounting is the inevitable method used by all low-cost leaders to scrub away periodic buildups of inefficient competition. Let's consider these items separately in light of WU's unmatched operating margins.
The Low-Cost Provider...It's Good to be the King
First, Western Union has a wide moat: it is essentially the low cost leader in what can be considered a commodity business, even though management often refers to itself as a premium provider. Sending small sums to recipients who require cash on the other end is a business which requires huge scale, and WU has far greater scale than others. Its scale enables WU to enjoy operating margins double those of its nearest competitor, quadruple those of its next nearest. This means that WU can always discount its competitors into oblivion when advantageous. It may charge more, but it doesn't have to. It also means that any industry-wide increase in fixed costs damages competitors and favors WU, as such costs eat into slimmer profit margins across the industry. The Consumer Financial Protection Bureau (CFPB) regulated WU's industry in February, imposing new compliance obligations and costs on everyone, a competitive victory for Western Union and a death sentence for the micro players in the industry and hapless newcomers.
Montezuma's Revenge, Western Union Style.
Now, Western Union must rebuild its Mexican agent base to comply and take advantage of the new CFPB regulations. How hard is this for WU? Quite easy, actually. Building agent networks is a core competency for Western Union and poses no problem. Mexico is very familiar territory to boot, where the brand is powerful enough to permit rapid reestablishment of the entire agent system. Competitors will have a much harder time however, meeting essentially the same burden. Western Union's Mexican refit demonstrates a Western Union regulatory triumph over competitors. Analysts have factored this in as a permanent loss of earnings power. Nothing could be further from the truth.
Discounting: The Nuclear Option.
Next, the overblown fear of discounting. Analysts worry that Western Union's discounting diminishes profitability. Over the short run this is correct, but no sane businessperson would want to be WU's competitor under such circumstances. Nobody can win a price war against Western Union; hence, any company which invests assets in a country-pair or money-transfer 'corridor' Western Union desires to dominate can be wiped out, at WU's discretion. This tried-and-true strategy, one which the company has employed many times throughout its colorful history, is virtually certain to succeed, after which the coast will be clear for resumed margin expansion and higher profits. It is a fine business plan for an international low-cost leader: milk high margins until competitors crop up, discount them out of business, then raise prices again, wash, rinse, repeat. Unless antitrust authorities intercede in a coordinated international manner, it works eternally, and Western Union's management is wise to deploy this strategy.
Long Term Forecast is Bright
Finally, there is the future. Western Union stands to make vastly greater profits when the U.S. labor and housing markets turn around, as construction jobs and other entry level employment attracts migrant labor and generates higher and higher paycheck repatriation and money transfer business. Moreover, global total use of cash has increased in every major economic zone for decades and will likely increase far into the future, even as use of credit increases. So long as both increase, WU has generates more business. Digital competition may make marginal inroads, but if somebody wants cash at the other end, this business requires ever increasing compliance and global scale, where Western Union cannot be beaten or challenged.
Lame Duck Competitors
Western Union's largest competitor, Moneygram International (MGI) nicely demonstrates WU's advantages. Setting aside the fact that MGI nearly put itself out of business during the financial crisis, they must contend with a competitor who can out-price them every day if desired, and they must ward off regulators who are intent upon eating into their already endangered profit margins, or in MGI's usual case, slim or negative profit margins. Every WU discount and every new regulation pushes MGI farther against the wall. MGI investors should carefully consider why they would want to be in such a business.
Other Happy Thoughts
Western Union has authorization now to repurchase up to 9% of its outstanding shares. As it has repurchased shares in each of the last seven years, odds are that the new 30% discount will generate serious buyback activity, making these shares even more valuable as time goes on. Meanwhile, the new 4% dividend in today's rate-starved environment puts a significant floor under WU's share prices.
Distant Inflation is No Worry for WU
For those worried about inflation, Western Union stands to gain from inflation, in fact, quite a bit. Inflation will immediately benefit WU by diminishing the real weight of WU's significant but manageable balance sheet debt, while eventually raising the general level of wages, which is a primary determinant of WU's cash transfer business volume. Since WU is paid by volume, WU revenues rise along with price inflation without any increase in capital spending, receivables, or any other metric. It is hard to find businesses more inflation-resistant than WU.
To summarize, Western Union is a wide-moat business using its moat to good effect. The company will almost certainly be doing far more business in 5 to 10 years as the world economy rebounds, and Mr. Market has handed savvy investors a significant opportunity to own shares in this great company at a very good price.
Disclosure: I am long WU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am adding to this position.
Tempur's Present Sell-off is Truly Unwarranted...
Its Growing Its Business Just Right. Consider from the conference call:
--TPX's two new models are so popular they are now unexpectedly back-ordered;
--International is growing well, even Europe, Japan and Korea;
--It grew its 'slots' of store display beds, gaining 'shelf-space';
--It gained sales locations & boosted their sales incentives, too;
--U.S. pillow sales are up, a significant and important domestic fact;
--Its margins will improve from Sealy efficiencies, including raw materials, transport and R&D gains;
--Sealy lets TPX now compete in every segment of the market
--TPX can now deploy its cost-advantaged vertical integration in all the lower-priced sub-markets of mattresses.
And now, ta-da! new home sales results are posting big gains today. TPX is the housing recovery play par excellence, now 25% cheaper, just in time for us to back up the truck. Thank you, investing gods.
As for management, well done. New competition? Bang, introduce new products and discount old ones. Blow 'em out at the top end of the market, buy them out on the bottom end. Use better margin and cost efficiency to crush them, just in time for the big housing recovery. Tempur will be printing profits in five to ten years, when it is the market leader and low-cost producer in every segment of this market. Tempur management, I love you.
(Disclosure: big TPX buyer today.)
Why Sell The Best-In-Breed?
Sure, its a bad quarter, but Tempurpedic will be setting outlandish profit records five and ten years from now. With its recent acquisition of Sealy, Tempurpedic has all but cornered the mattress market and has low-cost leadership at virtually every price point. All an investor needs to do is wait for the housing recovery.
Er...What Housing Recovery?
Yes, its here folks. Not only are housing prices rising every month now, but just today, Freddie Mac confirmed that residential real estate investment is now a net plus to GDP, for the first time since the crash, and that QE is working very strongly. Big news, along with recent declines in inventories of housing for sale, and huge increases in new housing starts. Most tellingly, MMM reported in its earnings today that its residential HVAC unit displayed exciting growth. That's right, I said residential HVAC. Add to this the fact that the Fed has promised to fire-hose money at real estate until employment picks up, and presto--a reliable unavoidable housing boom in the works. Its here. Now.
Tempurpedic is the housing recovery play par-excellence, and it is deliciously under priced, right now, on the cusp of a housing boom. Like the prom queen with no date, inexplicable but true. Its getting harder to find cheap housing plays these days, so thank Wall St. for its habit of selling off best in breed companies on the eve of boom times.
(Disclosure: Bought TPX today, will back up the truck tomorrow)
Aflac's Quarter Was Even Better...
-Float increased over 6%
-Underwriting profits remained strong at 5.5%
-Share buyback announced equaling half of 1% of share count
-Minimal portfolio impairments (finally)
-RBC ratio up nearly 10% to 590% (Kirsch team doing great)
-Investment returns improved and diversified away from yen
-Return on Equity now at 25% operating basis
What a wonderful company. As for the moat, it strengthened too..persistency improved during quarter, and debt funding costs relative to peers improved as well. It doesn't get much better than this, folks.
Is WU Inflation Protected?...Check!
WU is ideally suited to survive and prosper when inflation picks up, and this attribute is certainly not priced into the shares at the moment. Let's consider the various perils of inflation against WU's business.
A pickup in inflation harms companies with high levels of receivables, as these lose value the later they arrive. Luckily, WU's business format permits almost no receivables. Inflation protected? Check!
Inflation also hurts high capex businesses which must sink old money into ever pricier plant and equipment. But WU has extraordinarily light capital requirements. Inflation protected? Check!
Inflation pushes up wage levels. WU has low labor costs, but its core business, sending wages as cash around the world, rises on a one-for-one basis with wage inflation wherever it happens. Inflation protected? Check check check!
Inflation hurts creditor companies, like banks, which lend money and receive weaker money payments in future years. But, as John Burr Williams points out, indebted company shares can rise immediately on the fear of inflation, in addition to the boost they get later as general price levels actually rise, since their debt load can be eased by the onset of inflation. If the debt is fixed and has some years to maturity, and if it is not too cumbersome to refinance at higher rates when it does mature, inflation gives such a company a measure of free money. Western Union is in that position. Inflation protected? Check.
To the extent inflation is the product of an overheated economy, this too helps WU as it would signal an increase in migrant labor wishing to send money back home.
Inflation...What Me, Worry?
The Fed has for the first time in history targeted unemployment rates, a significantly lagging indicator, which will keep money easy long after an actual economic turnaround has set in, sparking significant inflation. Banks are repairing balance sheets and will not respond quickly to increased interest rates. They will likely keep lending in spite of the first few rounds of Fed tightening when it belatedly comes. Then the Eurodollar market will kick in and keep money easy even as our banks tighten up, since those markets are now bigger and deeper than ever, as well as less regulated. For those who think Bernanke will tighten up in time, reflect upon the fact that the Fed has put its prestige on the line and cannot tighten up until employment really picks up. Also note that Mr. Bernanke's personal legacy is now on the line too.
Feel like searching out inflation hedges? Me too!
(long WU, longer today)
Why QE3 is MASSIVELY Inflationary:
Targeting U6, a lagging statistic, is the most inflationary move in U.S. Federal Reserve history. Unlimited printing money until U6 falls low and stays there means letting the presses run and credit expand far into a major expansion, well beyond the point where the Fed has always taken away the punch bowl. It will be devilishly hard to reverse in the latter stages. Inflation will be very much out of control at that time. The hunt for inflation shelters will now begin in earnest among the early movers. Real estate, collectibles, commodities, oil, high ROA low capex consumer-monopoly businesses. Sitting in cash will become a wipeout.
A Moving Target
The Fed is targeting U6, an inscrutable statistic affected by immigration trends, fiscal policy, regulatory changes, technology movements, productivity changes, etc. The Fed will have a tough time figuring out its own effectiveness, much as it did when it attempted to target monetary aggregates during Volcker's early years. It will therefore almost certainly overshoot and keep the presses running too long, generating very high inflation.
The Inevitable Eurodollar Flood: Fatal
When the Fed belatedly tightens, Eurodollars, in record amounts now, throughout Asian and India in unprecedented hoards, will flood into the U.S. economy in response to the higher rate regime, offsetting the Fed's attempt to constrain credit and squash inflation, leaving the banks chock full of funds to lend. The already out of control Inflation will carry on. The higher rate environment will also not reduce lending as much as the Fed hopes, as loan demand will be compounding along with the rising rates, as firms are forced to borrow more to sustain their bloated balance sheets and animal spirits run rampant in an attempt to borrow big and inflate away the real debt obligation over time.
Redux 1981.
U6 is a dreadful thing to target and will destroy perhaps half the value of the dollar in real terms within a decade, if the late 1970's are any guide. There is no question that qE3 will work, in this respect. So yes, it will drive people into inflation shelters. Real estate, Art, collectibles, metals, commodities, oil.
Will QE3 push up real estate prices? Sure. Will it push up stocks? You bet. Will it frighten people out of cash? You're damn right. Will the long end of the curve go up? Just watch.
DTV is Hostage To Significant Risks
DTV shows why Ted and Tod are not in Buffett's league. This company has to get many things right every year in order to make money. Usually it does. But this good-looking business must deal with a tremendous number of risks such as:
Regulatory Risks, not only those of the FTC, but Consumer Protection Agencies governing the marketing side of the business. Satellite broadcast licenses can be whimsically yanked, especially by foreign regimes. Transponder licenses are vulnerable too. Direct marketing and telemarketing rules and regs are in constant flux, and a new consumer protection agency may be even more aggressive than the state regulators. Foreign regimes interested in content regulation...
Franchise Risks, since local governments can force Cable operators to lower rates on a whim, impacting DTV's rate competitiveness, DTV is indirectly facing a significant risk from CATV franchises.
Technology Risks. There are many here, but lets mention risk of orbital equipment failure, even with the in-orbit spares, local uplink vulnerabilities, eclipse by competing content delivery systems, etc.
Political & Social Risks in South America, where for instance, Argentina's femme fatale may nationalize something which triggers an economic crisis throughout South America and diminishes the consumer market, or inflates away the value of the subscription fees, imposing hedging costs or outright margin shrinkage.
Competitive Risks...Charlie Ergen is still out there, and so is Comcast etc.
Financial Risk...DTV has a significant need to refinance its debt on an ongoing basis, and its debt load is alarmingly high with respect to earnings. A disruption here could be fatal. Buffett has long said don't borrow amounts you can't repay tomorrow morning if necessary...guess Ted and Todd don't quite agree with him on that one...
Inflation Risk...DTV is a highly capital intensive business, having to sink essentially half of all its earnings into new capital investment each year. Ted and Todd seem undeterred by this, but Buffett remembers when this kind of requirement bled certain businesses of profits in the 1978-1982 period of high inflation. DTV's content purchases are inflationary and subject to unionized labor and personality risk, too. Deflation may be a big risk as well, as the debt load would be drastically heavy in the event of a major deflation...DTV needs a Goldilox price environment, not to inflationary, not too deflationary. Does this sound like Argentina to anybody out there? Does it sound compatible with QE Infinity?
Military Risk...This will sound far fetched, but the first significant war of the 21st century will almost certainly feature magnetic signal disruption, along with widespread destruction of satellites among the belligerents, and probably neutral orbital assets will be targeted, much as the U-boats targeted neutral shipping in the 20th century. This can be insured against, of course, but considering merely the inflationary tendency of large scale warfare, if not the loss experiences, the insurance companies themselves may not be in a great position to pay.
Content Risks. DTV can be starved of relevant content depending on shifts occurring on either side of its transmission infrastructure. Audiences may change tastes in a manner DTV is not well suited to accommodate immediately, or it may have difficulty dealing with the content providers, especially if rivals get hold of content in an anti-competitive manner.
DTV has some risks. It is a 'hard' business. It may mint money while things go right, but IMHO there are just too many things that have to go right to say, yes, DTV will certainly be a bigger and better company in 10 or 20 years than it is today.
I'd rather stick with easier businesses. Colgate Palmolive? Unilever? McDonalds? Philip Morris Int'l? Each may be hard in its own way, but none is as hard as DTV. As for markets like Venezuela, Argentina, Colombia, well I'd rather sell toothpaste, ice cream, cigarettes and big mac's there than satcom services. Upon reflection, I bet Buffett would agree.
(Long UL, MCD, PMI, CL. Long DTV via BRKA and nervous.)
Strayer has a big can of Lawyer Repellent.
Most big class-action securities lawyers are now shying away from cases against Strayer. None want to challenge the Harkin report findings favoring STRA. While this 800 page smear report is a blueprint for class action suits against many of the for-profits, it actually insulates Strayer, since few attorneys want to argue 'against' the conclusions of the Harkin report, which applaud Strayer in the first paragraph or so and then again in a detailed breakout section relating solely to Strayer.
Strayer has thus been handed not only a marketing bonanza, but a kind of litigation shield, which virtually no other for-profit has. This best of breed now has become inoculated to a great extent against the legal backlash in this sector.
(Bought more STRA today.)
Strayer's Debt a Net Positive
Hi Jimmy! Strayer's debt is laudatory for four reasons. First, Strayer lends more to students than its peers and thus has a much higher give-a-damn factor in their welfare and success. This is a key element of Strayer's edge over its competitors.
Second, with $90m total debt and $80m of net income in 2012, Strayer could pay it down in about 14 months. Interest coverage is about 20x. So this is a conservatively financed business, and of course there is no preferred ahead of the common and no pension liability, so no hidden debt (or false pension income) or charges against cash flow from things like that. Its pretty clean.
Third, inflation will likely be significant in future years, so companies with fixed rate financing will benefit from the compounding effects of inflation. Low or zero debt is a big mistake when the cheapest thing on earth is money and inflation is looming.
Lastly, when one's product is significantly virtual, like online classes, bad debt doesn't cost much besides lost profit. If a t.v. retailer fails to get paid for a t.v, they are out the profit AND out the t.v. But for Strayer, the incremental online student can default without Strayer really losing anything significant other than the income. When there is little or no cost of goods sold, or cost of service rendered, the defaults are disappointing but not highly injurious. So Strayer can afford to shoulder more student debt than others, and it improves Strayer. It keeps them more honest than their peers.
As for BP, well now that's a horse of a different color. Major oil companies are asset plays par-excellence and their inventory of oil really matters when calculating their price. Strayer's inventory is ideas, concepts, lessons. Strayer does not need to drill for new 'ideas' or replenish depleted inventories of lessons. Strayer sells something that never runs out, never depletes, and will always be in demand. Accounting classes will be taught a millenium from now, no doubt about it. Strayer is not an asset play at all...
Its a fascinating and important distinction. I'm glad you have focused on it.
Long BP(by coincidence!) and STRA
It's An Inflation Hedge.
The high price-to-book is a blessing, as it means the company uses very little capital to produce its sales, hence it trades off of earnings power without much regard to book value. This is a great advantage when inflation hits, since STRA will not be obligated to always buy new plant and equipment at current inflationary prices in order to earn incremental profits. This is similar to the 'economic goodwill' that Warren Buffet notes in his discussions of See's Candy.
In the old days, Warren followed Ben Graham's preference for stocks priced attractively relative to their balance sheets, i.e. book value or net current asset value. Munger helped Buffett see the beauty of companies priced cheaply with respect to their long-term earnings power, even if high priced with respect to book value.
Finally, book value is deceptive, since it can be dreadfully over-stated (or sometimes understated). Berkshire Hathaway's expensive looms were on the books at depreciated value but in fact when time came to liquidate, they were worth drastically less. Pennies on the dollar. Price to book often means nothing if the book value is illusory, or if the assets comprising the book value are so specialized that they have no real value in a liquidation situation.
Back to Strayer, the company can earn money from online students with very little capital investment. Adding a few students to an online program costs nearly nothing, beyond the marketing. No extra chairs, desks, teachers, parking spaces, etc.
When earnings are strong and reliable, a high price to book can confirm what looks like a good story. Finally, it also indicates a potential weakness if it betrays a low barrier to entry. If little capital is required to get into the business, competition may be attracted and eat away profits. In Strayer's industry, accreditation and other regulations supply this barrier.
New Denver Store: Case Study in BKE Genius
40% returns on assets prompt many of us Buckle shareholders to wish management would accelerate new store growth a bit, particularly since BKE grows at a painstakingly slow and deliberate pace and pays a significant chunk of cash flow to shareholders in dividends instead of reinvesting in growth. This strategy is one of the hallmarks of Buckle's genius, however, and nowhere is this more obvious than the new Denver location, at the Cherry Creek Mall, the glitziest retail location in a 300 mile radius, home to Nordstroms, Tiffany, Nieman Marcus...If you have a Mercedes or BMW from the local retailer, this mall will valet you for free. Its a tony affair.
Enters in Buckle. Knowing the traffic flows of this mall very well, I was dying to find out where they chose to locate. When I found the construction curtain, my eyes grew big, I sat down and said to my shopaholic wife, "This is why Buckle's managers are Geniuses".
Buckle's location is directly across from the Apple store, center of mall on the second floor. Prime prime prime, with the highest footfall store fifteen yards away. People flowing out of Apple must look into Buckle. All day. Every day. Feeling hip and needing to kill time while their friends hold places in line for the iphone or whatever the newest Apple candy will be. In 2012, in one of the top malls in the country, there is no better location humanly possible.
Now THAT is management. THAT is why Buckle's slow growth strategy is so devastatingly effective and produces the highest sales per square foot and ROA among the teen retailers.
I have written before about this phenomenal management, which first endeared me by having three different carpet patterns at the Nebraska headquarters, each from a former expansion...they only change as much carpet as absolutely necessary...my kind of cheapskates. I do hope they put a photo of this in the next annual report...a black and white photo.
(Long BKE. Long live BKE.)
Strayer: Congressional Seal of Approval
Senator Harkin's 800 page smear report on the for-profit education sector, released this summer, gives Strayer an unimaginable advantage in this sector for many years to come. Simply, it demonizes most all the competitors and lauds Strayer, publicly, in a way the marketing team at Strayer can leverage for years.
Strayer can now pound that report as they reassure fortune 500 clients and grow the business. They have been handed a congressional declaration of 'best-in-breed' status.
The report itself is spurious, of course, since it compares for-profits with non-profits but fails to factor in all of the subsidies the latter enjoy, or the low percentage of graduates finding work in their areas of study. Non-profit education actually costs the taxpayers far more when one includes the tax-free land, state handouts, and other taxpayer-funded benefits they get, and they often place far fewer students in the area of major study than the for-profits. Ever hear of high percentages of philosophy or medieval lit majors finding work in those fields? Harkin ignores all of this in order to hijack his committee and spend our tax monies on a highly biased report, as the committee minority members point out.
Still, its a goldmine for Strayer. If you want to know who is best in breed, Congress just told you. If you want to know which company's marketing campaign will be most effective over the next four years, Congress just told you.
(Long STRA because of this report)
Buckle Wins Below the Belt.
Teen fashions may be mercurial but the 'jean' remains eternal. For more than 60 years now, every generation has worn something different on top and roughly the same thing on the bottom. Buckle focuses on this island of predictability in order to derive a serious advantage relative to its peers. It also has the good sense to avoid manufacturing, so offerings can be quickly recalibrated if styles shift. This means Buckle will rarely be out of fashion-step by more than a quarter, whereas its major competitors are more locked in to their fashion commitments.
Buckle marries this advantage with its superior location strategy, which emphasizes locations where competition is minimized, the old Wal-Mart ploy...a.k.a. the Mao Zedong method--conquer the countryside first.
Long BKE, ROST, TJX
Aflac?
Many of us on Gurufocus have identified Aflac as a likely target, factoring in an 80% buyout amount, leaving the Amos management and family holdings undisturbed, and a 30% premium to market price, which we had estimated would bring the purchase to around $22 Billion or so. It would increase Berkshire's float by over $90 Billion, and Aflac runs a mouth-watering underwriting profit and features a prodigious 'low-cost-leader' moat in Japan, perhaps one of the strongest moats in the insurance business on the planet. Its portfolio exposure to Europe has largely been reduced and hedged away.
Your thoughts? Anybody's?
It's a very good point, Clarity.
I often wonder whether MCD's brand/real estate combo value is an illusion. One test is to imagine having MCD's $93 Billion of market cap in one's pocket and speculate as to whether one could out-compete McDonald's with it.
Call the new chain Blank-Burger. Would its signs and location be able to each generate a 20% net profit margin, a 21% return on assets, and a 40% return on equity, on average, at 31,000 locations? If this seems unlikely, then the off-balance sheet goodwill inherent in the real estate and trademarks is having a big impact.
I agree with you, brands and real estate can sometimes be a value trap, and Sears teaches many lessons about brands, like selling Allstate, Dean Witter, etc.; like not stocking haute couture brands, like relying on branded commodities in cyclical industries (true-value), on and on. In MCD's case, though, the brand, together with the land, is hugely profitable and, I would argue, not priced into the shares, since weaker businesses with lesser profitability trade at higher multiples.
As for six more years of recession, bring it on...MCD powered upwards every year of the last one, delivering dividends, share gains, buybacks, and those darn good french fries...