More BAM: cash flow analysis

from Desjardins Securities: read it here

BAM is one of my favourite longterm investments: wide moat real estate (both residential and commercial), "green" power generation assets along with prolific management fees, keeps the cash coming in. 17% of shares are insider owned. Capital allocation is carefully and intelligently considered: read CEO Bruce Flatt's comments regarding that topic in the Q3 2008 conference call transcript.

I have a low ball bid in for $10/share (below book value of approx $11/share!).

l

BAM-- Technical Knock out from the G&M

My confidence in the management and position of this company continues to grow. In an awful environment for financing and raising capital, they continue to outperform all their competitors.

I'll buy at <$20 with conviction. I'm also very interested in some of the preferred offerings.


The Canadian Press
November 7, 2008 at 9:53 AM EST
TORONTO — Brookfield Asset Management Inc., formerly known as Brascan, reported Friday a sharply higher net profit and rising revenue.
Its third-quarter net profit was $171-million (U.S.), or 27 cents a share, up from earnings of $93-million, or 13 cents for the same 2007 period.
Overall revenue jumped to just under $1.3-billion from $980-million, said the company, which reports in U.S. dollars.
In breaking down its quarterly results, Brookfield said increases in operating cash flows were offset by higher non-cash charges, including depreciation on assets bought since the 2007 second quarter.


“Our operating performance in the quarter reflected the durability of our cash flows, most of which are supported by long-term contractual arrangements with credit-worthy counterparties, the high quality of our asset base and operating platforms, and the stability of our long duration investment grade capitalization,” said Bruce Flatt, the company's senior managing partner.
“In the last few months we increased our overall cash holdings and liquidity to more than $3.5-billion, most of that at the Brookfield corporate level.”
“This is one of the highest levels of liquidity we have ever held, but given uncertainty in the markets we want to be prepared for the unknowns, and opportunities which may present themselves in this environment.”
Mr. Flatt said although Brookfield is “exercising caution during these turbulent times, and preserving a high level of liquidity, we are exploring a number of potential opportunities to expand our operating platforms and create additional shareholder value.”
Brookfield Asset Management is focused on property, power and infrastructure assets and has about $90-billion of assets under management.

Invest in the Investors: LUK Leucadia National Corporation

I'm attracted to holding companies that are:

1. trading below book value
2. have management with "skin in the game" (significant insider ownership) and a long term track record
3. little or manageable debt

I've admired Leucadia for a long time but much like BAM, held off actually owning shares because of inflated valuations. This clearly is no longer the case.



Run by gifted mavericks Ian Cumming and Joseph Steinberg, Leucadia National corp is an eclectic, diversifed holding company that was founded over 150 years ago. Its investment portfolio is quite focused and includes small cap biotechs, wineries, copper mines and boutique investment banks. They are deep value investors with a penchant for the "cigar butt" approach. To quote the duo in a shareholder's letter:

“We tend to be buyers of assets and companies that are troubled or out of favor and as a result are selling substantially below the values which we believe are there. From time to time, we sell parts of these operations when prices available in the market reach what we believe to be advantageous levels.”


Bull Case for LUK

• masterful capital allocation has produced a 21.4% CAGR increase in book value/share since 1979!
• average ROE is 21% over 29 years
• being mid cap (5 B) has allowed it to outperform Berkshire Hathaway's stock over the last 20 yrs
• high insider ownership. Steinberg and Cumming each own 13% of the outstanding shares.
• high degree of guru ownership, with many recently increasing their stakes including Bruce Berkowitz, Tom Gayner and David Winters.
• Mr. Steinberg and Mr. Cumming have signed a 10 year contract to stay with the company and in the last AGM they said they would work there as long as they physically could. Apparently they are both in excellent health.
• historically trades at 2 x book value, currently trading at 0.7
• plenty of liquidity current ratio> 3
• mostly long term debt with a low D:E ratio v.s. peers of 0.29 and leverage ratio of 1.38.
• currently P/E ratio 10 x P/B 0.7 = 7 (far below Ben Graham's 22 criteria)
• using an aggregate sum-of-the-parts, P/B value analysis and DCF analysis, they came up with a FMV of about $40/share roughly double what the shares are currently trading at.
  

Bear Case for LUK

• shareholders need to rely on the expertise of only 2 aging individuals as the company is a specialist in picking unprofitable and troubled investments and fixing them up as opposed to Buffett's strategy of picking wonderful businesses that essentially run themselves, with or without him
• heavy exposure to commodities and overseas ones to boot. These will suffer in the global slowdown and may well not survive
• a concentrated portfolio magnifies bad investment decisions as well as good ones
  
• recent heavy investment in JEF, a small investment bank they bailed out of trouble. It may have a rough run before the credit squeeze runs its course.
• LUK's assets under management has shrunk by almost half (9 B-->5.3B) since Jan 2008 due to dwindling valuations
• as the company grows, it will likely grow more slowly due to more competition for distressed potential investments and the law of large numbers
• dividend yield is very modest at 1%; however, the managers are considering increasing this
  

IMHO, this is an excellent long term opportunity to own a company with a superb track record at an affordable price. It would be appropriate for a 3+ year time horizon in an RRSP.

I've put in a low ball bid at $19/share and hope it gets filled on a really nasty day in the stockmarket!

Time to buy the survivors

I'm buying businesses today with the following "safe and cheap" characteristics:

• ample liquidity
• wide moat
• manageable or no debt
• trading at or less than tangible book value P/E <8
  
• high insider ownership (15% or higher)

Wow-- never in my life has there been so many opportunities. Rather than reel with the sheer number of them I've chosen to concentrate on a few:

BAM-- on sale like it never has been. I don't use conventional metrics to value this company.
SEB-- same
MKL
BBSI
PHG

I'm spending hours pouring over financial reports so I can decide the best way to allocate my limited capital. I may sell BPOP as its share price has been propped up by an improbable upgrade. I would love to own more CX, LYG, AXP and CKI.TO; however, these companies are being conspicuously quiet (well, other than Cemex) and there is a palpable opacity to their current liquidity situation that makes me nervous. All four have potential to be great investments and I'm monitoring them closely.



I'm putting in bids for some or all of them today and adding slowly over the next year to my stake in DIA, the diamonds of the DOW. I think the DOW has potential to drop into the 7000's and that would be great.

l

Wow

the streets (Bay and Wall) are running with blood.

I put in a bid for more BAM.A shares at $20 after a prior bid was filled at $25.

I'm trying to shore up some capital to buy initial stakes in PKX and DEO, both excellent wide moat long term plays that will survive a severe and protracted global slowdown IMHO.

Buffett pulls the trigger again.

one may view it as material proof of his belief that the global economy will improve. It looks like the bail package will be finally voted in on Friday (with a little pork being passed around as usual). Doomsday may be averted, this time. lol.

IMHO, there are a few opportunities developing that "bear" close observation if you have capital on the sideline:

1. American Express-- heading to the low 30's. a guru favourite with a great business plan that will almost certainly survive to fight another day.
2. Brookfield Asset Management BAM-- a personal favourite. Still hasn't hit my target entry price of $25 CDN or lower (for the BAM.A.TO equity traded on the TSX, anyway). I have a standing bid at this level and am waiting patiently.
3. Diageo DEO-- has hit my target entry of $69 or below, but my capital evaporated in that account (tax bill). I think this is a very safe long term investment with an excellent upside. I agree with Morningstar that it is trading at a 30-40% discount to FMV.
4. Conocophillips COP-- I'm not as bullish on oil as many others but the fundamentals, management, Buffett stake and exposure to nat gas makes this company compelling. It is approaching my original entry price over 2 years ago!
5. Seaboard Corp SEA-- if it were to drop below $1200, it would be irresistible.
6. Hamburger Hafen HHULF.PK-- still hanging in there about 40 euros/$57 USD. I'm holding out for an entry stake at $55.
7. Lloyds TSB Bank LYG-- the very large acquisition of HBOS and apparently opaque back room deals with the UK gov't is making the risk assessment of this investment a bit tough. I'm holding tight on my stake and considering add a bit when and if I get enough information about the bank's financial situation/liquidity status.
   

Watch BAM closely over the next week

As you're probably aware, in the USA and Europe short selling has been banned by the SEC for 799 financial sector companies. This is a temporary measure due to expire in 10 days.

Let's ignore the wisdom or folly of this move for a moment. Who are we to question the thoughts of giants? lol.

Brookfield Asset Management BAM and Brookfield Properties BPO are conspicuously absent from this list. I've written quite a few blog posts about BAM in the past and it remains one of my favourite long term holdings. Marty Whitman has described BAM as a company that he is "extremely bullish on". Tom Gayner, Chris Davis and recently Ken Fisher are adding to their stakes. Insider buying is steady and the insiders own about 17% of the company. Most of BAM's investments are not attributable back to the parent company so it is very well capitalized. It's a bit curious that BPO is not covered by the SEC edict as it doesn't even trade on the TSX. BAM owns 40% of BPO's shares (last time I read the financial report anyway). BPO owns premium Manhattan real estate (i.e. part of the World Financial centre) amongst other stuff. Its share price has been hammered as traders worry about leaseholders such as Merrill Lynch who may default/terminate the juicy payments.

Unfortunately, BAM has not been cheap and I've been looking for an opportunity to add to my position. The long term survival of this company is not in question here-- it's the contraction of the capital markets reducing opportunities for the type of investments BAM specializes in and a reduction in value of their considerable real estate and lumber stand holdings eating into their intermediate term profitablity. I wonder that if the short interest rises in the next few days (bored traders?) it might create an opportunity to own more of one the best managed companies in the world.

For the best presentation of the bull case for BAM, take a look at the Sept 08 webcast for Investor's Day.

For a sense of important balance, I need to include some of the bear concerns, well summarized here.

I'd buy below $25 enthusiastically and hold for the very long term.

l

The markets are boring these days, eh?

9 industrial sectors (not just financials) are demonstrating volatility comparable to a roller coaster ride.

The credit crisis, housing slump, bank liquidity crisis/deleveraging phenomenon seemed to be an isolated domestic US problem a year ago and time has proven that rot is global in scope. It's ironic that the US is one of the few developed countries in the world that has shown GDP growth recently despite the trifecta of grief.

When the markets move, opportunities arise that come along only once or twice in a generation. IMHO, the key principles to invest wisely when blood is still fresh on Wall St. and Bay St are:

• think like a business owner. If you wouldn't want to be the owner of the whole company (if you could afford it and had the ability to manage it), why would you want a partial share?
• buy what you understand. Particularly with respect to the quarterly and annual financial reports and with special attention to the "Notes" section at the back of the report . They are usually confusing for a reason. Put these shadowy companies in the "Too hard" pile like I should have done with AIG. Read BBSI's reports and you will follow them easily. Even a very complicated company like BAM can be methodically worked through, section by section, by almost anyone even if they are not a CFA. HHULF.PK (Hamburger Hafen Logistik) is extraordinarily simple and clearly laid out in their publications--- and these have been translated into english from german!!
  
• make sure the management has "skin in the game" (i.e. significant insider ownership >10% IMO) to assure that their decisions are aligned with your interests. The management's behaviour should be rational and independent of the "institutional imperative". One of the advantages of owning a business with a high degree of insider ownership is that most insiders cannot (due to company or SEC rules) or will not trade their stock for short term gains and this builds a bottom into the share price. It also acts as a partial protective shield against "bear raids" like what happened recently to Bear Stearns, Lehman and AIG. It's hard to manipulate the stock when you can't buy a large portion of the float. Examples: SEB, COLM, BRK, BBSI, BAM.
• try to buy the best balance sheet in the business v.s. competitors. It's easy to say you want companies with no debt and lots of cash on hand; however, in many cyclical industries this is not an efficient use of working capital. Just make sure that when the unexpected happens, your company will be the last one (or one of the last) standing and positioned to wrest away market share from the much weakened competition when the dust settles.
• focus on boring businesses in slowly changing industries with predictable cash flows and high barriers to entry for potential future competition i.e. insurance companies like Markel MKL, booze manufacturers like Diageo DEO.
• do your scuttlebutt (non-quantitiative research)-- go to the mall, talk to customers and to salesmen. My wife and I have done this with AEO: watching the stores full of teenagers, buying up their products while the rest of the mall is barren.
• watch for companies that have great fundamentals but a poor short term outlook or are irrationally hated by investors i.e. Cemex CX is currently priced as if another highway, bridge or apartment block will never be built in North America or Europe. Everyone hates DELL and simply won't hear any of the upside now that it is a different company than when it was a growth stock.
• when looking at such metrics as ROE, use 5 year averages as these numbers can easily be distorted by short term, non-repeatable events in one quarter or two. i.e. LYG, AXP have astounding 5 yr ROEs in the 30's.
• buy the asset managers not the mutual funds themselves. i.e. AGF, BAM, LM
• holding companies often have unlocked value, high insider ownership and are managed for the long term i.e. IVSBF.PK, POW.TO, TYIDF.PK
• choose to delve into the areas where hundreds of thousands of brilliant minds are not. I don't invest in oil or gold stocks because a lot of very smart people with far greater resources than I are spending 24/7 trying to figure out what the catalyst will be that will push commodity prices such as these up or down. What's the chance you'll get an edge on these guys? Pretty nominal, IMHO. The way the market works is that once the "smart money" has it figured out, the market follows seconds later and becomes priced into the stock ahead of time through the influence of futures/forwards/warrants exchanges. Instead of competing with these guys, take it easy on yourself and choose stocks that are extraordinarily boring, not traded on the NA exchanges, thinly traded and/or not covered much by NA analysts. These equities are conveniently often the same ones that have high insider ownership. Examples: Seaboard Corp SEB, Hamburger Hafen Und Logistik HHULF.PK, Investor AB IVSBF.PK, Toyota Industries TYIDF.PK
• Watch for consensus and bargain guru stocks for new ideas. Don't blindly follow them-- instead consider them an elite stock filter. My favourite (free) resource for this is gurufocus.com.
• Watch what the insiders are doing. Selling is of uncertain circumstance but large scale insider buying should be noticed and factored into your buying decision making. I use Yahoo's financial page for the US stocks and canadianinsider.com for the Canadian equities.
  

Happy hunting and enjoy the process. If you don't, buy ETFs, using dollar cost averaging, rebalancing once or twice and year and then forget about it. My favourite undervalued ETF is DIA "The DOW Diamonds" at <$110/share.

Brief Contrarian Portfolio review and a Shopping LIst

Just a few comments and observations regarding the businesses and their associated stocks. The majority have been reviewed in detail earlier in this blog. I have a penchant for wide moat stocks in unloved sectors so you will see an over-representation of insurance companies, holding companies, asset managers, consumer discretionary niche businesses and wide moat financials. I am a physician so pharmaceutical and medical device companies are somewhat in my "circle of competence", so you'll see some of them listed here as well.

If you're interested, use the search function in the upper left corner of the screen to find these posts.

Equities currently held:

MCO Moody's: much hated and blamed for the credit crisis (with some merit). Lawsuits and red tape type legislation are inevitable but Moody's has been through this before and will likely thrive when the debt markets recover. Extra-US revenue is increasing and likely to accelerate with financial markets eventual recovery. I'm holding on this one long term (3 years +) unless it drops into the 20's/share without a material change in the business plan and I'll buy more. I'm a bit more cautious with this investment as I find this business to be very complex and the reports tough to follow which raises red flags for me. Buffett is holding on to his stake which offers some reassurance. Hold for now. Target price $70/share.

COLM Columbia Sportswear: good valuation, high insider ownership (66% of outstanding float), no debt whatsoever (!) and a global footprint have me holding on to my stake for another 18-24 months. Shaky inventory management, lack of any moat whatsoever and lack of a tangible business plan to take market share from the prodigious competition (i.e. North Face, Underarmour) may undermine margins and downstream profits. If emerging markets (i.e. NOT Europe) take to the brand, it may do better than I expect. I believe that there is an excellent margin of safety on the downside; however, my expectation is a maximum 50% upside over the next 1-2 years. Hold for now. Target price $60

SPLS Staples : superior management demonstrated by increasing ROE and a competition-crushing increase in market share wrested from OfficeMax and Office Depot. SPLS has double the net margins of its weakened competitors. The company's delivery business is thriving, particularly outside North America. International exposure improved by the well timed and executed Corporate Express acquisition. Minimal debt, modest dividend (1.8% yield), a newly developing moat, and moderate growth make this holding an intermediate to long term one: 3-10 years. Target price $40+

CMH.TO Carmanah Technologies: A locally based, globally represented solar LED manufacturer/distributor. I bought this early in my investing career--- when it was the bright and rising star of the TSX Venture exchange and trading between $3.60 and $4.20/share. However, with time the inexperienced management fumbled, CMH's earnings vaporized and predictably, the balance sheet bled red ink. Carmanah rapidly became a penny stock. A new CEO, CFO and then a new board was brought in last fall to turn things around. CEO Ted Lattimore, a Vodafone turn-around specialist veteran, has sold off all the low margin product lines and concentrated on the LED biz. They've pared back the head count, out sourced the manufacturing component and cleaned up the balance sheet: no bank debt and a current ratio > 3.1. Last 2 quarters EBIDTA has turned positive and would have been (the dreaded "pro-forma" statement) profitable discounting the restructuring charges. Management expects to turn a profit by early 2009 and 10% top line growth thereafter. I think this is a reasonable entry point for a speculative investment, keeping in mind that there is absolutely no moat protection whatsoever and it may never become profitable. It is not a value stock now and may never be.

CKI.TO Clarke Inc. this activist catalyst holding company is trading at approximately 30% discount to its NAV. Recent aggressive investments in various income trusts including Granby IT, Art In Motion (which CKI plans to take private this fall), Avenir Diversified IT, Supremex IT and others along with recent NCI bids for share/debenture buy-backs have depleted cash from 44 M to 1.5 M and reduced the current ratio from 5.5 to 4.4. Although the balance sheet remains strong, I'm closely monitoring Clarke's liquidity risk. It's still paying a very modest dividend (1.1% yield). Mr. Armoyan's investments are holding up better than I expected considering the current economic environment: only 1 M writedown and 17 M non-realized loss in a 266 M portfolio. I intend to hold as long as the balance sheet remains reassuring. I think that the downside (further national/global economic weakness, strong loonie etc) is priced into the shares currently and that the upside will be rewarding. I find that Clarke's financial reports extremely easy to understand, even the notes section which is usually designed to confuse you. If I get a report that I can't understand down the line, I'll follow my usual sell displine and dump the stock.

COP Conocophillips: I sold 66% of my stake for a nice profit a few months ago despite very compelling valuations. Political risks (even in the USA!) along with an expected multi-segment margin squeeze make me leary. I'm finding this area too difficult to gauge as it is exposed to too many external forces to get an "edge". I prefer lower profile, boring businesses.

AEO American Eagle Outfitters: update recently posted on this well managed, no-moat company in a rapidly changing business with very fickle (read: not loyal) customer base. Great balance sheet, no debt and will likely appreciate rapidly with the turnaround in the retail sector, whenever that happens. I would buy more at $13/share and sell in the high $20's with a horizon of 1-2 years.

CX Cemex ADR: another extremely well managed narrow moat company in a hated industry, as it is tied in with housing/construction markets. It is also a major player in the infrastructure refurbishment worldwide which most analysts feel will be a multi-trillion dollar industry over the next few decades. Extremely compelling fundamentals==> trading at book value and P/E (both trailing and projected) about 7, PEG 0.85. Although the 20 Billion long term debt obligation is concerning post the Rinker acquisition, management is committed to debt reduction, aided by a 20% operating cash flow yield. Buying below $20 and intend to hold for 5 years+. Short term target is $30/share. This is one of my favourite investment ideas currently.

LYG Lloyds TSB Bank ADR: UK financial institutions are amongst the most despised in the world these days. This is the most conservatively managed and boring bank in the UK (and perhaps the world) with the stated goal of paying out 75% of earnings to shareholders in the form of dividends. The company's staunch conservatism is serving it well, propping up its reputation for safety. LYG has recently sold off its foreign operations and due to its strong brand in the UK it has a wide moat. Dividend yield of about 9% and ROE historically in the mid 20's. P/B 1.6 P/E 5.6 PEG

SEB Seaboard: shipping/food processing company with high insider ownership (70%) and great valuations. Margins being nailed by commodity prices, particularly grain for the hogs in their pork segment. A recent pull back in share price to a 52 week low presents a good entry opportunity for the long term. This was prompted by a 50% reduction in EPS yoy despite higher revenue (higher costs). Management communication with shareholders is opaque (no conference calls and minimal/no guidance) and analyst/Wall St. coverage is nominal---this can be both an advantage and disadvantage to the long term investor. P/E 9 P/S .43 trading around book value. It grows revenues 15%/yr over the past 5 years and increased it's tangible book value 23%/yr each year over the same period. Great balance sheet and liquidity with current ratio 2.7. Dividend negligible at 0.2% yield. Buy at <$1200/share and hold for the very long term or >$3000/share.

COV Covidien: "crown jewel" medical device manufacturer spin off from the old Tyco monster conglomerate. Although I think that it has excellent long term potential, the share price has appreciated 50% over the last year, within shooting distance of its Morningstar FMV of $65/share. Insider buying is impressive (one officer bought $1 M worth of stock at $51/share so he obviously still thinks it's undervalued) as is the product pipeline. I'd be interested in buying more shares in the low 40's and holding for the long term (3 years +) or until the shares hit the mid 80's. Hold for now.

NYX Euronext-NYSE: despite the inevitable emergence of competition on the horizon (narrowing the competitive moat), this global leader stock exchange is trading at 9% cash flow yield. Sellers have overlooked the fact that only 10% of revenue comes from domestically traded equity fees. I will buy below $40/share with an intermediate holding horizon of 18 months to 3 years and/or a target price of $90-100/share.

HOG Harley Davidson: undeniably wide moat niche manufacturer/retailer overly punished of late for its troubled loans division. Current ratio > 2.5 and strong overseas growth. 15% cash flow yield, 33% ROE, 3.2% dividend yield. Well managed and very strong brand with excellent overseas growth in revenues . Inventory management widely praised. Recent bump up in debt from virtually nil to $3 Billion for the Italian motorcycle maker MV Augusta acquisition has raised eyebrows. Margin compression (increased costs, decreased US revenues) recently and concern re: demographic shift in customer base continues to hammer at the share price. I intend to buy at prices in the low 30's and sell in the 70's as a long term hold (3+ years).

BMY Bristol-Myers Squibb: has been a disappointing long term holding for me, despite the generous dividend. The intermediate term drug pipeline thins out markedly between 2011 and 2014 although looks promising beyond. The reasonably leveraged balance sheet is be endangered by overpaying for the in-progress Imclone acquisition. The company is also joing its peers by being bogged down with lawsuits including the Apotex suit. Some of my favourite gurus have sold their stake in BMY in June as well including Bruce Berkowitz. Some large scale insider buys in May have followed by serial dispositions. I think that Bristol will turn itself around over the next 3-5 years for brighter days and that the pessimism I express is priced into the stock price. It may not be a bad entry for a very long term investor-- after all, BMY has been around almost 1.5 centuries and the nearly 6% dividend more than offsets inflation. I suspect there are better opportunies in this sector (like SNY). I am considering selling on any short term strength for a capital loss but I'm not in any rush.

BBSI Barrett Business Services: I've written frequently about this favourite small cap of mine. Short term uncertainty in the sector coupled with a superb balance sheet, superb management and high insider ownership and insider buying if late, plus a dividend (2-3%) makes this a long term hold. I would add to my position (and have several times over the past 6 months) as the share price moves towards $12 and below. I would pare down my stake in the mid $20's unless the great valuations are also maintained. The share price ramped up 40% after the last conference call. I will hold my shares for now and intend to do so for 3+ years.

BPOP Banco Popular: the last 12 months have been tough for Popular-- the share price dropped to $5 from $16 after 3 consecutive quarters of writedowns for bad loans. Management has responded appropriately by selling off their US mainland operations and focusing on their virtual stranglehold monopoly in Puerto Rico. They managed to pull in half a billion dollars of operating free cash flow despite reporting negative income for that period which bodes well for 2009 or 2010. Dividend is about 4% yield. Shares have rebounded to about $9 on a recent sale to Goldman-Sachs of more dodgy domestic mainland mortgages. It is over capitalized at 10.5%, providing a margin of safety in such tough times. I plan to hold with my stake for up to 3 years or a target price of about $20/share. I don't intend to acquire more shares because I have a large stake and find wider moat financials such as AXP more attractive as well has less risky.

PHG Royal Phillips Electronics: I was originally attracted to PHG because of its global footprint and very strong balance sheet (primarily due to the big cash reward from the Taiwan Semicondunctor divesture). I liked the way management was selling off the low margin, cyclical businesses (like flat screen TVs) and instead concentrating on the more profitable health care/medical device, "green" LED and personal care products. It has become a simpler company and easier to understand how they make money. Great fundamentals with P/E of 8 EV/EBIDTA of 9, PEG 1.06 P/S 0.79. ROE double digits. The downside I've come to appreciate is the expensive acquisition driven strategy (i.e. Respironics) focus instead of emphasizing organic growth. The share prices is slowly dwindling away from $41 down to $31/share. Certain gurus with large positions are selling as of June 08. I intend to hold for another 18 months as I'm not convinced that this is a great company worth sticking with through thick and thin. I would sell in the mid 50's.
Over time I've become more of a fan of the spin-off spawn (i.e. COV) of these big, bloated conglomerates rather than their parents. Recent legislation mandating LED use may be the near term catalyst to push up the share price.

MKL Markel Corp: an extremely well managed specialty insurance company that I've admired for a long time and has only recently become cheap enough to interest me. Pricing pressure on underwriting profits has squeezed the share price to 2005 levels. One of the most respected gurus, Tom Gayner (a potential replacement for Warren Buffet, according to rumour) is the chief investment officer. Short term outlook is weak, long term is excellent as its competition is crushed in the current adverse environment and its long term investments pay off. This is a long term RRSP type hold for me (3 years +++) that I intend to add to if the shares drop in the low 300's and consider selling some if they hit double that (and maybe not even then). The nice thing about insurance companies is that: 1. they are in a slowly changing industry with predictable cash flows (mostly) 2. product obsolescence doesn't affect them much 3. inventory management is moot. When they are cheap and well run, they are amongst the safest long term investments. This is why there are so many insurance companies that hang around for > 100 years.

Y Alleghany Corp: Another favourite of mine- an investment holding company with insurance subsidiaries and a very long term focus, currently trading at levels just above 2006 prices. High (35%) insider ownership but not so high that shareholders can be ignored. Debt = 0 and good fundamentals. This is a safe investment for very long term investors as most of the investments the company makes is in distressed companies---- an endeavour for the most patient. They bought Burlington North before Buffett did. I hold in my RRSP and will add at $300 and below, hold for 3 years++ and consider selling some at $550 and up.

Dell Computer DELL: over the last 5 months, Michael Dell has personally bought 200 Million dollars worth of common stock on the open market, half purchased last week after the stock plunged 18% due to a disappointing quarter. HP has been eclipsing Dell on the international stage, narrowing Dell's moat markedly. Dell hasn't brought its expenses into line fast enough to impress investors. This includes many long term value guru investors like Dodge and Cox, Bill Miller and Bill Nygren. It's true that top line growth was impressive in this hostile economic environment but this has been achieved at the expense of slimmer margins. The thrust of its business plan is to focus on the higher margin server, storage and peripherals segment of their revenue mix and they have executed in that regard. There is concern about conflicting efforts from their direct and indirect sales forces. One also wonders why they are delving so aggressively in the poorly rewarding area of low end notebooks. Despite all these worries, as the revenue mix improves and cost cutting measures finally show up in the bottom line, there is good potential for margins to turn around over the next 3 or so years. The other facts that should not be easily discounted is that Dell is a cash generating monster: virtually no debt, 10 billion dollars of cash in the bank and it generates $3 billion dollars of annual free cash flow (!). I would be happier if a dividend was being paid by this more slowly growing company during the protracted turn around and I think Dell should pay one. I have arbitrarily decided to wait another 4-6 quarters or until the share price hits the high 30's-- whichever comes first.

LM Legg Mason: a best of breed asset manager having hit hard times. SIV vehicles held in their income funds had to be supported by cash from the company's balance sheet in order to prevent LM from having to sell them under duress at pennies on the dollar. Certain managers have badly underperformed the market, particularly value guru Bill Miller and this has lead to prodigious outlows of the giant pile of AUM (assets under management). Few doubt that LM will survive though, with more than sufficient liquidity (current ratio > 2) 3.5 Billion dollars of unrestricted cash in the bank and considerable FCF generation and 3.4 B in long term debt. Management is seasoned and there is considerable insider buying. It is the most widely held security of the value gurus who have been aggressively adding to their stake of late. (One exception is Richard Perry who sold his stake in June). The stock has appreciated from about $28/share to about $44/share and I'm currently holding for the long term (3+ years). A 2% dividend helps offset the inflationary bite of the wait. I would add more shares to my portfolio if it dropped into the low 30's again. I would be tempted to sell some > $100/share.

AXP American Express: another badly wounded "Best of Breed", wide moat, minimal Capex, slowly changing and highly profitable (historical average ROE > 30%) business. Wall St. sold it off because of concerns regarding increasing default rates, even among prime cardholders. With 20 Billion in cash and a current ratio of 3.5, liquidity isn't an issue-- yet. 6.1 Billion dollars of annual free cash flow doesn't hurt either. AXP has not traded at such favourable valuations since that dark day on September 11, 2001. Berkshire is the largest shareholder. 15 value oriented gurus hold this stock in their portfolio, most of whom have added to their stake in the past 6 months. Some largeish insider purchases in February but not much since. The securitization used to fund the credit card business is a source of worry as well to analysts: dislocation in similar markets may impact earnings. Decreased prime and super-prime consumer spending will cause the discount rate charged to merchants to be squeezed and adversely affect margins. I think that these are short term concerns and I would happily buy more AXP in the mid 30's and hold for the very long term (3++ years) as it is a great company. Depending on the fundamentals at the time, I might be tempted to sell some at >$85/share. A modest dividend yield of 1.8% helps offset the effect of inflation.

UNH United Health: hated HMO (with good reason) with recent change in governance (a good one). Black clouds hanging over the whole managed care sector due to political risk (new president coming.... will there finally be reform down South--- doubt it), deteriorating medical cost ratios and the stink of the backdated options scandal lead by the former CEO. Wide moat with economy of scale. Knocked down by the market to unrealistically low valuations (<50% style="FONT-WEIGHT: bold">BAM.A Brookfield Asset Management (TSX version): a great company that I have blogged abundantly about; however, it hasn't been cheap lately. Worth holding for the long term or indefinitely. I would buy in the mid-20's and sell portions (possibly) in the 40's.


AIG American International Group: another famed Warren Buffet quote:

"I have three boxes on my desk: In, Out, and Too Hard."

this is an example of an investment assessment that has become "too hard". AIG had potential to become a great company but it has become too big and too complex. The corporate governance has reflected this fact and it seems clear to me that they are just as baffled as I am about the liquidity status of the whole as well as the risk assessment of the credit default swap portfolio and subprime mortgages they hold, particularly in Europe. I can't make heads or tails of their reports-- this should have been a red flag for me. I was (and still am) to their excellent reputation and footprint in emerging markets; however, it appears the horse is out of the barn in Europe and North America. Morningstar has laid out 5 different recovery scenarios and 4/5 aren't great for shareholders. The market is anticipating that AIG will need to do a secondary dilutive offering of stock to shore up their balance sheet and that's why the share price is in free fall recently. My plan is to wait until the Lehman panic boils off and then sell half of my stake on any strength and hold the other half for the intermediate term or until the share price (or if it does) increases into the 30's and beyond.

KMX Carmax: best of breed used auto retailer with an excellent business plan (described in a previous post) and superb management. Will likely take even more market share during the sector recovery. Good liquidity current ratio 2.8-- it's not going anywhere, unlike a lot of competition. Downside is slim net margins and competition may replicate their business plan (although they've failed so far). Lots of short interest (23% of outstanding shares are short!)-- subject to "short squeeze" when the shorts rush to cover during a turn around. I plan to hold my stake unless tempted to buy more at $12/share or less and sell if it hits the 30's+. Intermediate term hold due to narrow moat and tight margins-- 18 months-3 years.

NVS Novartis SGP Schering-Plough SNY Sanofi-Aventis: these are my "best of breed" favourite big pharma basket of companies. NVS is a leader in the vaccine market and has no debt. SNY is a Buffet stock with a great pipeline. SGP is well managed and overly punished for the Vytorin surrogate outcome studies and a data dredging phenomenon that suggests an increased cancer risk-- the significance of the findings that has been exaggerated by some silly academic doctors who still don't realize that a LOT of people will never tolerate statins and still need to be on a cholesterol drug for their entire lives. All are wide moat companies with excellent long term potential suitable for an RRSP.

Shopping List with entry target prices.

Note: I don't intend to buy all of these or even most of them-- being on this list means that I'm actively researching the companies and closely monitoring the share prices for a possible entry position

POW.TO Power Corp: < $30/share. One of the best of breed holding companies with high insider ownership, astutely managed by the Desmarais family.

IVSBF.PK Investor AB: <$19/share. One of the best of breed holding companies with high insider ownership, astutely managed by the Wallenberg family.

TYIDF.PK Toyota Industries Corp.: <$25/share-- a Marty Whitman favourite holding company to buy Toyota Motors on the cheap.

PKX Posco: arguably the best managed steel company in the world and may well have the best balance sheet. Buffet stock. I couldn't resist if it fell below $75/share.

DEO Diageo: This article summarizes the bull case better than I could. This is also one of my favourite investment ideas currently. Another excellent analysis here. Wide moat stock with growth and a dividend to boot. Definite RRSP material. Buy at <$70/share

ZMH Zimmer Corp: wide moat orthopedic device company. Great balance sheet and free cash flow. An excellent long term holding if you can get it cheap enough-- <$65/share

ATD.B.TO Alimentation-Couchetard: undervalued and a buy at <$11/share

HHULF.PK HAMBURGER HAFEN UND LOGISTIK: This virtual monopoly was reviewed earlier this year under post "Hamburger, anyone?", the first 1/2 2008 results are summarized in this investor presentation here. Strong results across the board with increasing ROE, gross margins, net profit (up 43%) and decreasing capex. The slowdown in emerging market's trade with the European hinterlands due to moderating global economic conditions is partially offset by anticipated further cost controls and the anticipated corporate tax cut for German corps. The stock took a huge hit this week-- dropping from about 55 Euros a month ago to hovering around it's all time low of 40 euros today. I assume that global recession concerns are the main driver of the sell off but I'll keep hunting. My entry point will be in the mid to high 30's. This is also one of my favourite investment ideas currently.

BAM revisited

This article presents a rare (for seekingalpha.com, anyway) balanced view of the current investment status of Brookfield Asset Management.

I agree with the poster that the long term view for BAM is excellent. I'm hoping for the share price to drop back to 52 week lows (around $25/share) and then I intend to double my position.

Read the article here.

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TKO for BAM

BAM Brookfield Asset Management has been discussed and analyzed fully in previous posts (use the search function in the upper left corner of the screen).

In an extremely hostile credit market long with irrationally negative views towards all types of property investment (both commercial and residential), BAM is thriving. The details are in Bruce Flatt's shareholder's letter.

The renewable power sector investment is driving the company's growth and the carefully selected commercial properties' performance has more than offset the residential property portfolio's under performance.

A 2 million share buyback was completed this quarter. The balance sheet has improved as well.

BAM's share price has reflected these observations by increasing from just above $25 to
just under $33 today. Morningstar and I agree that adding to an existing position on negative dips that are almost sure to come over the summer would be an excellent choice for a long term investment i.e. in a RRSP. I hold BAM and am planning to do exactly this in my RRSP.

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Bruce Flatt from BAM talks about investing

see the video here

Brilliant insight from a very, very smart Canadian.

Time is the friend of the wonderful company, the enemy of the mediocre.

In times like these, one needs to think like an owner rather than a generic shareholder. Do you consider selling your house every time your annual assessment drops or stays flat? Do you check the market value of your house every hour, day or week and fret when it doesn't go up steadily?

One should think the same way about quality wide moat companies as the homeowner's house. Most people actually only own a small share of their home (the bank owning the balance) so the analogy to the partial ownership of a public company through common shares holds.

One such company is Onex Corporation: OCX (TSE) a company that I view as Clarke Inc. (CKI)'s big brother

Profile: Legendary value investor Gerry Schwartz is the largest shareholder as well as the CEO and Chairman of the board of directors for this diversified Canadian holding company. It has a private equity arm which utilizes leverage heavily to buy out undervalued companies and 2 others subsidiaries which own various private and public companies such as Spirit AeroSystems, Sitel and Celestica. It also has developed an asset management firm that raises third party capital through limited partnerships and generates income for the parent company (OCX) by generating management/performance fees.

Like Clarke Inc (CKI) discussed at length previously, one has to be cautious using traditional valuation metrics to assess investment holding companies like Onex.
P/E, P/B, P/S ratios can easily be distorted by realizing one time gains from a previous investment. Thus when financial holding companies sell what they feel is an overvalued investment in a bull market, the P/E ratio drops because a large capital gain shows on the balance sheet and is calculated into the earnings. OTOH, during a bear market such as we are seeing now, the company is buying undervalued assets and holding their previous investments to sell later, in better times. The P/E ratio will rise, assuming their is not a huge sell off of the company's shares at that time (unlikely because of the high % of insider ownership), making the valuation look more expensive. So unlike many secular businesses with more or less continuous cash flow, the P/E multiple is often HIGHER when the company is a good value and LOWER when it is cheap. The use of NAV (net asset value) for valuation is a more appropriate metric and for value investors, the larger the discount to NAV, the cheaper the security is.

Bull Case for Onex Corp:

1. Remarkable track record for creating shareholder's value-- see chart at the top of the page. 10 year share price growth is 422% v.s. TSX of 147%.
2. Management's interests squarely aligned with shareholders. 28 Million shares = $1.4 Billion owned by insiders market cap $4 B. Options can only be exercised if 25% strike price and 25% of the carry realized must be reinvested in Onex stock and held until retirement---> management is highly motivated to make LONG TERM, sustainable profits.
3. No attributable debt for parent company. Individual debt attributable to each major investment is non-recourse to Onex-- a similar setup as with BAM (see previous posts).
4. Current portfolio is well diversified: 22% cash ($770 million), 14% private companies, 20% public companies, 44% limited partnerships. Healthcare and US industrials overweighted. Onex has set up funds to invest in distressed debt and US real estate-- a contrarian move that impresses me particularly since they initiated this strategy earlier than competitors-- August 07.
5. NAV conservatively calculated to be $32.86/share (10% discount). RBC analyst calculates FMV at $44 mostly due to overlooked profits from 3rd party management fees.
6. Aggressive stock buy backs when shares trading at discount to NAV. Has bought back and cancelled 34.2 million shares at an average share price of $19/share over the last 2 years. Another buyback is occurring right now.
7. Income from recent divestures and cash flow from 3rd party management fees plus a large surplus of cash on hand positions OCX to snap up more deep values plays.

Bear case for Onex Corp:

1. Cash balance is in US$ and high degree of US equity exposure. As the US bear market unravels further, this could diminish NAV accordingly.
2. Credit for near term large private equity finance deals will be trickier to arrange.
3. A large proportion of the company's direction and prospects rely on a single individual-- the CEO Gerry Schwartz. He is the controlling shareholder and is essentially immune to activist investor influence due to the share structure of this company.
4. Possible acquisition valuations are in flux so short term NAV/book appreciation uncertain.


Onex is definitely a stock to study. I've put in a small bid for $30 and hope to add to it over the next 12 months. Target price-- $60--$70

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Update on some portfolio stocks

The last 2 weeks have produced some tangible gains across the entire portfolio with the exception of DELL-- Wall St. and individual investors tire of waiting for Mr. Dell to execute his turn around and cost cutting measures.

My take on some recent information concerning stocks discussed earlier in this blog:

• DELL-- worth waiting for as its balance sheet only improves from a previously strong position and it grows overseas. I intend to double my stake at $19 or below and it's hanging just above that now.
• COLM-- was downgraded by a Citi analyst a few days ago on speculation that back orders have fallen off. Fundamentals and balance sheet are both extremely strong as is the opportunities in Europe and Asia. A senior officer (the COO) resigned recently and it's difficult to attach significance to this, but it always gets my attention. Very strong insider buying going on. Holding for 18 months+
• Schering-Plough SGP-- has spiked up from $14 (my entry point) to just under $17 after the market realized that the huge 26% sell off reaction to the cardiology panelists' comments on Vytorin was not justified. Several analysts (including Morningstar, my favourite) models suggest that SGP is worth $30/share with Zetia and Vytorin sales dropping to zero-- which they will not. What academic cardiologists/pharmacologists don't seem to realize is that adverse drug affects are much more important to patients than they are to doctors and many patients are prepared to pay more in order to avoid even nuisance side effects like cough and swollen ankles, particularly when these drugs need to be taken life-long. Many patients cannot tolerate statins, the cheaper and possibly slightly more effective competitive drug class. I doubled my stake at $14 and will hold for the long term in my RRSP.
• Legg-Mason LM--- despite Bill Miller having the worst quarter in 26 years in his Value Trust fund, LM has rebounded from $50 to $60. The new CEO recently bought $1000000 worth of common shares out-of-pocket and the gurus are buying LM aggressively. I have a fairly large stake in my RRSP and intend to hold for the long term.
• Brookfield BAM-- just completed a billion dollar share buy back. It continues to make careful acquisitions. It has increased slightly from a support level of $26 to $28 currently. I will happily buy more if and when it drops to $24 or less. This is also a very long term hold.
• Georgia Gulf GGC-- the Royal acquisition debt weighs heavily on the company's balance sheet and with many of its plants idled, cash flow is an issue. The share price has rallied on a hope and a dream that the US recession has peaked-- from $4 at its nadir to just under $8. It wouldn't take much bad news for the banks to call in their covenants/loans. I am hoping that the share price will come up to $10 (Morningstar's FMV) and then I will sell one third of my stake. After another quarter, I'll reassess whether to hold on to the remainder. If the economy turns around, I suspect that GGC will be acquired.
• Popular BPOP-- has rallied from it's nadir at $8 up to close to $12 and has continued to pay a generous dividend, while divesting itself of its underperforming mainland assets to pay down debt. It is still trading at below book value and has a "forward" P/E of 11 (estimates are duly pessimistic. Reasons to hold on to this one include the 5.65% dividend and the fact the bank is essentially a monopoly in its region (Puerto Rico). If it can survive the downturn, and it looks like it will as it is extremely well capitalized, one can expect the stock to increase by 50% or so to its FMV. I will hold for 18 months to 3 years. If the bank has not learned its lesson and starts to make stupid and expensive acquisitions on the mainland again, I will sell before that.

I have just read the Q4 BBSI conference call and the annual report for SEB and am more convinced than ever that they remain excellent long and intermediate term investments. As they have both made relatively large share price gains very recently, I hope to wait for a pull back to add to existing positions.

HOG, PHG, SPLS, COV commentary to come soon.

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Great Ideas from Businessweek: buy the deep value investors

Have a read of the article below. Not only can you be a deep value investor, but you can also buy shares of holding companies (usually also involved in insurance, much like WB's Berkshire) that specialize in buying discounted gems and holding them for the long term. Since they have considerably more resources and experience than most of us do, they often have an edge. Look for the following:

• a long term track record of double digit ROIC and at least 10% insider ownership in the small to mid caps
• low to no debt and leverage that is on the low end for the industry
• trading at or near book value (current bargain)

BAM is well covered in my other posts and a core holding of mine.

I am doing further research in to PICO (where I see there is big time insider buying, short term misery and long term good prospects being water suppliers in the US Southwest) and Y where there is no debt, respected conservative management, attractive fundamentals and a Morningstar endorsement that says, "For the long-term investor, we endorse buying this stock any time it settles into 5-star territory". Y is solidly 5 star-- trading at $349 and FMV at $518.

How to Feast with the Vultures

by Anne Tergesen

A credit crisis. A volatile stock market. A projected wave of corporate bankruptcies. To most people it sounds like hell. But for investors who specialize in distressed assets it's just the opposite. "Bear markets are often when these guys plant the seeds for their next big winners," says Chris Mayer, editor of Capital & Crisis, a newsletter that focuses on contrarian investments.

Such scavengers scour the market for stocks, bonds, or whole companies to buy on the cheap, paying less than they think the company's assets are worth. A subspecies, known as vulture investors, aims even lower. These investors pick at carcasses of companies in or approaching bankruptcy, often amassing sizable stakes in order to wield influence in a restructuring or liquidation.

While some of these high-risk investments fail, others can be "monster home runs," says Mayer. His favorite "deep value" players—chiefs of little-known companies such as Leucadia National (LUK) and Brookfield Asset Management (BAM)—boast average annual returns of 15% or more over the past 10 years.

The most obvious way to get into the action is to buy a value-oriented mutual fund (tables). A more rewarding approach may be to invest in companies such as Leucadia. Like Berkshire Hathaway, these are publicly traded holding companies run by managers with histories of sniffing out value. Yes, the risks are more concentrated. But returns, on average, exceed those of the typical value fund over the past decade. Patience is crucial, since returns can fluctuate unpredictably, rising in years when managers sell profitable investments and stagnating when they hold a lot of cash.

Because of the stock market sell-off, share prices of many of these players are cheap vs. historic norms. And after largely sitting on the sidelines during the bull market, many of the companies are flush with cash. They are positioned to take advantage of lower stock prices as well as a projected spike in the default rate for U.S. speculative grade bonds. BusinessWeek's guide to leading publicly traded value players is a good place to start your research.

LEUCADIA NATIONAL

New York-based Leucadia owns everything from a biopharmaceutical company to wineries to a 38% stake in Light & Power Holdings of Barbados. Once weighted toward insurance, the company's portfolio now tilts toward natural resources, including Australian iron ore producer Fortescue Metals Group and Goober Drilling, a Stillwater (Okla.) oil-and-gas concern.

Chairman Ian Cumming and President Joseph Steinberg practice "the epitome of distressed investing," says Steven Rogé, whose Rogé Partners (ROGEX) and Rogé Select Opportunities (RSOFX) funds are shareholders. After Hurricane Katrina nearly destroyed the Hard Rock Hotel & Casino Biloxi, Miss., in 2005, for example, Leucadia bought about half of parent Premier Entertainment Biloxi. In 2001, with Berkshire Hathaway (BRK), it purchased half of bankrupt financial-services company Finova Group. More recently it bought some 25% of subprime auto lender AmeriCredit.

Cumming and Steinberg are often compared to Warren Buffett—and not just for their strict value approach to investing. Like the Oracle of Omaha, the two write engaging letters to investors. "Shareholders who gamble are encouraged to come visit the [Hard Rock Hotel & Casino Biloxi] and leave some money behind!" the most recent one reads. "As always, the odds favor the house, but in this case you own the house." Also like Buffett, Cumming and Steinberg tend to be shareholder-friendly. In 2006 each earned a relatively modest $678,362, in addition to stock-based compensation linked to Leucadia's performance. Between the two, they own some 25% of outstanding shares.

Leucadia trades at 46, and Morningstar analyst Ryan Lentell is in the process of revising his fair-value estimate of 39 upward. "If you're going to buy and hold for a long time, you'll do well," he says. Since 1979 the stock price has appreciated a compounded 25% a year, on average.

WHITE MOUNTAINS INSURANCE

White Mountains Insurance Group (WMT) in Hanover, N.H., buys troubled insurers and then engineers turnarounds. The insurance properties throw off cash White Mountains can use to finance acquisitions. But when markets get frothy, management hoards cash rather than risk overpaying. "Intellectually, we really don't care much about leaving our capital lying fallow for years," the company says on its Web site. "Better to...wait for the occasional high-return opportunity. Frankly, sometimes shareholders would be better off if we just all went to play golf."

With insurance experts, including Buffett, predicting an industrywide profit decline this year, White Mountains's stock is down 6% since Jan. 1. It trades at 476, a hair above its per-share book value (assets minus liabilities), a measure often used to value financial-services firms. Consistent with Buffett's outlook on insurance, Berkshire Hathaway recently sold its 16% stake in the company. CEO Raymond Barrette cited the growing rivalry between the firms. Other value investors see an upside: Shareholders include Mutual Beacon Fund. Morningstar analyst Jim Ryan estimates fair value at 625.

ALLEGHANY

Like many in the deep-value camp, Alleghany (Y) shuns publicity. It doesn't hold quarterly conference calls. Wall Street coverage of the New York company is virtually nonexistent, in part because with lots of cash and little debt, it doesn't often hire investment bankers. Alleghany, which focuses on insurance, also has seen its shares beaten down. That has attracted bargain hunters at fund companies Franklin Mutual Advisers and Royce & Associates. At 342 a share, the stock, up an average 20% a year over five years, trades at a hefty discount to its 518 fair value, Ryan figures.

Alleghany, founded as a railroad holding company in 1929, also owns a portfolio of stocks and bonds. A big winner: Burlington Northern Santa Fe Railway (BNI), on which it has earned over 500% since 1994. Recently, Alleghany bet successfully on energy stocks, which comprise 32% of its equity portfolio.

PICO HOLDINGS

Small-cap PICO started out as a medical-liability insurer in 1981. Now about 70% of assets are in the rights to underground aquifers and other water resources in Southwestern states. "It's one of the better water-asset plays," says Jesse Herrick, who follows alternative-energy technologies for San Francisco institutional broker Merriman Curhan Ford (MERR). PICO also has a portfolio of big-stakes investments that enable it to play a role in management. They include 23% of Jungfraubahn Holding, a railway in the Swiss Alps.

In the 14 years that current management has been at the helm, the stock has delivered compounded average annual gains of 18%—more than twice that of the Standard & Poor's 500-stock index. But housing woes have raised concerns about water demand, sending the La Jolla (Calif.) company's shares down 7% this year, to 31, just above its book value of 27. Herrick puts fair value at 62 to 67.

BROOKFIELD ASSET MANAGEMENT

Over the past five years, Toronto's Brookfield has transformed itself from a wide-ranging conglomerate into a company largely focused on real estate, power, and infrastructure properties. Those include prime London office buildings, millions of acres of timber, and hydropower generating plants around the world. The rationale? Such assets generate steady returns and last a long time without requiring large ongoing investments.

Managing partner J. Bruce Flatt recently invited institutional investors such as pension funds to invest alongside Brookfield. In return for managing the money, Brookfield pockets a small annual fee. The stock, up an average 36% a year since Flatt took over in 2002, has pulled back, partly on concerns about real estate. At 27, it trades below Morningstar's 34 fair-value estimate. Among the shareholders betting on Flatt: vulture Martin Whitman of Third Avenue Value Funds.

Tergesen is an associate editor for BusinessWeek in New York .

Status/Strategy Report

BAM.A Brookfield Asset Management--> I think the market deeply misunderstands this company as a REIT. A relatively small share buyback of 1 million shares was just completed this month (remember the market cap is $17 Billion). I have put in a standing bid for more shares at $25, hoping that this bear market rally will collapse soon and drag BAM down with it to even cheaper levels. It is definitely possible that BAM may find it more difficult to find other equity partners to make their multi-billion dollar deals with in the current environment-- without such a catalyst, I doubt that this stock will take off any time soon, so I'm biding my time to acquire shares in small increments, slowly.

BBSI Barrett Business Services--> Remains debt free despite acquisitions. I went over the annual report in detail and barring one accounting irregularity, the company's prospects appear solid. The irregularity was an internal control problem with the IT dept regarding the cash management and reporting of cash flows between offices and the head office in Vancouver, WA. The remediation procedure was well covered. I'm surprised that the analysts didn't bring it up in the Q4 conference call but it may be possible that this information wasn't available to them at that time. Accounting irregularities of any type do make me nervous so I may wait for another quarter before adding to my position as I previously planned. I doubt that this issue will make a material impact on the company's financial health and it is the only big question mark/vunerability I can find to date. This company is maximally exposed to the turn down in the local California economy, so we are seeing the company remain profitable and debt free during adverse times, something that strongly suggests a large margin of safety despite being a small cap security. I think that the management is top notch.

KMX CarMax--> Wall St. is not enamored with this stock but its customers and employees certainly are. I've been hard pressed to find any negative feedback about it, even on the Motley Fool discussion boards. It's not dirt cheap at a P/E multiple of 20; however, the following issues add to the margin of safety: EPS growth exceeding 16% p.a. over the last 5 years, the lowest leverage in the industry D:E 0.12, a current ratio of 2.4 and committed management with considerable insider ownership (7%) and let's not forget that Berkshire is a major holder (10%). Their business plan (discussed previously) is solid and difficult to replicate.
Like BAM, I don't expect the share price to appreciate much in the next 18 months and I think recession has been already factored into the share price. Despite small-mid cap status, I think it is another good long term hold that I will add to on dips. Morningstar has reaffirmed its fair market value at $32/share recently and since its currently trading at about $19 this gives a P/FMV ratio of 60%. I would buy at any price less than or = to $19.

CKI Clarke Inc--> Definitely not a boring company. Armoyan (the CEO/President/Chair all in one) is aggressively buying back shares personally and through Geosam, a holding company owned by his family. He is still buying up small Canadian trusts and although I can see the strategy he is using paying off over the long term, I am concerned about debt. The annual report suggested a current ratio of over 6; however, recent investments (and share buy backs) will have consumed this readily available cash. It's difficult to estimate CKI's total short and long term debt with the information I have available. The last D:E ratio was 0.67 and I'm guessing it's closer to 1 now. I plan to hold tight with my fairly large stake until the next financial report. Unfortunately, Clarke doesn't host conference calls so the tough questions don't get asked. Armoyan is no dummy and he has a massive stake in this company, so I think that his interests are still aligned with the shareholders--- definitely more so in Clarke Inc that in the trusts he's swallowing up.

Brace yourself

After deep share price valleys in almost every equity yesterday, the same shares are up 5-10% in one day--- all because of the anticipation of a full point shave by the US Fed. I wouldn't be surprised if the market slumps again sometime next week, particularly if there's any more bad news along the lines of Bear Stearns and the like.

My current approach has been to set limit orders for the best quality equities that represent the greatest discount to intrinsic value. If new cash for investment is short (and when isn't it? ;-) ), I allocate capital equally between shares that I already own that I rate based upon (in order):

1. Discount to Intrinsic Value. I do my own calculations by guesstimating discounted future cash flows and compare them to Morningstar's. They are usually pretty close although I'm guessing the model Morningstar is using is more sophisticated than mine. 20%+ discounts get my attention-- this would mean that the company would not have to grow earnings beyond their current growth rates in order for me to profit. example: LM's discount is now 50%. Try it yourself: DCF CALCULATOR.

2. Capitalization: No Debt or if in a capital intensive sector, a current ratio >2.0 and high free cash flows sufficient many times over to cover interest payments. This is the mistake I've made several times in the past, particularly in small to medium cap businesses that did not anticipate the storm coming and it wiped them out despite excellent products, profit margins etc etc. Buffet's favourite saying is, "When the tide goes out, you get to see who's being swimming naked". i.e. KMX, COLM, SEB, BBSI, AXP, DELL, CSCO

3. Committed Management with an excellent track record, double digit ROIC and ROE and high (>10% depending on the market cap) insider ownership. This folks will usually buy more when the stock drops, building in a floor for the share price. i.e. BAM, SEB, BBSI, AXP, CSCO. Notice how BBSI and SEB (both with >30% CEO ownership)'s share price has actually INCREASED over the past 2 months, unlike pretty much everything else, even the oil companies? The management's understanding and commitment to their business is unwavering. This is a strong endorsement for the shareholder.

4. I prefer companies that have a global footprint to take advantage of overseas growth, yet have US SEC oversight and are not so large that they are unmanagable. I quite honestly do not trust Chinese or Indian financial reports. They are only worth the paper they are written on. I prefer the businesses that I have part ownership of to be accountable to the US, where they will happily incarcerate fraudsters for 20 years when they inevitably get caught. This is in stark contrast to Canada, Europe and Asia where executives very, very, very rarely do jail time even after flagrant theft and incompetent stewardship of shareholder's hard earned money. i.e. BAM, COLM, SEB, COV, GSK, BMY, LM, COP, CX, DELL

I suggest that you do not buy on the fed rate cut rally. Wait until the almost inevitable--- Mr. Market will get depressed again and a great buying opportunity will present itself like yesterday.

When will this all turn around? I don't know. Hang tight and enjoy the ride.

Why it's better to own the asset managers rather than their crappy mutual funds

... because they don't just have a license to print money- they have their hands in your pocket too! (Read this Economist article)


Despite this sad fact, I think the industry will only grow as the population of the world ages. People are generally bored by money matters and I think they will continue to give their hard earned cash to bozos who happily follow the other Wall Street lemmings over every asset bubble cliff that will come along and then be very smug about "at least matching or slightly beating the Market".

Don't fight 'em-- join 'em!

I own LM, BAM and have a bid in for AIG. I am interested in ORI as mentioned before.

l

This month's focus

in my portfolio I'm focusing on looking for dips to add to positions in:

1. AXP American Express-- one of the best companies for the long term now (big time insider buying also)
2. LM Legg Mason (new CEO recently bought 1 M worth of stock)
3. ORI Old Republic Insurance-- a conservative way to indirectly buy the monoline mortgage insurers eventual recovery without losing your stake if they go bust-- a very well managed high dividend paying company regardless
4. HOG Harley Davidson (see this article)
5. MCO Moody's
6. BBSI Barrett's Business Services
7. CKI.TO Clarke Inc.
8. BAM.A.TO Brookfield Asset Management
9. CSCO Cisco--- cash machine with massive market share
10. KMX Car Max----extremely well managed Buffett pick with some recession potential
11. DELL-- much maligned cash machine avoiding di-worse-ification despite lots of acquisitions.

I've covered all but ORI in previous posts. I'm hoping for some more ugliness to wash out in the market so I can get more of these real cheap. The uglier the better. I'm finding these short term stock rallies very annoying ;-)

I believe (as does Morningstar) that all these equities (except perhaps Clarke Inc.) are trading with at least a 30% margin of safety.

l

More on BAM- Brookfield Asset Management

For an honest, insightful and succinct view of this amazing company and it's view going forward read J. Bruce Flatt's shareholder's letter here.

Note: Infrastructure oriented companies can't be assessed by the standard metrics like P/E and P/B ratios. Cash flow/share is the best fundamental number for comparison when you have a company that owns toll bridges, hydroelectric dams and entire forests as well as malls in Brazil and the Middle East.

The truly global footprint, superb management, strong balance sheet and share price hanging close to 52 week lows makes this one of the safest and most attractive long term investments I've seen in a long time.

I plan to accumulate a position in small quantities over the next year and hold them in my personal RRSP.

l