“Communism proposes to enslave men by force, socialism — by vote. It is merely the difference between murder and suicide.” – Ayn Rand
Reading the News
I ignore the headlines because the news generates too much distracting noise. For example, (yesterday, April 3, 2012) markets sell off because the FED will not continue with Quantitative easing “It’s just surprising that so many investors had expectations all over again that we would get an announcement that could indicate QE3,” said Zane Brown, fixed income strategist with Lord Abbett. http://www.cnbc.com/id/46942271.
Watch what they do not what they say: http://scottgrannis.blogspot.com/2012/04/with-no-shortage-of-liquidity-more-qe.html or go to the Federal Reserve Data Site: http://research.stlouisfed.org/fred2/series/STLFSI. If you couple the current data with Austrian Business Cycle Theory (“ABCT”), you know “quantitative easing” is at full throttle. Go Obama!
Part 4: Using Value-Line
In the first 45 seconds, the video describes Buffett’s search for “cigar butts” through looking through Moody’s Manuals: http://www.youtube.com/watch?v=35u8hoVIguM&feature=relmfu
Here are several Buffett investments found through Moody’s manuals (Interesting blog): http://compoundingmachines.wordpress.com/category/warren-buffett/
Go to Part 3 of our series on Value-Line http://wp.me/p1PgpH-CJ to download the Case Study on Balchem if you have not done so.
Balchem is found in the Value-Line Small Cap Edition with only 8 or 9 years history. I penciled in Balchem’s 2011 numbers from their most recent (FY 2011) press release. Go here for the Value-Line: BCPC_VL
I IMMEDIATELY glance at the return on total capital (return on total capital is annual net profit plus ½ of annual long-term interest divided by the total of shareholders’ equity and long-term debt) and Return on Equity, ROE. Both are mid-to-high double digits for the past 9 years. Returns over 15% on total capital are strong and since returns track ROE there has been no-to-low levels of debt to fund growth (almost no pension obligations). Book value has been growing on average 20% per year. The company is growing through internally generated funds and excess cash of over $4 per share (144 million) in 2011.
A glance at the balance sheet shows only $3.4 million of LT debt versus $100 million (and more recently $145 million in cash in FY 2011). Here is a strong balance sheet which reduces bankruptcy/default risk. Good.
The business has steady and high returns so I classify tentatively as a potential niche franchise. The company is generating cash so what are they doing with the cash? They are raising their dividends and letting cash build up. Shares are rising minimally but not shrinking. Good.
I jump up to sales and see a 10% to 14% rise in sales per share over the past 9 years with a blip down in 2009, but cash flow per share rose in 2009. All companies’ financial performance is somewhat cyclical but Balchem has shown amazingly steady results. Customers’ demand seems inelastic. The $290 million in revenues means the market is relatively small for their products? There is a need to understand the market size for this company’s products.
Sales are about $270 to $300 million so the business seems relatively small. Market cap is sub-$1 billion. Three analysts follow the company. There probably isn’t much following on Wall Street since the company doesn’t raise money through Wall Street. But with performance being so steady for the past 10 years, this is not an orphan stock.
I estimate Free Cash flow is $about $1.30 or $1.60 – 0.28). To put a back of the envelope value I take $1.30 and divide by a cost of capital of 10% to 11% minus a perpetual growth rate of 5% to 6% (real growth of 2% and 3 to 4% of nominal growth) which–based on its past 22% growth in sales, earnings, cash flow and book value over 10 years–seems conservative. This past year, though, profitable growth “slowed to 10% to 14% in sales to cash flow per share. Perhaps there will be an immediate slowing of growth. If cash is building up then perhaps growth opportunities are harder to find? A $1.30 per share in FCF divided by (r-g) or (11% – 5% or 10%-6%) or $22 to $32 then add back the $4 per share in cash to get an estimate of $26 to $36 per share. This is a down-and-dirty back of the envelope use to ball park my urgency.
STOP! I use a DCF because this company is being valued on its future growth, but with three divisions, I will need to break out the valuation of each business–perhaps do a sum of the parts. This exercise is simply to ball park a tentative range of values to assess my urgency of doing more work on the company. It is NOT a comprehensive valuation!
Balchem seems reasonably priced. If the market were to believe the growth could stay at 10% for several years then probably in the $40s.
Right now, I am looking at a company with a good balance sheet that has grown at a high (15% to 22% rate) for the past 5 to 10 years through internally generated funds. This seems like a good business but I do not know what are the sources of competitive advantage. Is the company experiencing a hiccup or a more fundamental competitive issue in its markets? Problem #1.
Can I understand this business? There are three segments: Choline Chloride to feed cows, sterilization products, encapsulation products for the food industry. I don’t know, but I will read the last two years of annual reports of the business description and Management MD&A to see if I can get at the source of their returns and the market size of their products. Problem #2.
This may be time-consuming so find an hour to review. This business seems like it is a niche company compounding its capital at double-digit rates—it warrants the time. If the price dropped into the low $20s or high teens, there might be a good opportunity to buy. Do the work now, if you can grasp the business and what drives the company’s returns and whether it operates within protective barriers to entry.
If growth slows and cash keeps building up what will management do with the excess cash? Check management ownership and share ownership. Problem #3.
Verdict put this in the Read Annual Report File.
Retained to common equity also known as the “plowback” ratio,” is net income less all dividends (common and preferred), divided by common shareholders’ equity and is expressed as a percentage. It measures the extent to which a company has internally generated resources to invest for future growth. A high plowback ratio and rapidly growing book value are usually considered positive investment characteristics.
All dividends to Net Profit, or “payout ratio, “ measures the proportion of a company’s profits that is distributed as dividends to all shareholders—both common and preferred. Young, fast-growing firms reinvest most of their profits internally. Mature firms are better able to pay out a large share of earnings.
How do companies’s operating margins compare with the industry’s operating margins? Better
How do a company’s net profit margins compare with the industry’s margins? Better
Are a company’s returns on total capital and on shareholders’ equity greater or smaller than those of the industry? Better
The problem I see in deepening my analysis of Balchem is just my ability to understand the business, but I would need to check this by at least reading the annual report.
Comments and complaints welcomed. I will proceed with the Pepsi and Miller Industries in the next few posts.
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