Finding Value. More on JCP. Dell at 2xs Earnings?

How to find value (Video Lecture) http://youtu.be/MxgGHJ2K0xQ   Basic, but a good review. To download the presentation go here: http://www.asx.com.au/resources/asx-podcasts-2012.htm  http://rogermontgomery.com/about/

Century Management Valuation Video http://centman.com/insights/2012/11/jim-brilliant-play-all-3236/

More on JCP 

Michael Price: http://www.businessweek.com/news/2012-09-21/price-bullish-on-j-dot-c-dot-penney-on-pent-up-demand-tom-keene  In the video Price mentions $15 per share of real estate value. (Don’t take that on faith.)

AckmanJCP and a recent review of the last quarter from an intelligent investor http://www.gurufocus.com/news/196924/jc-penney–my-thoughts-on-q3 (He refers to the Ackman presentation.)

JCP Tilson Analysis

My take: Turn off the price news and just look at the business as if you owned it. It is a tale of two cities (Dickens). The old JCP (which is the majority of sales/profits) is sliding faster than expected as the typical/traditional customer is confused, while the new JCP is doing well. In the long run this is good news but in the short run the news is worse.

Ron Johnson had this to say about the future of Penney’s on the conference call: “It’s really becoming a tale of two companies… one is J.C. Penney, a promotional department store; the other is jcp, which is a start-up, which is a specialty department store. And it turns out what’s good for one isn’t necessarily good for the other – and that’s why we’ve seen this year, J.C. Penney has performed tougher than we’ve expected… but the good news is jcp is much better than we imagined. As we wind down J.C. Penney over the next 36 months, my job is to deliver as best it can and generate as much cash as possible to fund the new jcp.”

Will management just do the same thing if sales keep dropping at the same rate? Probably they will look to sell some of their real estate while being more aggressive on a simple discount plan.

Yes, I agree with a reader that JCP is a “special situation” or transformation. You have a good vs. bad business here. But you also have hard assets of decent real estate and a balance sheet that isn’t too indebted so there may be replacement value for the real estate. However, retail is a very difficult business. More “value” investors hit the rocks in this industry than in any other except financial.  Be very careful to get a rediculous price or stay away. It is hard to buy a lot of JCP when you have CSCO, INTC and other franchises at decent prices.

However, institutions who have owned this stock probably want out so expect continuous pressure and volatility with the stock price which is good for patient buyers. There might be an opportunity to see JCP trade at its real estate value with little or no value imputed to the new JCP.  But if you are confused or uncertain of the value or the risk/reward, then walk away. Learn from the outcome.

The main lesson to be gleaned is to focus on the numbers and what the company is trying to do not the pundits.  Let’s revisit in 2014.

Southeastern 3 Q 2012: Longleaf_09_30_12

Few stocks detracted from returns. Dell fell 21% over the last three months, and the stock’s 33% decline in 2012 made it the primary detractor to the Fund’s performance for both periods.

The primary challenge over the last two quarters was a larger than-expected decline in End User Computing (EUC) revenue due to several pressures. Tablets and other mobility devices displaced notebooks more rapidly than anticipated; demand in India and China shrunk, where Lenovo aggressively priced to take share in these geographies; and commercial purchases slowed because of general economic weakness and the anticipated release of Windows 8. In spite of the decline in notebooks and PCs, margins held up in EUC, a testament to the company’s successful cost cutting and variable cost structure.

Far more importantly, the growing, higher margin Enterprise Solutions and Services (ESS) business had strong networking and server growth with servers gaining market share. While ESS represents about one-third of revenues, it constitutes over half of profits and a far higher share of our appraisal. The company’s transformation to a solutions-based company is well underway and leverages Dell’s direct distribution advantage of over 20,000 employees responsible for customer relationships with small and mid-size businesses. Interestingly, IBM successfully refocused its business over a ten year period starting in the early 1990’s from mainframe hardware to multifaceted technology solutions for large-scale customers. The head of IBM’s mergers and acquisitions was Dave Johnson, who joined Dell in 2009 to lead its strategy to enhance solutions offerings and has purchased a number of companies and products that have grown through Dell’s expansive distribution.

VALUATION: If we assume that EUC continues its rapid decline and has no value, we appraise the remaining ESS business at over twice the current stock price. With adjusted cash earnings of $2.00/share and an enterprise value of less than $3.50/share (share price minus net cash and DFS), the stock trades at less than a 2X adjusted P/E for a growing business (ESS) with good margins and an owner/operator as CEO who is focused on growing value per share.

Wow, I am skeptical Dell is that cheap. The question to ask is: “Does ESS have a competitive advantage? Because only then will growth matter.

 

15 responses to “Finding Value. More on JCP. Dell at 2xs Earnings?

  1. “Let’s revisit in 2014.”

    Will be interesting.

  2. Isn’t the answer to the Dell ESS question largely dependent upon whether there is a Dell “lock in” effect, similar to the “lock in” effect which Buffett finds in IBM. Go into hospitals or governmental agencies or small to mid-sized businesses, and you see Dell installations which have Dell service. The PCs, tablets and other box-equivalents are now the mechanism by which Dell obtains the long-term service relationship.

    • Yes, if Dell has customer captivity plus economies of scale. So we should see good profitability (normalized) in that devision. I don’t know Dell, but I think this is the key area to focus on.

  3. I wont keep on posting ad naseum, I promise, but I just had to mention this Bottarelli Research Tip: “JCP is in free fall right now. It’s so bad that I advised my wife to return a pair of mis-sized jeans ASAP in case JCP goes Chapter 11 before she can get to the store.”
    http://is.gd/mn3fL4

    The last time I heard that much hysteria was when BP was “going to go bankrupt in a week” during the Macondo disaster. I don’t remember who had that brilliant insight, but it sounds like something that Cramer would come out with.

  4. It is a very nice case-study – either to invest in or to watch the outcome (nicely formulated). Looking around a lot of ‘value’ investors are often interested in retailers but I believe few made money with it. I also follow the Spanish fund Bestinver – they made very compelling investment case for the UK clothing retailer Debenhams (it used to be in PE hands but then came back to the market) but they are however also struggling to deliver on the Dutch company Macintosh.

    It seems also one public investor already surrendered since I believe Tilson sold out of the position looking at his most recent 13F. This was their initial presentation: http://www.scribd.com/doc/94571779/Why-We-Re-Long-J-C-Penney-T2-Partners

  5. There is some real estate estimate in this last presentation btw.

  6. Dell is an interesting one. I think they have a decent reason for why it’s undervalued, and I’ll pose a few questions:

    1. Yes, ESS is a highly profitable division and is growing. How do we know that the margins here aren’t at a peak? Every competitors feels the pressure in the personal consumer segment – won’t they move to the enterprise division? What stops them from doing it? What are the barriers to entry here, if any?

    2. How much true “excess” cash does Dell produce, after all of their M&A? Dell does a decent bit of M&A, and maybe this is needed in technology based firms where the products sold rapidly change. In a sense, this is an alternative to R&D, and so it should, IMO, be expensed as such.

    3. Can we actually trust management? With such a low stock price relative to where they did a ton of buybacks historically, why would they issue a dividend? If the managers are really good capital allocators, they should not issue a dividend, and take advantage of the low price to buy back even more stock.

    I get the feeling that Dell is caught up with Wall Street & stock analysts. I think they’re buying companies to create & show growth, because that will get analysts more interested in the stock. I think they’re issuing a dividend, because that will get the stock moving up more quickly from dividend buyers. I think they initiated share repurchases in the past to pump up the stock price too.

    I think Dell has some decent businesses, however I do wonder about the ability for shareholders to realize it in the face of how capital is allocated.

    • “I think they’re buying companies to create & show growth”

      Ankit, that’s an interesting comment. Wasn’t the same thing being said about HP, where they used their cash pile to buy up businesses to mask deterioration? Jim Chanos pointed this out.

      I also wonder what people’s views on “mergers of equals” is. Should they be generally regarded as a bearish sign? Two examples I can think about here:
      1. Quite a few years ago (over a decade), some big UK pharmas (Glaxo and Smithkline spring to mind) merged together. In hindsight, it seemed that they had weaknesses in their drug pipeline, and this was a way to effectively disguise that weakness.
      2. Recently, UK defence company BA (British Aerospace) attempted a merger with aircraft manufacturer EADS. Analysts thought the move wouldn’t be feasible, and BA shareholders absolutely hated the idea. In the end, the analysts were proved right, and the whole idea was canned. I wonder, was the motivation by BA to basically hide the cyclical weakness of its business?

      Shoud we perceive these “waves of consolidation” as indicating problems ahead, maybe due to factors such as capacity oversupply, cyclic nature of the business, lack of growth prospects, or failure to invest? So investors in these areas should consider selling their holdings?

      Comments?

      • That’s a really interesting though Mark – I don’t believe I’ve ever heard this, you’re clearly thinking it through really well.

        Because this is limited to mergers of equals, I don’t have a lot of examples. The one I was thinking about in relation to capacity oversupply was the railroad business. Charlie Munger once mentioned that railroads were overbuilt and they didn’t become a good business until consolidation occurred. He said this in regards to telecommunications today – he said he doesn’t know much about telecom, but he saw the oversupply with railroads and wouldn’t be surprised if it is occurring today in other areas. So in some businesses, a merger of equals could be great. You have examples that are good too – it might be seen as a way to hide what is really occurring.

        As a side note, I would make sure to read John’s compilation of Henry Singleton’s items. He knew how to handle M&A far better than anyone I have come across. Buffett regards him as the best American capital allocator of all time: http://csinvesting.org/2011/09/20/henry-singleton-and-teledyne-a-study-in-excellent-capital-allocation/

    • Dear ANKIT: Excellent insights. Thanks. I need to do many posts on “growth” capex. M&A should be D&A or MCX 🙂 You hit the nail on the head. Dell, XRX (see below) make acquisitions to maintain their “growth” but at the end of the day what are the returns for their investments? Is Dell “cheap”? Perhaps, but Southeastern (Mason Hawkins who manages billions) is making a critical (IMHO) mistake AS YOU POINT OUT.–The $2.00 in EPS that he quotes is probably WAY overstated due to underestimating true capex. Note XRX overpaying to grow. You see this over and over.

      Believe me I have made the same mistake when analyzing companies.
      Now CSCO makes acquisitions all the time but at least they are following through on returning 50% of their FCF.

      See another smart investor who points out the same things…

      http://www.gurufocus.com/news/157348/xerox-corporation-overpriced-acquisition-increases-risk
      http://www.frankvoisin.com/2011/08/26/lexmark-international-lxk/
      http://www.frankvoisin.com/

      a PRIZE will be emailed to you. Sorry, Lindsay Lohan is in rehab now. Typically, the prize has been a date with her.

      • More: from http://www.gurufocus.com

        Einhorn came to a similar conclusion:

        David Einhorn on Dell (DELL) – Jul 24, 2012
        Dell (DELL) proved to be a disappointment. We had thought that the growth in the non-PC business would be enough to offset the deterioration in the PC business. The non-PC growth was smaller than we’d hoped and the PC deterioration was worse than we’d anticipated. While DELL has a good balance sheet, it appears likely that management will try to use much of the cash to try to buy its way into better businesses. At a minimum, this will erode some of the value cushion that the cash balance creates. We exited with a loss.Check out David Einhorn latest stock trades

        Bill Nygren Comments on Dell – Jul 10, 2012
        From Bill Nygren’s second-quarter letter:

        Today we are focused on the growth of Dell (DELL)’s non-PC businesses, whereas investors are worried about declining sales of PCs, a division we don’t think we are even paying for. In each case, if we are right, the fundamentals will force investors to reevaluate their prejudices, and we will profit from the repricing of the stock.
        Check out Bill Nygren latest stock trades

        Mason Hawkins’ Southeastern Asset Management Comments on Dell – May 23, 2012
        Summary: Of everything they own, they measure on intrinsic value of the business, and on that front Dell (DELL) has blown away all expectations. They are organically growing in the 20s; bears are focusing on metric they want to, that revenue growth is low. Southeastern does not care about that. Most relevant that they are growing profits. They are not worried about it at this point. Dell has evolved from a PC business to becoming the IBM for small and medium-sized businesses, domestically and globally. Sells for cheaper multiples than IBM and believe it will outgrow IBM in the next decade. Believes there could be a surprise after November when U.S. companies are not treated discriminatorily as they are today and our tax policies allow us to bring our foreign cash back to the U.S. Dell has $5 in net cash predominately overseas and if that comes back to the U.S., they will be more aggressive on the repurchase front therefore building more intrinsic value per share at low risk. That cash earns very little and contributes almost nothing to current earnings so there’s great opportunity to put it toward acquisitions to add to earnings power or used prospectively if we have the laws changed for us to repatriate it back to the U.S.

        Listen to complete audio here.

  7. You can also subscribe for the Marcus today investment newsletter at marcustoday.com.au

  8. Great article

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