Tag Archives: Miller Industries

Pepsico, Inc. (PEP) Value-Line Case Study

Robert L. Rodriquez, CFA and CEO of First Pacific Advisors in a speech to Institute for Private Investors on Feb. 15, 2012: “I met Charlie Munger in my USC graduate school investment class and had the opportunity to ask him this important question, “If I could do one thing to make myself a better investment professional, what would it be? He answered, “Read history! Read History!” This was among the best pieces of advice I ever received.”

The full speech  at Gurufocus is here (scroll down for the direct link): http://www.gurufocus.com/news/162873/caution-danger-ahead–r-rodriguezfpa

Value-Line Analysis of Pepsi

Our last analysis of a Value-Line Tear Sheet was Balchem (BCPC): http://wp.me/p1PgpH-CY

Now lets look at Pepsi Co., Inc. (PEP): Pepsi_VL

Without glancing at price (easy to do when flipping through the Value-Line at the library or open the digital PDF while looking away from your computer, scroll down and then focus on the numbers) I see Return on total Capital (ROTC) of 30% to 16%, now in the high teens. Return on Equity has ranged 42% to 29%. The 80% higher ROE than ROTC means debt is helping boost returns significantly. Debt is useful as long as its doesn’t impair the company under stressful conditions. The ten-year history of 16 to 25% ROTC shows that this is probably a franchise. Good. Value will be in the growth.

As a review for beginners from Value-Line:

Return on Shareholder Equity, meanwhile, reveals how much has been earned on just the stockholder equity. Value Line calculates this by dividing net profits by shareholder equity, which includes both common and preferred equity. Again, higher percentages are generally better.

Neither of these measures can be used in exclusion, however. They are best used as a starting point or as a comparison tool. Note that comparisons between companies in the same industry will provide more insight than comparisons between companies in different industries. Indeed, because of the differences between industry fundamentals, some industries will have a preponderance of low scores while others will have large numbers of companies with high scores. That said, using these two measures as a first screen can help to quickly limit the number of companies under review and will, generally, direct investors toward higher quality entities.

It is also interesting to compare these two measures for the same companies, which can provide insights into how well companies are making use of their debt. For example, if Return on Total Capital is going up but Return on Shareholders Equity isn’t following along, or, worse is static or falling, additional debt financing isn’t benefiting shareholders.

Another statistic to consider along with these two is Retained to Common Equity, which is colloquially referred to as the “plowback ratio”. Value Line calculates this measure by dividing net income less all dividends (common and preferred) by shareholder’s equity. It measures the extent to which a company has internally generated resources to invest in the company’s future growth. A high percentage here, coupled with an increasing Book Value, is a clear signs that management is increasing the value of its business. This can help validate both the above measures and provide a degree of reassurance that a business is self-sustaining. Like the other two measures, this data point is available in the Statistical Array of each Value Line report.

Back to the PEP Value-Line

Operating margins 20% and net profit margins at 10% with a slight trend down. This may be good or bad depending if margins will stabilize or go up. Even if the margins go down even more–if the company is earning more than its cost of capital and the market price is more pessimistic–then the company could still be a good investment, depending upon price. Just note the slight decline in margins, the business is under temporary stress? Higher capex, higher costs that are not passed through, etc.  We don’t know the details of the story, just a question we need to answer with further research.

Sales per share have been rising 8% to 10% for the past decade, and sales did not drop in 2009, so this company has a stable product with low cyclicality.

Book value shows a steady 6% to 7% increase. 40% to 45% of their earnings are being paid out to shareholders in the form of dividends, share count is declining very slightly. Good, the company is a slow grower and is returning excess capital to shareholders.  The danger might be if management leveraged the company too much.

A glance at the balance sheet shows $26.8 billion in long-term debt; $5.5 billion in net pension obligations and 1.6 billion in cap. leases then subtract 3 billion in cash so we have 30.9 billion or $31 billion in net debt (round up) to add to the market cap to reach our Enterprise Value (Remember we are buying the whole company including its debt). With 1.55 billion shares that is $31 debt/1.55 shares or $20 of net debt per share.

I see about $6 of “Cash Flow” and about $2 of capex for $4 of FCF per share. Note the jump in Capex from 2009 to 2010-what happened? With no growth I certainly would pay $40 to $45 for about a 10% return if I was confident of the company’s franchise. All metrics have grown 7% to 10% over the past ten years. Can that growth continue? This company seems like and inflation pass-through–Sales and profits will rise at least as fast as nominal inflation on average. Good. So if this company could grow at 5% to 6% and I was confident of that growth I would pay $65 to $80 per share for that cash flow, but my confidence level for that future growth had better be high.

Anyway, I have about $40 no growth value for the company but more like $65 to $80 for the business if I assume 5% to 6% growth–like buying a bond. My alternatives are 3% for 20 year US Bonds.

Now to the market price, I see we have a $66 share price as of April 4, 2012 so the market cap is 1.55 billion shares x $66 or about 102 billion but for simplicity–$100 billion then add the 31 billion in net debt for a total of $130 billion for the business (133 billion if we wish to be more precise) for an Enterprise value of $84 to $85 per share.

My range is $65 to $80 (aggressive assumptions?), so the company is out of my range by $5 to $20 or a 5% to 25% swing in price), but a swing of 10% to 15% in price (thank you index selling!) could make this an attractive investment.

Now I do a quick double-check. I have about $85 per share in enterprise value divided into $4 of FCF for an earnings yield of 4.7%. Growth has averaged 9% for the past ten years and I will knock that down to 4% to 6% to be conservative, then add that to 4.7% earnings yield–over 45% of that earnings yield is being paid out to me in the form of a 3.5% dividend yield based on the current market price. Now I have a range of return 8.7% to 10.7%. Not bad assuming I can have confidence in the franchise which 80 years of history leads me to believe I can. However, I do need to note the issues I brought up like the increase in capex from 2009 to 2010, insider activity and the terms of the company’s debt (ALWAYS check terms of debt and READ THE PROXY).

The company trades at a market multiple but is an above average company. If I HAD to own stocks, I would own PEP because you are getting an above average company for the market price. However, I (not you perhaps) seek a 12% to 15% return. A $8 to $15 dollar drop (certainly possible) could make this very attractive to me. Conversely I could sell a 2013 or 2014 put at a 55 strike for the amount of shares I would wish to own (I want a 20 to 25 company portfolio of “cash gushers” to supplement my spin-off asset investments).

I place this in the #2 work-on pile. Remember not to fool yourself. If I drove up to Pepsi’s headquarters in Purchase, NY (20 minutes from where I live) and spent two years studying the company, I don’t think I would understand the business better than reading the last 5 annual reports and proxies.  PEP is a world-wide conglomerate operating in 100 countries with 100s of different products in major food categories. I am looking at this more as a financial machine. Since the company is selling consumer products (branded food) I know the operational risks are lower than a cyclical steel company.  I will look for bombs on the balance sheet or any tricky accounting. If I can’t understand the financials, then pass. Time spent 2 minutes.

Miller Industries, Inc. (MLR)

Anyone want to take a crack at MLR: MLR_VL? I will post your analysis.

Our Job Search Continues….Advice from Readers and Sleuth Investing

 “Politics: “Poli” a Latin word meaning “many”; and “tics” meaning “bloodsucking creatures”.”–Robin Williams

Our Job Search Continues

We will continue from our last post discussing a search for a job at a hedge fund found here http://wp.me/p1PgpH-lB

Several readers contributed insights that expand on my narrow, eccentric view.  I want to repost some of their comments:

PT writes: As a side remark, I believe you should also be aware that there aren’t that many real analyst jobs available at funds. First of all, the same team often manages different funds. Secondly, from time to time they are actively recruiting but the boutique investment funds for example are not recruiting on a regular basis. Therefore, I believe going your own way is probably a rewarding one in the long term. By going your own way, I mean doing your own research, talking to people, writing about your findings, etc. It is probably a cliché but…for example if you are not printing an annual report and reading it (at home) because you are curious and have fun reading it…you are probably not made for it. When you have a clear investment process, valuation techniques, thinking outside the box mentality, etc. etc. you probably get involved into better and better discussions with other people (fund managers) as well.

From  llmarsii

I strongly agree with your point about figuring out what one’s true passion is. I can’t remember where I saw this (maybe from one of the videos that you actually) but I believe there’s a clip where Bill Gates talks about the 10,000-hour rule in Malcolm Gladwell’s Outliers. Gates mentions how the rule is more tiered than linear, e.g. you do the craft for a hundred hours, then 50% of the people stop and after 500 hours, 70% of the people quit, etc. By extension, I think first determining one’s true passion and then the discipline to dedicate 100% of one’s effort are very underrated keys to success.

Here are two of my favorite “motivational” videos that I would like to share:

1.  Will Smith on Success: http://www.youtube.com/watch?v=q5nVqeVhgQE

2. Maybe it’s my fault: http://www.youtube.com/watch?v=cEVCjUG1Mww

Also, to PT’s point, I’ve observed that many good investors don’t hire teams of analysts.  My guess is that they limit their investment decisions to their circle of competence and must invest in something they have researched and fully understand.  Nevertheless, there are still great investors that use/have used the help of analysts (Graham, Einhorn, Klarman). The struggle for a young aspiring investor with financial difficulty is s/he may not have the financial means to start independently yet it’s often hard to find a real research-based analyst job.  With that said, I’m confident that anything is possible with hard work, perseverance, and time. END

Skills not Credentials

Wonderful advice from those readers. Reviewing the previous post, I seemed critical of MBAs and CFAs. No, those are great credentials, but having gone through those programs is neither necessary nor sufficient to developing into a good investor. Certainly, a hiring money manager may think that if someone has completed a Columbia MBA, then the candidate is smart and motivated so one less worry in that hire. But what they really want is someone with the ability to find, research/analyze and communicate in order to help he or she add value for his clients.

Show Your Passion, Skills and Strengths

How can you leverage your time and efforts to learn while pursuing your job search? You can follow the lead of Michael Burry who posted his investment ideas on various web-sites to obtain feedback to improve his process. He not only learned but he got “discovered” by Joel Greenblatt. Yes, luck was involved, but he pursued his passion while learning. Burry also realized that if HE was to be successful he was going to have to do it his way and not just be a mimic of Buffett—just as Buffett went his own way versus Graham’s style.

Whether you only have $3,000 to invest or $300 million, you want to keep careful track of your reasons for each investment so over and over again you can go back and try to see your patterns of thinking, success and failure to improve. Learning for your mistakes is often harder than it seems, but you would be surprised how few professionals ruthlessly do it.

The Sleuth Investor

So how does that help you find a job? You need to show someone the quality of your thinking/work so they have a compelling reason to hire you. Depending on your personal situation look around in the town where you live and what businesses or industry catches your attention? One day, I flipped through my Value-Line at the library and came across Miller Industries, Inc. (MLR), a tow-truck manufacturer- MLR_VLhttp://www.scribd.com/doc/80380931/MLR-VL. And Tow-Truck Magazine http://www.scribd.com/doc/80381569/Tow-Times-Miller-Industries.

I noticed the high returns on capital prior to 2007 and wondered how can a dinky tow-truck company earn such good returns, and then why was there a decline in ROA? Could I normalize earnings and was this a good business?

In the 10-K I saw that the business wasn’t that capital intensive plus the industry structure was more like a monopoly with MLR having a dominant share. In fact, a few years back, Miller was sued by the U.S. Justice Department to prevent an acquisition. Miller buys trucks beds at cost which they pass onto to the customer, then they make their money in assembly of the hydraulic winches and pumps plus providing parts to the dealers. Similar to Catepillar, success was driven by their dealer relationships. The wider selection of models, the better product offering for the dealers, while more dealers improved sales and service which allowed for economies of scale in making tow trucks. The strong become stronger. The decline in capital seemed temporary due to a retooling and restructuring investments plus the drop in sales due to the recession. Also, even I could grasp how the tow truck business worked.

To prove this to myself, I called on tow truck operators, dealerships and competitors. Sitting in a tow truck at 11 PM on a freezing Chicago Winter’s night, I learned about the importance of a strong dealer network. An operator doesn’t buy a tow truck to take Betty Lou to the drive-in; he or she buys a capital asset to make money. If the capital assets is out of service, then costs mount quickly. The winch stopped working while pulling out an over-turned bus. The dealer had two mechanics out there within 35 minutes and a hour later, we were up and towing the bus to its garage.

The analyst can writeup an industry map, show how the competitive dynamics work, prove that the company has strong assets (dealer relationships) that are reinforced by economies of scale as shown by their market share and low unit costs by work done outside of just the 10-K and normal analysts’ reports. When in 2009 the company was trading at a $36 million enterprise value with excess cash, you could buy the business for well under liquidation value plus its growth would be profitable. No one on Wall Street was covering the company. Yes, you have to spend a few nights drinking cold coffee, and driving around with a guy who chews tobacco, but go the extra mile.  The investment worked out, but I no longer own the company’s stock. The point is to show you can do deep due-diligence and original work on your own.

Go back to this post on the Sleuth Investor: http://wp.me/p1PgpH-W to learn how to do more in-depth research.  I can guarantee you will set yourself apart.  You can even check your work by sending your report to the CEO of Miller or a competitor and asking what might you have done better before you send it to a small/micro cap money manager. You will receive feedback and may even get referrals to other opportunities.

Many Ways to Heaven

Also, Wall Street is not the only place you can research companies. You can work for the M&A depart of a corporation; you can do investigative business journalism; you can become a loan officer, etc.  There are many ways to go to heaven.

Leave Your Comfort Zone

Granted, you might be out of your comfort zone like Gene Hackman, but you will learn: We Are Family http://www.youtube.com/watch?v=dYLk34GCXbo Turn up the volume after the annoying 30 second commerical (I don’t put those there!)