Regular readers of this blog know that Mr. Biglari is both Chairman and CEO of Western Sizzlin (WSZL), a publicly traded holding company, and The Lion Fund, an investment partnership (or “hedge fund”). While at Western Sizzlin, he made a concentrated bet on Friendly’s (FRN) that paid off well. That seems to be his modus operandi – bet big and be heard.
This approach may sound similar to the one favored by many other “activist” investors – and perhaps it is, but based on what Biglari has done in his brief time at Western Sizzlin and some comments he made, I think it’s likely that (at Western Sizzlin) he will favor a more concentrated (i.e., less diversified) approach than almost all other activist investors.
That makes each mention of one of his investments a little more interesting. Generally, the more concentrated an investor’s portfolio, the more promise each position has as a source of good ideas for other investors.
The company reported its earnings and the stock is up $3.85 (or a little over 14%) as I write this. Obviously, the share price ($30.50) will be out of date by the time you read this – most likely there will be a lot of shares changing hands today.
I didn’t “call” this one. I just liked the stock long-term, because as I wrote on Monday:
This is a good business with a lot of debt and a lot of temporary, transitional stuff obscuring the company’s true earnings power.
Two major players, Hanes Brands (HBI) and Fruit of the Loom (a Berkshire Hathaway subsidiary), control most of the U.S. underwear market.
Hanes considers itself to be in the “apparel essentials” business which is to say the “t-shirts, bras, panties, men’s underwear, kids’ underwear, socks, and hosiery” business. In 2005, the U.S. apparel essentials market was about $44 billion. Apparel essentials have been growing faster than the overall apparel industry – still this isn’t a fast growing market. You’re unlikely to see sales growth exceed 5%.
Hanes divides its business into four segments: Innerwear, Outerwear, Hosiery, and International. The company doesn’t do much international business. Hosiery is a dying business with good margins. It generates cash; but, it’s going the way of the Dodo – fast.
That leaves innerwear and outerwear. Together these two segments account for something like 85% of Hanes sales.
Innerwear is underwear – and yes, it’s just as profitable by any other name. This segment is the heart of the company. It generates more than $2.5 billion in sales and plenty of free cash flow. Apparently, you can achieve low double-digit profit margins in this segment, which is impressive given the volume involved.
The innerwear business is a ridiculously high volume business. Looking at it solely in dollar terms doesn’t make that clear enough. So, let me give you some unit numbers.
Hanes manufactures and sells a billion socks a year – literally. That’s 500 million pairs of socks a year. Even the T-shirt business is high volume; Hanes produces about 400 million T-shirts a year.
The company’s biggest customers have high volume needs. Wal-Mart accounts for nearly 30% of the company’s sales. Does Wal-Mart have leverage over Hanes? Maybe. Does Wal-Mart have many other options? No. Hanes supplies them with well over $1 billion in product each year. It’s a cheap product that can only be produced in such volumes at competitive prices by a few companies on the planet. In the U.S., your choices are basically Hanes or Fruit of the Loom.
Furthermore, customers don’t contract this stuff. They simply buy what they need. The excess inventory costs on these high volume products could easily eliminate all the profit for any company that isn’t accustomed to producing on this scale. Hanes averaged total inventory reserves of just under $100 million a year over the last three years. That’s the cost of guaranteeing you have enough product to meet your customers’ needs.
Hanes employs a lot of people – and the workforce isn’t particularly cheap considering how cheap the product is to produce. Before the spin-off, Hanes employed close to 50,000 people worldwide. The vast majority of the company’s employees were located outside the U.S.; however, the vast majority of the company’s labor costs came from inside the U.S.
Using American labor to produce underwear isn’t particularly …
The first problem is self-explanatory and hasn’t changed since early 2006. The second problem has to do with a bad acquisition made by the company that has changed what the company looks like. Journal Register was once focused on communities with excellent demographics and thus excellent economics for newspaper publishers. Now, not so much. The Michigan properties are a real problem.
Finally, the debt. The biggest problem with the debt is simply that it exists. Journal Register’s market cap makes the company look cheap, but you have to take out the debt as well. Is the company worth much more than its debt load? No. Probably not.
If it weren’t for the debt, Journal Register would actually be an exceptionally easy takeover target in the most anti-takeover of industries. The company doesn’t employ the gimmicky protections most old media companies do.
The combination of a cheap common stock with a heavy debt load will amplify any changes in the value of the enterprise. We’re not far from the point where a 10% change in the intrinsic value of the enterprise would lead to a doubling (or halving) of the value of the common stock.
In that sense, this is a highly speculative stock – for better or worse.
It would also be a good investment if I was sure the value of the enterprise is clearly in excess of the debt. As it is, I think there’s a risk that the value of the enterprise and the value of the debt are too close for comfort. That doesn’t mean I think Journal Register will fail to make its payments any time soon. It just means I don’t think there will be a lot left over for shareholders when you consider I expect the bottom line to decline in the long-run along with the industry.
Of course, it is tempting to take JRC’s market cap and divide by what the company earned in the past. But, on an EV/EBIT basis the business isn’t nearly as cheap as the stock. That’s what I mean when I say this is a speculative stock – you only have to be right or wrong by a small amount in your estimate of the business value to make or lose a lot of money on the stock.
If you’re looking for a stock where leverage will amplify your returns, I still like Hanes Brands (HBI). It’s not as leveraged as Journal Register (though it has plenty of leverage) and it’s a much better business. Hanes was the most interesting spin-off of …
Energizer Holdings (ENR), a stock I’ve written about before on this blog, announced it will acquire Playtex Products (PYX) for $18.30 a share in cash (total consideration of approximately $1.9 billion). The size and nature of this acquisition looks like a perfect fit.
Energizer had made no secret of its desire to make such an acquisition. Playtex has some very strong brands. Of course, this will only broaden the front on which Energizer competes with Procter & Gamble (PG) – and that’s already the biggest mark against Energizer in most peoples’ minds. But, these are good businesses and it’s often better to be a smaller player in a good business than a larger player in a bad business despite what it does to your ego.
Posco (PKX) is another stock I wrote about here (and in my now defunct newsletter). Today, there’s only one problem with Posco – the price. When I first wrote about the stock in the April 2006 issue of my newsletter, the ADRs were trading under $65 a share. Now, they’re around $150 a share. Then, I wrote about the stock on this blog in March (after Berkshire’s annual report showed it owned about 4% of Posco). At that time, the ADRs were trading at over $90 a share. So, they’ve come a long way even from that post. I also reprinted my July 2006 review of Posco where I gave a “Best Guess” price of $124 a share and a “Suggest Selling” price of $190 a share and I wrote this:
The wide discrepancy between my best guess price ($124/share) and my suggest selling price ($190/share) for Posco is due to my being extremely conservative on the best guess price. Posco at $124 a share probably is fairly valued as a steel company – however, it’s probably not fairly valued as Posco, because Posco is a great steel company even if it isn’t a truly great business.
So, if you take me at my word and say that $124 a share was a conservative intrinsic value estimate and $190 a share was a good dividing line between investment and pure speculation you can split the difference and call it an honest estimate – without any undue conservatism – and that gives you $170 a share. I know that $190 and $124 don’t average out to $170, but the estimates do because of the difference in time – those value estimates were made in July of 2006, assuming I discounted by 8% (which is basically what I do whenever the long bond is below 8%) the average 2007 value would be something like $170 a share. A year later, that sounds about right.
The point of this little revisitation exercise isn’t to say Posco is worth $170 a share – I have no way of knowing that – but to remind you that (those of you who subscribed to the newsletter) were getting my views on the stock at $65 a share, those who read …
Rick of Value Discipline (one of The Eight Best Investing Blogs) has a good post on what goes into value creation. It’s an especially good post for new investors or anyone who isn’t intimately familiar with all of a company’s financial statements and how they interact. You don’t hear a lot about working capital management for instance and you almost never hear a serious discussion of cash flow that isn’t centered around the EBITDA multiples various acquisitions were (or might be) made at. The post is actually an excerpt from a piece Rick wrote for Market Thoughts.
When Standard Oil was broken up, eight of the resulting companies were small pipeline operators. Wall Street didn’t pay much attention to them. Little was known about their finances – and they liked it that way. Their “income accounts” literally consisted of a single line. They didn’t provide detailed balance sheets.
Ben Graham spent a lot of time looking through information provided by the Interstate Commerce Commission (ICC), a regulatory body that oversaw the railroads (among other businesses). One day, as Graham was looking through an ICC report, he found some statistics clearly furnished by the pipeline companies. The statistics were accompanied by a note that read “taken from their annual report to the Commission“.
Graham realized that the pipelines were filing reports with the ICC that contained information not known on Wall Street. So, he requested a blank copy of the report from the ICC. The blank form included “a table which required the companies to set forth a list of their investments at cost and market value.”
Ben left for Washington the next day. He reviewed the reports for all eight pipeline companies. What he found amazed him:
“I discovered all of the companies owned huge amounts of the finest railroad bonds; in some cases the value of the bonds alone exceeded the entire price at which the pipeline shares were selling in the market! I found, besides, that the pipeline companies were doing a comparatively small gross business, with a large profit margin, that they carried no inventory and therefore had no need whatever for these bond investments. Here was Northern Pipeline, selling at only $65 a share, paying a $6 dividend – while holding some $95 in cash assets for each share, nearly all of which it could distribute to its stockholders without the slightest inconvenience to its operations. Talk about a bargain security!”
Northern Pipeline had the greatest amount of securities per share relative to its market price; so, Graham focused on buying shares of that company. He bought slowly but surely. Eventually, he was able to acquire a 5% stake in Northern Pipeline. Not surprisingly, the Rockefeller Foundation was still the largest shareholder. The foundation held 23% of the shares outstanding.
Graham didn’t count on a contest. There were no such things as “activist investors” in those days. Besides, Graham didn’t see any need for activism. The correct course of action was clear. He would simply explain the situation to management and they would distribute the excess cash.
Graham met with the company’s President and General Counsel (they were brothers). He explained the situation and what needed to be done.
The Bushnell brothers explained they couldn’t distribute the cash, because the par value of the stock was too high. Graham explained how they could reduce the par value and treat the distribution as a return of capital. The brothers explained they needed the capital. Graham asked for what. The brothers said the investments were a depreciation reserve. Graham said fine …