October 2017 – Focused Compounding

Geoff Gannon October 25, 2017

Cimpress (CMPR)

Guest Write-up by Jayden Preston

Introduction

Vistaprint was founded in 1994 by Robert Keane, on the idea that there was a market for producing business cards cheaply for companies too small to order in large quantities. Through utilizing the internet, creating better software and printing technologies to make such mass customization cost effective and efficient, the business has turned out to be a huge success.

23 years later, Vistaprint has become a clear leader in mass customization of marketing materials for small businesses. It has also increased its portfolio of businesses and target markets through acquisitions and now offers thousands of products that customers can customize to their needs. It was renamed to Cimpress in 2014 to reflect their growing number of business units.

Business Summaries

Cimpress has changed their business segmentation a number of times in the past. We look at their current segmentation below:

1. Vistaprint

This is still their core business. Vistaprint currently operates globally, with a special focus on North America, Europe, Australia and New Zealand markets. Their Webs-branded business is also grouped under Vistaprint.

The target customers of Vistaprint are micro businesses, i.e. companies with fewer than 10 employees. Since they are small operations without marketing expertise, they rely heavily on the software technologies provided by Vistaprint when designing and making their marketing materials.

In FY2017, Vistaprint served 17 million micro businesses and generated $1.3 billion in revenue, representing 60% of Cimpress’s overall revenue. Adjusted net segment operating profits were $165 million, for a margin of 12.6%. This is a depressed margin though. The two-year average from FY2015 and FY2016 is higher than 17%.

2. Upload and Print

This segment is mostly built up through acquisitions. Companies/brands in this segment include: druck.at, Easyflyer, Exagroup, Pixartprinting, Printdeal, Tradeprint, and WIRmachenDRUCK businesses. These companies mostly focus on Europe.

Some companies that have more resources would look for professional graphic designers, ranging from local printers, print resellers and graphic artists to advertising agencies and other customers with professional desktop publishing skill sets, for their marketing needs. The segment focuses on serving such graphic professionals.
As a group, they generated $589 million in revenue in 2016, which is 28% of the total. Adjusted net segment operating profits were $64 million, for a margin of 10.9%

3. National Pen

This business was acquired at the end of 2016. Given its scale and vertical integration, National Pen is the leading provider of a wide array of customized writing instruments for small- and medium-sized businesses in more than 20 countries. The company also sells other promotional products, including travel mugs, water bottles, tech gadgets and trade show items.

It serves about a million small business customers through a successful direct mail marketing and telesales approach, as well as a small growing e-commerce business.

The business generates around $113 million in revenue.

4. All Other Businesses

This segment includes the recently sold Albumprinter, Most of World, and Corporate Solutions businesses. These businesses have been combined into one reportable segment based on …

Geoff Gannon October 25, 2017

Seeking Out Strange Stocks: How to Create a Value Investing Basket that MIGHT Get Decent Returns Even When the Market Falls

Someone emailed me this question:

“I know you are a stock only person.

But just for a minute I need your knowledge…I don’t look for 15% per year. I look for 6% a year for the next 5-7 years…on my money.

What would be the best/safest way to get it? Will a certain ETF, a dividend stock? SPY? Japan ETF? India or Russia?”

I don’t know of anything that can safely guarantee you anything like 6% a year. To give you some idea, even junk bonds now yield about 5.5%.

And I wouldn’t call junk bonds safe. Their prices would fall as interest rates rose and the economy entered a recession. Both of these things will happen at some point. Will it be in the next 5-7 years? I don’t know. But, you can’t buy assets like that at today’s prices if you’re hoping to make 5-7% a year over the next 5-7 years even if the stock market does badly.

However, you can certainly find things that should return at least 5% to 7% a year over the next 5-7. It’s just that:

1) Some of them will be specific stocks – not ETFs

2) Some of them may return a lot more than 5% to 7%

3) Some of them will lose money

4) It will take a lot of work on your part to find them

5) You will need to use a basket approach

6) Actually: I’m going to recommend a “basket of baskets” approach

I don’t diversify widely. But, if you’re looking to find something that will return 5% to 7% a year over the next 5-7 years, your best bet is to own a basket of very cheap (probably obscure) stocks. If these stocks are cheap, small, obscure, illiquid, etc. – it’s less likely they will move with the overall market. Special situations (like spinoffs and other things mentioned in Joel Greenblatt’s “You Can Be a Stock Market Genius”) should also help get you closer to your goal of 5% to 7% annual returns over 5-7 years no matter what the market does.

The reason I’m starting off a discussion with “cheap, small, obscure, and illiquid stocks” is that I’m not at all confident I can find an entire stock market for you that will return 5% to 7% a year over 5-7 years given today’s starting price. Although, in a moment we will discuss the possibility of putting 20% to 40% of your portfolio in things that are either directly or indirectly “funds” rather than specific stocks. More on that later.

But, first, let’s start with the specific stocks.

If you aren’t doing a lot of intense stock picking that results in you only owning maybe 3-5 stocks at once (like me), you need a process for finding investments that is a more formulaic, “wide-net” approach.

A fund manager has to worry about putting large amounts of money to work. So, they lean in the direction of owning even more …

Geoff Gannon October 24, 2017

Working My Way Through Your Stock Write-Up Requests

I just sent out replies to everyone who requested a stock write-up. I got a lot of requests. So, it may take me several months to work through the backlog.

People have asked if I will open myself up to requests for stock write-ups again. The simple answer is: it depends on how this first batch goes. How long does it take me to do them? How much do the people who receive them like or hate the write-ups?

(And, of course, how many people actually pay me. I’m doing the write-ups up front and getting payment – only if the requester is satisfied – after I send them the write-up. We’ll see if that was a dumb idea on my part.)

If I open myself up to requests again: 1) The price will probably be higher and 2) The request window will probably be shorter. Or maybe I’ll come up with some better way to ration things so the backlog doesn’t get this big again.

For those who requested write-ups, I’m sorry that the volume of requests means I can’t promise a reasonably quick turnaround time. If your stock request is time sensitive, I may not be able to help you.

Sorry.…

Geoff Gannon October 19, 2017

How I “Screen” For Stocks – I Don’t

I get asked a lot how I screen for stocks. And the basic answer is that I don’t. I sometimes run screens, but I rarely find ideas off them.

I can rephrase the question though. When most people ask me how I screen for stocks, what they’re really asking is something more like: “How do you decide which 10-K to read next?”

In other words: “How do you come up with new names to research?”

Other Investors Tell Me What They’re Interested In

I meet about once a week with my Focused Compounding co-founder, Andrew Kuhn, to just talk stocks. We both read a specific 10-K and analyze that stock. We bring our notes, Excel sheets, etc. to a local restaurant. And then we have a cup of coffee together and take 2-3 hours to go over the idea. Recent ideas Andrew has wanted to talk about include: Hostess Brands (TWNK), Cars.com (CARS), Green Brick Partners (GRBK), and Howard Hughes (HHC). I wouldn’t have researched these stocks if Andrew hadn’t pick them as our next meeting topic.

I also talk via Skype’s text messaging system with investors around the world who I’ve never met in person.

I spend several hours a week doing all this.

But I guard my time pretty closely. If you’ve ever asked to chat with me this way – you’ve probably noticed two things: 1) I don’t talk on the phone (or do audio on Skype) with anyone no matter how nicely you ask and 2) I insist we agree on a specific stock to talk about. I’ll talk about whatever you want to talk about, but I’m not interested in any sort of general discussion.

These are anti-time wasting rules I’ve learned to adopt through experience.

I Mine My Favorite Blogs for All They’re Worth

I’ve mentioned before that my favorite blogs are:

Richard Beddard’s Blog

Value and Opportunity

Clark Street Value

Kenkyo Investing

I go through all their archives and make up lists of stocks they’ve written about. Some of them also have “portfolio” type pages (Value and Opportunity, Richard Beddard) that help generate a list of stocks they’ve covered.

Now, I’ll tell you a secret. Although I love these bloggers and the way they look at things – there’s one situation where I specifically don’t read what they’ve written. It’s when I’m interested in a stock they’re writing about.

So, let’s say I’m reading Clark Street Value’s write-up on the Hamilton Beach (HBB) spin-off from NACCO (NC) or one of Richard Beddard’s articles on Howden Joinery and something in that post makes my investing antennae twitch. I stop reading the post the second I hit that line. I just go off and research the stock myself. Then – and only then – I come back and read what one of my favorite bloggers has written.

This brings up a bigger point. Once you know an investor you think is a clear thinker owns a …

Geoff Gannon October 19, 2017

What’s NACCO’s Margin of Safety?

After reading my write-up, a member asked me about the margin of safety in NACCO (NC):

“…why would someone put half of their portfolio weight in a stock like this where there is customer concentration risk plus a real risk that one of the customers may close shop? Agree that its FCF yield is 10% or so but does it deserve that kind of weight?”

I don’t want to exaggerate the safety of this stock. I didn’t write it up for a newsletter. This isn’t a recommendation for anyone else to buy it. I put 50% into it knowing I would have future control over decisions to sell that 50%. I don’t think I’d recommend this stock to anyone else because the headlines will all be negative and that is very tough for people to hold through.

Having said that, let me take you through how I might have seen the potential margin of safety when I bought the stock at under $33 a share on October 2^nd. The way I framed it, the margin of safety in NACCO was a lot higher than what I can get in other stocks. That’s despite the customer concentration and the possibility those concentrated customers are coal power plants about to be shut down.

When I bought the stock, I believed it was then trading at something like a 10% to 15% free cash flow yield. I also believed that the company’s balance sheet will be essentially unleveraged pretty soon (taking into account build up of cash during this year, the expected $35 million cash dividend from Hamilton Beach just before the spin, etc.). The parent company has liabilities but these are not immediately payable in full. Meanwhile, the unconsolidated mines pay cash dividends immediately each year. So, what I’m saying here is that I don’t believe the parent company is more leveraged, more short of cash relative to potential liabilities, etc. than an average stock.

So, the balance sheet is like an average stock.

But, a normal, unleveraged stock usually trades at about a 5% free cash flow yield.

So, NACCO’s free cash flow yield is 5% to 10% higher than an average stock while the balance sheet is similar.

Now, if it is true that when NACCO loses a big contract this means it mostly loses an equal percentage proportion of both revenues and expenses (this is an exaggeration – but I don’t think it’s a huge exaggeration because the mines really are administered very independently and are non-recourse to NACCO), you can kind of think about your margin of safety and the value in this stock as follows…

NACCO has a free cash flow yield no lower than 10% to 15%.

A normal stock has a free cash flow yield no higher than 5%.

5% is 0.50 to 0.67 times less than 10% to 15%. Therefore, NACCO would decline to a normal valuation after it has lost about 50% to 65% of its earnings. Let’s …

Geoff Gannon October 18, 2017

Does NACCO (NC) Have Any Peers?

A Focused Compounding member who analyzed and bought NACCO himself read my write-up on NC and was curious if I did a “peer analysis” for NACCO:

“Did you consider looking at any potential peers with your analysis? I was quite simplistic with my approach. Omnicom splits cash out year in year out. Its current EV to free cash flow is around 10x whereas I looked at NACCO and thought its EV to free cash flow was around 5x (NOTE: At the much lower spin-off price he bought at) and appeared very undervalued as it should at least be 7 to 10x even though Omnicom is a higher quality business. My hurdle for any new position is Omnicom.”

I tried to keep it simple. Really, I asked myself 3 questions early one:

After the spin-off, will the balance sheet be pretty close to net no debt/no cash (you did something similar seeing there would be the $35 million dividend but then there’s the asset retirement obligation and the pension).

Would NACCO produce its earnings mostly in the form of free cash flow?

Would “earning power” be 10% or higher as a percent of my purchase price.

In the end, the decision is really just whether you would buy a stock or wouldn’t buy a stock. To me it didn’t matter if the stock’s earnings would be $3.25 a share or $6.50 a share if I was buying at $32.50. What mattered was how certain I was of the $3.25 number. Once I think I have a 10% yield, I don’t spend a lot of time wondering if I have a 13% yield, 15% yield, or 20% yield. So, I didn’t spend time worrying about this. If the stock was pretty much unleveraged, the earnings pretty much came in the form of free cash flow, and the earnings yield was greater than 10%, that would be enough.

As far as growth, it’s difficult to value that. The company has a goal of growing earnings from unconsolidated mines by 50% within the next 5 years or so. However, they had the same goal about 5 years ago. Because the Kemper project was cancelled, they won’t achieve this. However, they will achieve growth of say 15% or so over last year due to newer mines producing closer to the tons they were eventually expected to produce.

I don’t know what they’ll use free cash flow on. I know that the two businesses I like are the unconsolidated contracted coal production and the lime rock draglines. But, neither of those businesses absorbs capital. So, they will grow through signing new deals in that area but they shrink through losing existing customers. I couldn’t judge one way or the other on this.

I feel they have no peer. Omnicom (OMC) is not a good peer, because OMC is permanently durable in my view. I think advertising agencies will be around in 2047 and even 2067. It’s …

Geoff Gannon October 18, 2017

NACCO (NC): The Stock Geoff Put 50% of His Portfolio Into

On October 2^nd, Hamilton Beach Brands (HBB) was spun-off from NACCO Industries (NC). That morning I put about 50% of my portfolio into NACCO at an average cost per share of $32.50. Since that purchase was announced, several members of Focused Compounding have sent in emails asking for a write-up that explains why I made this purchase.

Unfortunately, there just isn’t much to say about my NACCO purchase. So, this write-up will be both brief and boring.

I bought NACCO, because the stock’s price after the Hamilton Beach spin-off seemed low relative to the earning power of the coal business.

All Value Comes from the Unconsolidated Mines

After the Hamilton Beach spin-off, the earning power of NACCO comes entirely from its “unconsolidated mines”. NACCO – through NACoal – owns 100% of the equity in these mines and receives 100% of the cash dividends they pay out (which is almost always equal to 100% of reported earnings). However, the liabilities of these mines are non-recourse to NACoal (and thus NACCO). Each mine’s customer (the power plant) is really supplying all the capital to operate the mine. This is why NACCO doesn’t consolidate the mines on its financial statements (because it isn’t the one risking its capital – the utility that owns the power plant is taking the risk).

You can see the financial statements for the unconsolidated mines here.

(It is very important that you click the above link and read through it carefully).

There Are Risks

NACCO also owns one consolidated mine (MLMC) which could potentially destroy value. And at the parent company level – so NACCO rather than NACoal – the company has legacy coal mining liabilities (“Bellaire”) and losses related to general corporate overhead.

NACCO’s customers are almost all “mine-mouth” coal power plants. They sit on top of coal deposits that NACCO mines and delivers to the plants to be used as fuel.

Coal power plants throughout the U.S. have been closing. The power plants NACCO supplies could close at any moment. And it would only take one such closure to seriously dent NACCO’s earning power.

NACCO’s largest customer accounts for probably 35% of the company’s earning power. NACCO’s two largest customers account for probably 50% of earning power. And NACCO’s three largest customers account for probably 65% of earning power.

NACCO’s Business Model

NACCO sells coal to its customers under long-term (most contracts expire in 13-28 years) supply agreements. The agreements are “cost-plus” and indexed to inflation.

Each Share of NACCO is Backed by 5 tons of Annual Coal Production

As you can see in this investor presentation, NACCO delivered 35.5 million tons of coal over the last twelve months. The company has 6.84 million shares outstanding, so each share of NACCO is now backed by 5.19 tons (35.5 million / 6.84 million = 5.19) of coal sold under a cost-plus contract indexed to inflation. I paid an average of $32.50 a share for my stake in …

Geoff Gannon October 17, 2017

MSCI

Guest write-up by Jayden Preston.

Overview

Spun off from Morgan Stanley in 2007, MSCI is a leading provider of investment decision support tools to investment institutions worldwide. They produce indexes and risk and return portfolio analytics for use in managing investment portfolios.

Their flagship products are their international equity indexes marketed under the MSCI brand. They also offer other products that assist investors making investment decisions. These include portfolio analysis by their Barra platform; risk management by their RiskMetrics product; provision of ratings and analysis that institutional investors to integrate environmental, social and governance (“ESG”) factors into their investment strategies; and analysis of real estate in both privately and publicly owned portfolios.

Their clients include both asset owners and financial intermediaries.

Their principal business model is to license annual, recurring subscriptions to their products and services for a fee, which is, in a majority of cases, paid in advance.

They also charge clients to use their indexes as the basis for index-linked investment products such as ETFs or as the basis for passively managed funds and separate accounts. These clients commonly pay MSCI a license fee, primarily in arrears, for the use of the brand name mainly based on the assets under management (“AUM”) in their investment product. Certain exchanges use their indexes as the basis for futures and options contracts and pay them a license fee, primarily paid in arrears, for the use of their intellectual property mainly based on the volume of trades.

Clients also subscribe to periodic benchmark reports, digests and other publications associated with their Real Estate products. Fees are primarily paid in arrears after the product is delivered.

As a very small part of their business, they also realize one-time fees related to customized reports, historical data sets and certain implementation and consulting services, as well as from certain products and services that are purchased on a non-renewal basis.

Business Segment

MSCI categories its business segments into the following: 1) Index, 2) Analytics, and 3) All Other.

Index Segment

This is their key segment. As I will explain below, this is where I believe the lion’s share of value of MSCI lies.

MSCI indexes are used in many areas of the investment process, including index-linked product creation and performance benchmarking, as well as portfolio construction and rebalancing. Index-linked product creation generates asset-based fees and the latter is the source of their subscription revenue within the Index segment.

MSCI currently calculates over 190,000 global equity indexes, including approximately 7,300 custom indexes.

For 2016, Index generated $613.5 million in revenue, or 53% of their total revenue. Adjusted EBITDA from this segment was $431.5 million, or 76% of total EBITDA. You can see that the EBITDA margin from this segment was 70%.

Analytics Segmen

This segment uses analytical content to create products and services which offer institutional investors an integrated view of risk and return. A few examples of major offerings under …

Geoff Gannon October 16, 2017

The Chains of Habit

In my last post, I mentioned Twitter is a distraction most investors are better off keeping themselves clear of. I got some responses like:

“Agree (Twitter) can be (a) distraction. I’m careful who I follow, restrict my usage, save leads for later like you!”

But also:

“…if it’s a distraction for him I get it. But you can literally pick who you follow, don’t have to tweet, connect (with) other investors…”

And:

“…get Geoff’s (point) here, but Twitter has led me to some great ideas, resources, convos. Great tool if used correctly.”

All of these responses are right, of course.

Some people I’ve gone on to meet in real life have mentioned the first place they saw my name was on Twitter. It helps that my Twitter profile says I live in Plano, Texas. This has encouraged investors who live in Texas or are passing through one of Dallas’s airports to reach out to me for a face-to-face meeting. In a couple cases, good things have come from that. And I have Twitter to thank for it.

So, why don’t I think Twitter’s so great?

Part the First: Wherein Geoff Complains All the Good Playwrights have Gone to Hollywood

I started blogging on Christmas Eve 2005. Back then, I used to read a lot of value blogs. Most of them don’t exist anymore. And not enough good ones have been stared up since. Why? Twitter. Some of the best “would-be” value bloggers spend their time on Twitter instead of blogging.

I talk stock ideas with a lot of people via email, Skype, etc. You wouldn’t know the names of anyone I talk with. But some of them are good. Very good. And they know small, obscure stocks in their home regions – Benelux, Nordic countries, India, Southeast Asia, Hong Kong, Latin America, wherever – so much better than I do or likely ever could. In the past, I’d tell them “you should start a blog.” And sometimes, they would. Now, I tell them “you should start a blog”. And they say: “If I have something to say, I can put it on Twitter.”

And they can. And in terms of visibility, I think they’ll get more out of Twitter. They’ll reach a bigger audience. But, if I can be selfish here for a second…

They are robbing me of depth.

Part the Second: Wherein Geoff Complains that All Music Ought Not to be Pop Music

They are robbing me of a considered, potentially contrarian take. Because Twitter is many things. But the one thing it is above all else is: “catchphrase”. To appear on Twitter, an investment idea has to be distilled into a single phrase. And that phrase – if it’s to be re-tweeted widely – has to be catchy.

I’m writing this post in a noisy environment. There are other people here doing other things. And they’re a distraction. So, I have on some good headphones and I have a piano version of “…

Geoff Gannon October 13, 2017

Hostess Brands (TWNK) Warrants

Note: Hostess stock is down about 8% as I write this; the warrants are down 10%. Make sure you check for an updated quote on both.

My Focused Compounding co-founder, Andrew Kuhn, recently wrote up Hostess Brands (TWNK) common stock on the member site. Today, I put up a link on my Twitter noting that the company’s CEO is leaving and the Executive Chairman (billionaire Dean Metropoulos) will assume additional duties in the interim. From these two facts, you can probably guess Andrew and I have been looking at Hostess.

That’s true. But, this post isn’t going to be a write-up of Hostess stock. It’s a good business with very strong brands (most famously Twinkies). But, it’s also highly leveraged. Hostess Brands is essentially a publicly traded LBO. And, in the past, Metropoulos has flipped the food companies he’s turned around (example: Pabst Blue Ribbon 2010-2014) fairly quickly.

The above suggests there may be two important limitations on Hostess Brands common stock:

1. The company is so leveraged the stock may be unsafe even if the brands are safe

2. The company may be sold within 5 years, limiting the stock’s long-term potential

Downside protection and unlimited time for your idea to work out are usually two of the biggest advantages a common stock holder has over an option holder. If, in this case, the common stock itself is a very leveraged bet and is less likely to be public in 5 years than is normal – you might want to consider buying options instead.

Or better yet: long-term warrants.

Hostess has publicly traded warrants (they trade under the ticker TWNKW – that’s TWNK with an extra “W”) that expire on November 4, 2021 (so, just over 4 years from now).

You need two warrants to get one share of common stock. So, I’ll simplify things by talking in terms of a “pair” of warrants. A pair of warrants are exercisable at $11.50 a share. However, they really must be exercised once the stock exceeds $24 a share, as you can see from this quote taken from the prospectus:

“Once the Public Warrants become exercisable, we may call the Public Warrants for redemption:

• in whole and not in part;

• at a price of $0.01 per warrant;

• upon not less than 30 days’ prior written notice of redemption to each warrant holder; and

• if, and only if, the last reported sale price of the Class A Common Stock equals or exceeds $24.00 per share for any 20 trading days within a 30 trading day period ending on the third trading day prior to the date we send the notice of redemption to the warrant holder.”

So, if you buy 2 warrants today, what you get is: 1) 4 years during which you only need to put down the price of 2 warrants instead of the price of the common stock (as of yesterday, the common stock was over $13 a share and two warrants were priced …

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