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Geoff Gannon January 26, 2020

Hilton Food (HFG): A Super Predictable Meat Packer with Long-Term “Cost Plus” Contracts and Extreme Customer Concentration at an Expensive – But Actually Not Quite Too Expensive – Price

Hilton Food Group (HFG) trades on the London Stock Exchange. It qualifies as an “overlooked stock” because it has low share turnover (17% per year) and a low beta (0.28) despite having a pretty high market cap (greater than $1 billion in USD terms).

On a purely statistical basis, Hilton Food is one of the most predictable – in fact, in one respect, literally THE most predictable – companies I’m aware of. There’s a reason for this I’ll get into in a second. But, first let me explain what I mean about the predictability here. Over the last 11-13 years, Hilton Food has shown very, very little variation in its operating margin. EBIT margin variation can be measured in terms of ranges (this would be 2.2% to 2.9% in the case of Hilton Food), standard deviations (this would be like 0.2% in the case of Hilton Food) or the coefficient of variation (0.08 in the case of Hilton Food). When talking about margin variation – I almost always am talking about this coefficient of variation, which is the standard deviation scaled to the mean. So, if a company had 27% EBIT margins on average and a 2% standard deviation or a 2.7% average margin and a 0.2% standard deviation – I’d talk about those two situations as if they were equally stable or unstable margins. Another way to look at it would be to think about standard deviations. If you own a stock for any meaningful length of time, you’re going to see one standard deviation and probably two standard deviation moves in margins. You may not see a three standard deviation move. And it’s entirely possible – unless something major changes with the business, which of course, it often does – you won’t see a 4 standard deviation move. With Hilton Food, a move of 4-5 standard deviations to the downside would only be a 1% of sales move in EBIT. Now, margins at Hilton Food are so low that 1% of sales is like 35% of EBIT and awfully close to 50% of earnings. So, it’s a big move. But, 4-5 standard deviation moves in margins are obviously unusual. And you’d be surprised how common 35% of EBIT to 50% of after-tax earnings swings are for many public companies. They happen all the time. I don’t want to go too far into the statistical weeds here – but, I will say that margin fluctuations that literally happen every 1-3 years for a normal company might only happen once in like 1-3 decades for Hilton Food. Now, Hilton Food has not been around for 3 decades (the original plant started operating in 1994 and the company only went public like 12 or so years ago). And what I’ve been discussing here is the predictability of earnings in cases where sales are fixed. Sales fluctuate. So, Hilton Food’s earnings will move around. It’s just that earnings will move around very, very little relative to sales compared to almost any other …

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Andrew Kuhn January 22, 2020

Your Greatest Advantage as an Investor in 2020: FOCUS

For this week’s post, I decided to talk to the camera. Be sure to watch if you haven’t here.…

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Luke Elliott January 17, 2020

AdvanSource Biomaterials Corp. (OTC: ASNB) – An Attractive Microcap Arbitrage Opportunity With Limited Risk

17 Jan 2020

Quote: $0.18/share    

AdvanSource Biomaterials designs and manufacturers materials used in medical applications. They primarily make polyurethane materials that are used in long and short-term implants and disposable products (plastics).  The business has been around for 20 years but neither the history of the business nor what they do make much difference to the investment case.

On November 25, 2019, AdvanSource announced that they had entered into an agreement to sell all of their assets to a subsidiary of Mitsubishi Chemical Corporation for $7.25 million in cash- which AdvanSource stated should translate into approximately $0.20/share. If the deal closes and management’s calculations prove to be accurate, it will provide an absolute return of ~11% (or higher if you can get in below $0.18/share). The company expects the transaction to close in Q1 2020. This is not a long holding period and obviously produces a much higher annualized return. (https://www.otcmarkets.com/stock/ASNB/news/AdvanSource-Biomaterials-Corporation-Enters-Into-a-Definitive-Agreement-to-Sell-Substantially-All-of-Its-Assets-to-a-Sub?id=247497)

I stay away from most arbitrage situation. However, I like this one for a few reasons:

  1. It provides a 10%+ return on an absolute basis (most arbitrage situations I read about provide a low absolute return, but the author is always promoting the high figure on an annualized basis).
  2. It’s a nice “tuck-in” acquisition of a tiny company by a much larger corporation and therefore, has much lower (virtually none) risks of government intervention due to antitrust laws in the US or abroad, push-back from acquirer shareholders, etc.
  3. It has already been unanimously approved by the Board and insiders own ~30% of shares outstanding. The company’s largest shareholder is the CEO who owns ~13%.

What’s the downside?

On January 21, 2020 (this coming Tuesday), shareholders will vote on the deal (only shareholders of record Dec. 10, 2019 can vote). Prior to the deal announcement, the stock was trading at around $0.12/share (33% lower than current price) and if for some reason the deal is not approved, it’s likely it will trade lower. On a valuation basis, paying the current price of $0.18/share is paying a ~6x EBIT (based on their last 10Q from Sept. 30 2019 and using TTM numbers) but please note these figures are cherry picked and 2019 was their most profitable year in the last several.   

Why does the opportunity exist?

Most arbitrage opportunities have smaller spreads. I think the ASNB spread exists for two reasons.
1) the average daily volume is only $8,800 (however, the last three days the volume has been much higher- 24K, 16K, 51K, so there is some variability) and so it is only suitable for small, private investors.
2) Related to reason #1, this is an OTC stock that trades for less than a quarter and has very few eyes on it. It’s extremely unknown and undiscovered compared to most deals.

Disclosure: I own shares of ASNB…

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Andrew Kuhn January 5, 2020

One of My Goals For 2020 – Blog More! 

To Focused Compounding Members,

 

I hope everyone had a great holiday! Let me start by saying I am not one for New Year’s resolutions. I genuinely believe you should start today instead of tomorrow – and that an arbitrary date should not dictate when you should work to become the better version of yourself.

 

That said, one of the things I wanted Geoff and myself to do before the new year was to write down 5 goals that we would be proud of if we accomplish by this time next year. We had professional and personal goals. I decided on 5 because this was right out of Warren Buffett’s 5/25 strategy for focus. You can learn about that below from James Clear’s blog post below. (Hopefully James won’t mind me stealing his story if I link to his great book, Atomic Habits: https://www.amazon.com/Atomic-Habits-Proven-Build-Break/dp/0735211299/ref=tmm_hrd_swatch_0?_encoding=UTF8&qid=1578004386&sr=8-1

 

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https://jamesclear.com/buffett-focus

 

“The Story of Mike Flint

 

Mike Flint was Buffett’s personal airplane pilot for 10 years. (Flint has also flown four US Presidents, so I think we can safely say he is good at his job.) According to Flint, he was talking about his career priorities with Buffett when his boss asked the pilot to go through a 3-step exercise.

 

Here’s how it works…

 

STEP 1: Buffett started by asking Flint to write down his top 25 career goals. So, Flint took some time and wrote them down. (Note: you could also complete this exercise with goals for a shorter timeline. For example, write down the top 25 things you want to accomplish this week.)

 

STEP 2: Then, Buffett asked Flint to review his list and circle his top 5 goals. Again, Flint took some time, made his way through the list, and eventually decided on his 5 most important goals.

 

Note: If you’re following along at home, pause right now and do these first two steps before moving on to Step 3.

 

STEP 3: At this point, Flint had two lists. The 5 items he had circled were List A and the 20 items he had not circled were List B.

Flint confirmed that he would start working on his top 5 goals right away. And that’s when Buffett asked him about the second list, “And what about the ones you didn’t circle?”

 

Flint replied, “Well, the top 5 are my primary focus, but the other 20 come in a close second. They are still important so I’ll work on those intermittently as I see fit. They are not as urgent, but I still plan to give them a dedicated effort.”

 

To which Buffett replied, “No. You’ve got it wrong, Mike. Everything you didn’t circle just became your Avoid-At-All-Cost list. No matter what, these things get no attention from you until you’ve succeeded with your top 5.”

 

 

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One of my goals for 2020 is to write a lot more. To quantify this, I’m committing to one post a …

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Geoff Gannon January 2, 2020

Geoff’s Thoughts on Cheesecake Factory (CAKE)

Someone asked me my thoughts on Cheesecake Factory. It’s a stock we’ve looked at before. But, I have written about it recently. The stock hasn’t done well lately. It looks fairly cheap. Here was my answer:

“I haven’t followed it lately. I know the stock hasn’t done that well. I did a very quick check of the stock price just now looking at the long-term average operating margin, today’s sales, today’s tax rates, etc. It seems that on an earnings basis (normalized for a normal margin on today’s sales) it would be about 13x P/E. That seems like a good price for a stock like this that has grown EPS almost every year. By the numbers alone, it reminds me of a Buffett stock. I was recently reading what I think is one of the best books on Warren Buffett. It’s called “Inside the Investments of Warren Buffett: Twenty Cases”. And one thing that stands out in each case study is his looking at the last 10-years or more of historical data. In time after time, the increase in revenue and net income and EPS year-over-year is positive in almost 10 out of 10 years. Sometimes it’s 9 out of 10 or something. But it’s very consistently positive compared to most stocks. Also, while people talk a lot about moats and high ROE – I’m not sure that’s as much as a focus for him. I think he looks more to find something that is already consistently showing good results year over year almost every year. Then, if the ROE is 20% or 30% – that’s enough for him. Because the stock is unlikely to be able to grow that fast anyway – it’s just a question of whether it can get a higher return on retained earnings than he can. ROE at Cheesecake Factory is generally adequate. It’s high enough that you could buy it based on its growth rate and P/E ratio. Now, I do notice that the 10-year results in terms of the top line really aren’t that strong. However, this has been true for a lot of restaurants in the U.S. I think Cheesecake also has the added problem that it doesn’t grow same-store real sales after the first year. These restaurants open VERY full compared to the industry. So, some companies have restaurants that do better in year 2 than year 1. That’s not the case here. But, the growth in things like earnings per share versus assets has been good. So, the economics have been – if anything – improving in terms of free cash generation versus the tangible assets used in the business. I’m not, however so sure it’s a growth stock anymore. But, in the company’s defense I think these last 10 years have been some of the toughest for restaurants. Inflation has been very low. Food inflation at supermarkets has been incredibly low to the point where eating in has been much more attractive than eating out. I don’t think that’s …

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