Indeed, early May in Omaha, Nebraska, is almost like a spring-break destination for value investors (with fewer Señor Frog or Girls Gone Wild moments). But for a value investor, May is also the most intellectually stimulating time of the year.

As well as dinner in the evening with old and new friends — mostly at steakhouses, so I am sure my cholesterol, just like the stock market, was hitting all-time highs — I get to participate in several investment panels.

This year, for the fourth time, I was on the Value Investing Panel at Creighton University. For an hour and a half, I had the immense pleasure of answering questions from students. I also participated in an investment panel hosted by YPO, where I joined some great value investors, including Markel Corp’s smart, funny and articulate CIO Thomas Gayner, and Thomas Russo, a well-known value investor who has held some stocks for longer than the life expectancy of a Twinkie.

Continue reading on Institutional Investor… 

A very successful oilman dies. He faces Saint Peter, who says, “You’ve been a good man and normally I’d send you to heaven, but heaven is full. We only have a place in hell.” The oilman says, “Any chance I could talk to other oilmen who are in heaven? Maybe I can convince someone to switch places with me?” Saint Peter says, “It’s never happened before, but sure, I don’t see any harm in it.” The oilman goes to heaven, finds an oilmen convention and yells, “They found a huge oil discovery in hell!” Oilmen are stampeding out of heaven to hell, and our oilman is running with them. Saint Peter asks him “Why are you going to hell with them? I have a spot in heaven, you can stay.” The oilman answers – “Are you kidding, what if it’s true?”

The morale of the story: don’t drink your own Kool-Aid.

 We build a lot of models. I went back and looked, and we built over a hundred models last year (we bought only a handful of stocks).  Building models is important for us; they help us to understand businesses better. They provide insights as to which metrics matter and which don’t.  They allow us stress test the business: we don’t just look at the upside but spend a lot of times looking at the downside – we try to “kill” the business.  We usually try to drill down to essential operating metrics.  If it is a convenience store retailer, we’ll look into gallons of gas sold and profit per gallon.  If it is a driller (see our Helmerich & Payne analysis), we look at utilization rates, rigs in service, average revenue per rig per day, etc.

 In the past, when we owned Joseph A. Banks, a model helped us understand the impact maturation of its new stores had on same-store sales (PDF, see slide 49).  Half of JOSB’s stores were less than five years old, and their maturation drove significant same-store sales increase for years.

 We looked at American Express before the crisis, which gave us insight into inflated profit margins of the financial sector, and thus we avoided for the most part the carnage in the financials.  We thought Amex stock was not cheap enough at the time, but we learned that Amex’s high swipe-fee revenue provided an important buffer to help the company absorb significant loan losses.  Amex could have withstood over 10% loan losses on its credit card portfolio and still have remained profitable.  This insight gave us the confidence to buy Amex during the crisis.

 Models are important because they help us remain rational.  It is only the matter of time before a stock we own will “blow up” (or, in layman’s terms, decline).  We can go back to our model and assess whether the decline is warranted. The model then gives us the confidence to make a rational (very key word) decision: buy more, do nothing, or sell.

 Sometimes we build a model and then, though the stock may look statistically cheap, we move on.  Six months ago we looked at Herbalife and Verifone.  With Herbalife – and this was before the Ackman fireworks – we could not get comfortable with the company’s business model, as I wrote.  And in the case of Verifone, after we did a lot of qualitative research, even though the stock looked cheap, we discarded the idea because we felt that smart devices like iPods and iPads diminished the value of Verifone’s machines.  Whether we were right or wrong, time will tell, but Verifone was not our company.

 Models are frameworks that help us think about the businesses we analyze.  We are always aware of John Maynard Keynes’ expression, “I’d rather be vaguely right than precisely wrong.”  Models are not a panacea, but they are an important and often invaluable tool.  However, models are only as good as their builders and the inputs to them.

 Here comes mea culpa time: I’ve made a mistake in my Whistler Blackcomb model.  We built a fairly simple yet a very comprehensive model that helped us understand the dynamics of WB’s business: the importance of destination visitors vs. regional visitors, the value of WB’s ability to raise prices, the distortion that depreciation expense has on WB’s net income.  The model helped us in our avid attempts to “kill” WB’s business. When we could not, our model also brought to light WB’s potential earnings power if destination visitors came back to pre-recession levels.  So far so good.

 However, WB’s common shareholders own only 75% of the total business, and the other 25% is owned by Nippon Cable.  Our income-statement model captured a deduction for Nipon Cable’s minority interest.  However, when I went to compute free cash flows I linked to the wrong cell.  Instead of linking to net income attributable to WB shareholders (i.e., net income less Nipon Cable’s minority income) I linked to net income to the firm (a higher number).

 I never thought I’d be making Reinhart and Rogoff-like Excel mistakes, but I did.  This goof led to an overstatement of free cash flows by at least 25%.  However, that mistake was partially cancelled out by my next mistake. I was working on the scenario template for my Value Investing Congress presentation on my laptop while in Omaha.  In the “Likely” scenario analysis, a reasonably conservative scenario was that WB’s regional visits would continue to grow at 1% a year and WB would gain back half of the destination visits it lost since the recession set in: they would go up by 200,000.  I did not, however, increase destination visits by 200,000, but rather indicated no growth.  Therefore, net income and depreciation should have been about $6 million and $5 million higher, respectively.  Bottom line, net net, instead of “likely” free cash flow per share of $1.70 a share, it should have been $1.61.

 But that is not where the story ends.  Because of the minority interest I should have computed free cash flows differently.  I should not have just taken post-minority interest net income, added depreciation, and subtracted total capital expenditures.  By doing so, I ignored the value of depreciation to the minority shareholder; and that value is significant, considering that depreciation exceeds total net income.

 The right approach was to compute free cash flows to the firm and then deduct Nippon Cable’s portion of the cash flows.  In all honesty, this is the only right way to compute WB’s free cash flows (so I suggest you ignore the $1.61 “likely” scenario number above).  This reduces WB’s free cash flows in the likely case to $1.50 a share (that number in presentation exhibit is $1.48 because of the tax shield impact in my model).

 I am attaching corrected scenario analysis, and I am providing our WB Excel model so you can scrutinize it at your pleasure.  Priced at $14 today, or about 10x “likely” free cash flows and about 13x this year’s free cash flows (normalized for growth capital expenditures), WB is still an attractive stock. Its dividend is still well-covered, and considering that many REITs of much lower quality have much less pricing power (yielding in the low single digits) WB is a still an attractive stock.  But yes, it is 15-20% less attractive than I originally thought.

 There is a lesson here that goes beyond my making a mistake on a spreadsheet.  This lesson was graciously called to my attention by the Whopper Investments blog, whose proprietor did not take my Whistler Blackcomb presentation as the ending point of his analysis but as the starting point.  He (I am assuming it is a he, knowing the ratio of men to women in value investing) tried to reconstruct my numbers and found my aforementioned mistake. He posted a great write-up pointing out my mistake and making a very simple but important point: always do your own homework.  Anyone can make a mistake.

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

I’ve lived in Denver for twenty-two years,  and I’ve skied maybe a few times each year.  My wife doesn’t ski, nor do my close friends, so getting out skiing was a logistical ordeal. However, as my kids got older, I realized that I now had skiing partners.  My seven-year-old daughter, Hannah, skied for the first time four years ago. (I remember that vividly because that was the day of Obama’s first inauguration.) And Jonah, who is going to turn twelve in a week, started when he was seven. (I wasted a few years with him.)  Two years ago it really hit me: people come from all over the world to ski in Colorado’s beautiful mountains, and we go to Mexico in the winter.  That makes no sense.  So we bought season passes, rented skis for the kids for the whole season (it makes no sense buying them skis because they grow out of them every year), and started taking skiing seriously.  Now we go skiing almost every winter Sunday, and a few times we rent a condo and stay in the mountains for the weekend.  It is an incredible experience.  It takes us about an hour and half to get to the mountain. We listen to music in the car, we talk.  No iDevices allowed.  While we are on the lifts we talk some more.

Skiing helps to build my kids’ character: they’ve had to overcome their fears.  At the beginning of last season, Jonah was timid, very cautious.  I’d ski down, and Hannah and I had to wait a few minutes for him every time.  This year he is Bode Miller, flying down the mountain with perfect form and no fear.  Hannah’s biggest fear is not skiing, actually – she is just afraid I will lose her on the mountain.  Last year I did lose her a few times.  Now she skies with my wife’s iPhone so I can always locate her with the Find Friends app.  I hope when the kids grow up, skiing will be a favorite childhood memory, as it is mine.

So why I am telling you all this?   I’ve looked at Vail Resorts (MTN) for a long time. MTN has some incredible assets, but the stock is never cheap on free cash flows. However, recently I stumbled on a ski resort no less impressive; in fact, it is the largest ski resort in North America: Whistler Blackcomb.  I wrote an article about it for Institutional Investor, I presented the stock at the Value Investing Congress a few days ago (link here), and I even made a karaoke music video.  This is how much I like the stock .  The title of my presentation was “I Love Big Dividends and I Cannot Lie.”  Our multitalented intern Gavin Parsons (we have three interns at IMA – actually we call them apprentices) wrote the lyrics (I contributed maybe 10% at most), and he sang.  Michael Conn (my partner at IMA) and I were the background singers.  You’ve got to watch this video!

While I was presenting WB at the Value Investing Congress and listing all the categories in which WB is #1 – size, amount of snow, vertical drop… – I joked that it is also #1 in number of apologies per square mile.  I thought I’d get a good laugh, but the audience was silent.  It is not a good joke when you have to explain it, but I did anyway: Canadians are known for being very polite and apologetic.  That explanation brought a lot of laughs.  In fact a few people came up to me after the presentation and said, “Whistler Blackcomb – the politest resort, period!”

Value Investor Congress Las Vegas 2013 – I Like Big Dividends and I Cannot Lie – Vitaliy Katsenelson by VitaliyKatsenelson

Here are few events you may find of interest if you are in Omaha:

Friday – May 3rd

12:30 pm – 2:45 pm: Cheap Talk, - Billy Blue’s Alumni Grill. We’ll have our 5th annual informal gathering where value investors get together and share ideas.  Everyone is welcome to come.  (Creighton University, Harper Center, 20th and Cass)

3 pm – 4:30 pm: Value Investing Panel V, Creighton University (located in the same building as Billy Blue’s; see above). This will be the the fourth time I have have had privilege of participating on this panel.  For an hour and a half we answer questions from students.  Last year I had a great time arguing with Bruce Greenwald, an insanely smart and articulate professor from Columbia, about the value of the discounted cash flow model. (I think it is a great tool in your toolbox; he had some reservations).  This free event is followed by free refreshments – a veritable value investor’s paradise.

Saturday – May 4th

4 pm – 7:30 pm: Young Presidents Organization, World Presidents Organization, and Entrepreneur Organization are putting together an investing panel.  I’ll be in the terrific company of Tom Gayner, CIO Of Markel Corporation; Tom Russo, famed value investor; and Tim Vick, author of How To Pick Stocks Like Warren Buffett.  I did this panel last year – loved it.  If you are a member of any of the above organizations, you can RSVP by email to ypo@cox.net (the deadline was April 26th, but you may get lucky). Venue: Holland Performing Arts Center, 1200 Douglas Street.

Sunday

10 am: Markel annual gathering.  Markel is a very well-run insurance company.  I’ve been attending its meetings for the last couple of years, and they are very educational. (Hilton Omaha Hotel)

But if I were a dividend, I’d be more upset because I never get the credit I deserve. Over the past century dividends delivered close to half of all stock market returns. Think about that. If you were fortunate to be alive for the past 100 years and had your money invested in the stock market, half of your returns would have come from dividends.

However, the above statement needs an important clarification: It sometimes takes decades for investors in broad stock market indexes to obtain “average” returns. Historically, the stock market has gone through exciting phases of above-average returns (secular bull markets), which were usually followed by less satisfying phases of below-average returns (secular sideways markets), each lasting about a decade and a half.

I have written about why my research leads me to believe we are in a long-lasting sideways market. During the past three sideways markets, dividends were responsible for more than 90 percent of stock market returns. Yet the current dividend yield of the S&P 500 index is only 2.1 percent, less than half of what stocks yielded, on average, over the past century.

A few months ago a client asked my firm if we could come up with a defensive stock portfolio that would yield more than 7 percent. In an environment in which the Federal Reserve has let loose a jihad on interest rates and carpet bombed anything even remotely resembling yield through its purchase of riskless (or near-riskless) instruments of all durations, I thought it was not doable. Most stable, income-producing assets (I am not even talking about bonds), such as real estate investment trusts, yield a miserable 3 percent or so and are likely to be candidates to short, not buy, in the long run.

To my surprise, we have been able to identify a diversified portfolio of 20 stocks that meet the 7 percent hurdle. We have had to step outside the U.S. of A.: Half of the portfolio is in European (mostly multinational) stocks, a quarter is in master limited partnerships, and the rest is in plain-vanilla U.S. equities.

Here are two stocks that we are considering for the portfolio:

Vodafone Group is one of the largest global mobile phone companies in the world and yields more than 8 percent, counting annual recurring “special” dividends. It has an A-rated balance sheet, and it can pay off any annual debt maturity from its ample free cash flow. In addition, at some point Europe will come out of what seems to be a perpetual recession, and Vodafone’s earnings growth will accelerate. The company’s crown jewel — its 45 percent stake in Verizon Wireless — will be monetized. The Indian market, where Vodafone is a big player, will continue to improve, and the company will start earning a reasonable return on investment there. Last, our societal addiction to being able to access the Internet anywhere at any time on any device will kick into ever-higher gears, and data sales will accelerate Vodafone’s revenue growth.

Ekornes is a Norwegian manufacturer of pricey furniture that is sold all over the world. Despite making its gorgeous products in high-cost countries like Norway and the U.S., the company is still achieving an impressive return on capital. It is run with Norwegian conservativeness: It has no debt and a cash-rich balance sheet and remained profitable even in the midst of the Great Recession. Its stock sports a yield around 7 percent, which will likely go up once the situation in Europe normalizes.

 (We own Vodafone in other portfolios and added to it recently, but after doing more work we decided we need a higher margin of safety for Ekornes, so we passed on it for now.)

Though this may sound banal, I’ve often seen it happen that in the quest for yield in a very low-rate environment, yield can easily turn into a shiny object that obfuscates one’s analytical thinking. Investors suspended their judgment and held on to high-dividend-paying financial stocks in the early phase of the financial crisis because of those dividends — and we know how that story played out.

Analysis of high-yielding stocks should come with a warning label: Dividends are only part of the equation, and one’s analysis of a high-dividend stock should not be any different from that of a low-yielding one. After all, sustainable high-dividend yield is just a by-product of a company’s low valuation (it usually serves as a good indicator of value) and capital allocation decisions.

Once you find a company with a high — and sustainable — dividend yield, its price-earnings ratio has to work a lot less hard for you to receive a good future return.

This article was originally written for and published on Institutional Investor  Magazine

A young American from Louisiana, Harvey Lavan ”Van” Cliburn performed parts from Tchaikovsky’s Piano Concerto No. 1 and Rachmaninoff’s Piano Concerto No. 2.  He was an American, in Moscow at the height of the Cold War, performing incredibly difficult concertos by two Russian composers; and he did it so well that the Russians in the audience stood and applauded him for eight minutes!  Remember, those were the Russians that were brainwashed to hate “evil, imperialistic” Americans (my grandparents, my parents, and even I, for part of my life, belonged to that group of brainwashed people).

Political tensions were so high at the time that before the judges could award Van Cliburn the gold medal, they had to check with Soviet Premier Nikita Khrushchev.  “Is he the best?” Khrushchev is said to have asked; “then give him the prize!”  There is something very pure and uplifting about this story – how the power of music trumps hate.  Hollywood should should get going on a movie.

Sadly, Van Cliburn passed away on February 27th (read his obit in the Wash Post).  Just last month my kids and I were listening to Van Cliburn playing Rachmaninoff’s Concerto No. 2 in the car, and I was telling them his story.  Today I want to share with you Van Cliburn performing the Rachmaninoff Piano Concerto No. 3, in 1958. (parts: 1, 2, 3, 4 and 5).  I’ll write about this concerto and the impact it had on me sometime in the future.

A few years ago, when Apple co-founder Steve Jobs was asked about his vision for the tablets and PCs of the future, he said they reminded him of cars and trucks: We need both, but there are more cars on the road than trucks. Steve was right, but success or failure will come down to how big the total market for personal devices (irrespective of form factor) will be and what the mix between PCs/notebooks and tablets will be.

The tablet is a terrific tool for consuming information — reading e-mail, watching movies, communicating on Skype, playing games — but its form factor limits it as an effective productivity device. Large screens, a mouse, high computing power, multitasking and multiple windows open at once are the features for which we’ll still need PCs.

This article was originally written for and published in Institutional Investor  Magazine  … Continue reading there…  

In 2011 I got three things wrong about HP: printers, services and culture. To better understand the company, it’s helpful to use an analytical framework based on two companies in different time periods: computer maker IBM Corp.circa 1993 and film giant Eastman Kodak Co. since 2006.

Kodak was responsible for pioneering work in digital photography as early as the 1970s. In the ’90s, when digital photography was introduced commercially, Kodak’s 35mm film sales at first continued to grow, as digital cameras were an expensive novelty. But as digital cameras got better and cheaper, and thus more popular, sales of 35mm film started to decline. If you were a value investor analyzing Kodak, the stock would have appeared cheap on past earnings. And if you assumed that Kodak’s cash flows would gradually decline years into the future, you’d have been dead wrong. Kodak turned into the value trap of all value traps. Once digital cameras went mainstream, Kodak’s sales went off a steep cliff, falling from $13 billion in 2006 to $5 billion today. Cameras are replaced every few years, and the cost savings from not buying expensive film any longer were substantial. Also, the new digital cameras were simpler, and the learning curve was not steep.

This article was originally written for and published in Institutional Investor  Magazine … Continue reading there… 

I remember many moons ago I bought a used CD of La Boheme.  I don’t think I knew anything about that opera (my parents were not big into opera), but it had Pavarotti on the cover, so I bought it.  I listened to it a few times, thinking to myself, how could anybody possibly like this opera. Now it is one of my favorite operas.

When my brother Alex and I were in Sydney in November we went to a concert in the famous Sydney Opera House.  We were in luck: it was a “Russian night” (no, not so-called because Alex and I were in attendance).  The famous Russian conductor (and pianist) Vladimir Ashkenazy was conducting music by Russian composers: Tchaikovsky’s Symphony No. 4 and Rachmaninoff’s Concerto No. 4.   After the concert I talked to my father, and I told him than I did not care for Tchaikovsky’s Symphony No. 4.  To which he replied that it was his favorite symphony.  The next day we went walking on the beach in Sydney, and I made a point to listen again to that symphony.  On the second or third listen, I fell in love with that piece.  After I came home to Denver I had my son listen to that symphony, and predictably, he at first hated it, but now he loves it!

So today I want to share with you Tchaikovsky Symphony No. 4.

 By the way, I’ve listened to Rachmaninoff’s Concerto No. 4 probably two dozen times over the last fifteen years, and I still don’t “understand” it.

I have to admit I’m completely smitten by Anna Netrebko.  I am going to sound shallow for a second – so be it.  Usually, female opera signers don’t fit the characters they try to portray on stage, especially characters of Verdi and Puccini operas (frail beauties that men are supposed to lust for).   It is very difficult to find an opera singer that has all three qualities: a great voice, great acting ability, and physical beauty.  You usually get one, maybe two, but three? – well, you get them with Anna Netrebko.  I am going to stop here before I say something politically incorrect… So here is La Traviata – you can watch the full opera on Youtube in HD.

On the surface this switch makes sense. Wall Street’s time horizon has been shrinking for decades. With Nobel-winning theorists and their by-products — betas, thetas and whatever other “etas” — leading the charge, investors’ long-term decisions are analyzed on a daily and monthly basis, thus turning what might otherwise be long-term investors into long-term traders (an oxymoron).

The media are, of course, a great amplifier of this misalignment. A recent Wall Street Journal article that describes Coca-Cola Co.’s “performance” is a great example of this: “Over its past 20 earnings releases, the company has lagged behind estimates only three times, and always by less than 1 percent.” This is statistically accurate but primitive journalism; a ten-year-old could have written this sentence describing how “well” Coca-Cola management performed. I don’t want to beat up on the Journal too much — the article did have some meat in it — but “beating” the guidance is a game that has little to do with Coke’s core business.

Continue reading on Institutional Investor….

]]> http://ContrarianEdge.com/2013/02/20/michael-dell-who%e2%80%99s-your-daddy/feed/ 0 http://ContrarianEdge.com/2013/02/20/valuex-vail-2013/ http://ContrarianEdge.com/2013/02/20/valuex-vail-2013/#comments Wed, 20 Feb 2013 22:37:23 +0000 Vitaliy Katsenelson http://ContrarianEdge.com/?p=3251 VALUEx Vail 2013 

The Third Annual VALUEx Vail will be held in Vail, Colorado, June 19th through 21nd (Wednesday – Friday)

VALUEx Vail is created for serious investors to share ideas and learn from one another’s experiences, all while enjoying each other’s company and fun activities in the gorgeous Colorado mountains.

You can read my thoughts from the last two conferences here and here.

We’ll have about six  presentations every evening (Wednesday, Thursday, and Friday) starting at 4:30 pm for about two and a half hours, followed by dinner (we’ll change restaurants every night).  In addition we’ll have a “dessert speaker,” who will do an informal talk and Q&A on an interesting subject.  (In 2011 Jim Chanos shared his insights on subjects from short selling to his favorite value traps.  In 2012 Jon Markman talked about his latest work, an annotation to Reminiscences of a Stock Operator.)  To conclude each day, the more adventurous types are welcome to join us at the bar for drinks.

Success of VALUEx Vail depends on participants’ presentations.  Therefore, all attendees will be asked to share ideas, whether they are shared in a 15-minute presentation, in a “dessert talk,” or more informally late at night in the bar.  We’ll only have time for about twenty 15-minute presentations; therefore, while everyone should be willing to present, we’ll choose only twenty presenters.  The presentation could be on any investment topic, including but not limited to stock ideas (long or short), macroeconomic or geopolitical discussion, sector or industry analysis, insights into the investment process, etc.  (Once the attendee list is finalized, attendees will be contacted about their presentations.)

In the morning, if you can get up after the night before (!), please join the group for breakfast.  Sometime after breakfast we’ll do a fun activity.  Last year we went to two different ranches, played volleyball, threw horseshoes, and tried our hand at bocce ball; and the kids did some fishing.  The location of the group lunches will depend on which fun activities we choose.

VALUEx is a perfect opportunity for a family vacation.  Family members, including children of all ages, are encouraged to participate in activities during the day.  I’ll bring my whole family.

My family has been going to Vail for almost twenty years.  We spend a few weeks there every summer, riding bikes, going for long walks, riding the gondola to the top of the mountain, or simply doing nothing.

Accommodations: In late April or early May we’ll send a list of recommended hotels.  Mid-June is fairly slow in Vail, hotel prices are very reasonable, and you should not have a problem (with a reasonable lead time) finding a decent room.  Almost everything in Vail is within walking distance.  There are no cars allowed in Vail Village or Lions Head (the western side of Vail), so you either walk, ride the free bus (which comes along every 10 minutes), or ride a bike, which you can also rent nearby.

Dress code: Very casual, comfortable clothes

Cost: This is a not-for-profit event.  There will be a nominal fee of $250 to cover organizational expenses (it is nonrefundable).

 Attendees will be responsible for hotel, food, and activities.  It is important to note that we are not in the conference business.  All we are doing is taking your hard-earned money and transferring it to the even more hard-working service providers (restaurants, activity providers, etc.)  Last year the cost of exclusive use of the facility where presentations were held, plus food and drinks, averaged about $150 an evening per attendee.  As we get closer to the event we’ll send you a link where you’ll be able to prepay for dinners and activities.

How to apply: Since all content is attendee-generated, we are more concerned about the quality than the quantity of attendees (also, for the best flow of ideas, we limit size to 40 attendees).  If you’d like to attend, send us an email to tml@imausa.com , and in a few paragraphs tell us about yourself, your experience, your areas of expertise, and a  topic/idea you’d like to discuss at the conference.  I understand that things may change in a few months, but this will give me a general idea.  It is important to note that you don’t have to be a professional value investor to apply.  Though we envision that the majority of attendees will be professional value investors, there is also value in a diversity of views, so if you are a diehard nonprofessional value investor, please apply!

Deadline to apply:  April 7h.  We will not be able to accept requests to attend after April 7th.

Contact information: If you have questions, please feel free to contact Theresa Lewingdon at tml@imausa.com or (303) 796-8333.

Apple’s ecosystem is an important and durable competitive advantage; it creates a tangible switching cost (or, an inconvenience) after Apple has locked you into the i-ecosystem. It takes time to build an ecosystem that consists of speakers and accessories that will connect only via Apple systems: Apple TV, which easily recreates an iPhone or iPad screen on a TV set; the music collection on iTunes (competition from Spotify and Google Play lessens this advantage); a multitude of great apps (in all honesty, gaming apps have a half-life of only a few weeks, but productivity apps and my $60 TomTom GPS have a much longer half-life); and, last, the underrated Photo Stream, a feature in iOS 6 that allows you to share photos with your close friends and relatives with incredible ease. My family and friends share pictures from our daily lives (kids growing up, ski trips, get-togethers), but that, of course, only works when we’re all on Apple products.(This is why Facebook bought Instagram for $1 billion. Photo Stream is a real competitive threat to Facebook, especially if you want to share pictures with a limited group of close friends.)

The i-ecosystem makes switching from the iPhone to a competitor’s device an unpleasant undertaking, something you won’t do unless you are really significantly dissatisfied with your i-device (or you are simply very bored). How much extra are you willing to pay for your Apple goodies? Brand is more than just prestige; it is the amalgamation of intangible things like perceptions and tangible things like getting incredible phone and e-mail customer service (I’ve been blown away by how great it is!) or having your problems resolved by a genius at the Apple store.

Of course, as the phone and tablet categories mature, Apple’s hardware premium will deflate and its margins will decline. The only question is, by how much? Let me try to answer that.

From 2003 to 2012, Apple’s net margins rose from 1.1 percent to 25 percent. In 2003 they were too low; today they are too high. Let’s look at why the margins went up. Gross margins increased from 27.5 percent to 44 percent: Apple is making 16.5 cents more for every dollar of product sold today than it did in 2001. Looking back at Nokia Corp. in its heyday, in 2003 the Finnish cell phone maker was able to command a 41.5 percent margin, which has gradually drifted down to 28 percent. Today, Nokia is Microsoft’s bitch, completely dependent on the success of the Windows operating system, which is far from certain. Nokia is a sorry shell of what used to be a great company, while Apple, despite its universal hatred by growth managers, is still, well, Apple. Its gross margins will decline, but they won’t approach those of 2003 or Nokia’s current level.

For Apple to conquer emerging markets and keep what it has already won there, it will need to lower prices. The company is not doing horribly in China — its sales are running at $25 billion a year and were up 67 percent in the past quarter. However, a significant number of the iPhones sold in China (Apple doesn’t disclose the figure) are not $650 iPhone 5’s but the cheaper 4 and 4s models. (Also, on a recent conference call, Verizon Communications mentioned that half of the iPhones it has sold were the 4 and 4s models.) Apple’s price premium over its Android brethren is not as high as everyone thinks.

What is truly astonishing is that Apple’s spending on R&D and selling, general and administrative (SG&A) expenses has fallen from 7.6 percent and 19.5 percent, respectively, in 2003 to a meager 2.2 percent and 6.4 percent today.R&D and SG&A expenses actually increased almost eightfold, but they didn’t grow nearly as fast as sales. Apple spends $3.4 billion on R&D today, compared with $471 million in 2001. This is operational leverage at its best. As long as Apple can grow sales, and R&D and SG&A increase at the same rate as sales or slower, Apple should keep its 18.5 percentage points gain in net margins through operational leverage.

Growth of sales is an assumption in itself. Apple’s annual sales are approaching $180 billion, and it is only a question of when they will run into the wall of large numbers. At this point, 20 percent-a-year growth means Apple has to sell as many i-thingies as it sold last year plus an additional $36 billion worth. Of course, this argument could have been made $100 billion ago, and the company did report 18 percent revenue growth for the past quarter, but Apple is in the last few innings of this high-growth game; otherwise its sales will exceed the GDP of some large European countries.

If you treat Apple as a pure hardware company, you’ll miss a very important element of its business model: recurrence of revenues through planned obsolescence. Apple releases a new device and a new operating system version every year. Its operating system only supports the past three or four generations of devices and limits functionality on some older devices. If you own an iPhone 3G, iOS 6 will not run on it, and thus a lot of apps will not work on it, so you will most likely be buying a new iPhone soon. In addition — and not unlike in the PC world — newer software usually requires more powerful hardware; the new software just doesn’t run fast enough on old phones. My son got a hand-me-down iPhone 3G but gave it to his cousin a few days later — it could barely run the new software.

As I wrote in my previous column, Apple’s success over the past decade is a black swan, an improbable but significant event, thanks in large part to the genius of Steve Jobs. Today investors are worried because Jobs is not there to create another revolutionary product, and they are right to be concerned. Jobs was more important to Apple’s success than Warren Buffett is to Berkshire Hathaway’s today. (Berkshire doesn’t need to innovate; it is a collection of dozens of autonomous companies run by competent managers.) Apple will be dead without continued innovation.

Jobs was the ultimate benevolent dictator, and he was the definition of a micro-manager. In his book Steve Jobs, Walter Isaacson describes how Jobs picked shades of white for Apple Store bathroom tiles and worked on the design of the iPhone box. He had to sign off on every product Apple made, down to and including the iPhone charger. His employees feared, loved and worshiped him, and they followed him into the fire. Jobs could change the direction of the company on a dime — that was what it took to deliver black i-swans. Jobs is gone, so the probability of another product achieving the success of the iPhone or iPad has declined exponentially.

What is really amazing about Apple is how underwhelming its valuation is today — it doesn’t require new black swans. In an analysis we tried very hard to kill the company. We tanked its gross margins to a Nokia-like 28 percent and still got $30 of earnings per share (the Street’s estimate for 2013 is $45), which puts its valuation, excluding $145 a share in cash, at 10 times earnings. We killed its sales growth to 2 percent a year for ten years, discounted its cash flows and still got a $500 stock.

There is a lot of value in Apple’s enormous ability to generate cash. The company is sitting on an ever-growing pile of it — $137 billion, about one third of its market cap. Over the past 12 months, despite spending $10 billion on capital expenditures, Apple still generated $46 billion of free cash flows. If it continues to generate free cash flows at a similar rate (I am assuming no growth), by the end of 2015 it will have stockpiled $300 of cash per share. At today’s price it will be commanding a price-earnings ratio (if you exclude cash) of 4.

Of course, the market is not giving Apple credit for its cash, but I think the market is wrong. Unlike Microsoft, which does something dumber than dumb with its cash every other year, Apple has a pristine capital allocation track record. It has not made any foolish acquisitions — or, indeed, any acquisitions of size. Other than buying an Eastern European country and renaming it i-Country, Apple will not be able to acquire a technologically related company of size, nor will it want or need to. The cash it accumulates will end up in shareholders’ hands, either through dividends or share buybacks.

What is Apple worth? After the financial acrobatics I’ve done trying to murder the valuation of Apple, it is easier to say that it is worth more than $450 than to pinpoint a price target. When I use a significantly decelerating sales growth rate and normalize margins (reducing them, but not as low as Nokia’s current margins), I get a price of about $600 to $800 a share.

Growth managers don’t want Apple to pay a large dividend, as though that would somehow transform this growing teenager into a mature adult. But I have news for them: Apple already is a mature adult. Second, when your return on capital is pushing infinity (as Apple’s is), you don’t need to retain much cash to grow. Two thirds of Apple’s cash is offshore, but that doesn’t make it worthless; it just makes it worth less — only $65 billion, maybe, not $97 billion, once the company pays its tax bill to Uncle Sam.

In the short term none of the things I am writing about here will matter.Remember, “Everyone knows Apple is going to $300,” as a client recently e-mailed me, as everyone knew it was going to a $1,000 a few months ago when Apple’s stock was trading at $700. The company’s stock will trade on emotion, fundamentals will not matter, and growth managers will likely rotate out of Apple, because once the stock declined from $700 to $450, the label on it changed from “growth” to “value.” But ultimately, fundamentals will prevail. Like the laws of physics, they can only be suspended for so long.

This article has been originally written for Institutional Investor…. 

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

]]> http://ContrarianEdge.com/2013/02/12/how-much-would-you-pay-for-the-apple-ecosystem/feed/ 0 http://ContrarianEdge.com/2013/02/12/understanding-apple-requires-an-analysis-of-fundamentals-and-psychology/ http://ContrarianEdge.com/2013/02/12/understanding-apple-requires-an-analysis-of-fundamentals-and-psychology/#comments Tue, 12 Feb 2013 00:43:34 +0000 Vitaliy Katsenelson http://ContrarianEdge.com/?p=3237 So many articles have been written recently about Apple — defending it or explaining why this glorious fruit will turn into a shriveling pumpkin by midnight (with Samsung’s help) — that I really haven’t felt the need to contribute to the unending debate. But then Apple’s stock crashed to $450 last month, and we bought a little for our clients. After receiving an outraged e-mail from one of them calling the purchase “irresponsible” and proclaiming that everyone (including his neighbor) knows that Apple is going down to $300, I decided it was time to join the discourse. Clients rarely (almost never) contact us about stocks we own in their accounts. More important, this is far from the most “radioactive” stock we own or have owned.

Here, in the first of two columns on Apple, I have no intention of defending or prosecuting the company, but I would like to share some thoughts about it that many pundits have either overlooked or ignored.

What makes Apple stock difficult to own is psychology. The company’s success since 2000 is a black swan. We tend to think of Nassim Nicholas Taleb’s black swans as significant random negative events, but Apple is a positive one. When co-founder Steve Jobs came back to the company in the late ’90s, Apple was about to take its last breath. Jobs pulled off a miracle. He revived the company’s computer product line, making Macs exciting again, and then came out with three revolutionary “i” products in a row: the iPod, iPhone and iPad. You could argue that the success of each “i” product in itself was a black swan, exceeding all rational expectations and revolutionizing, transforming and in some cases creating new categories of merchandise that had never existed before.

Apple’s revenue and market capitalization deservedly surpassed those of almighty Microsoft Corp. — the hairy monster with stinky breath that performed CPR on dying Apple in the late ’90s by injecting liquidity into the company by buying its preferred stock. We have a hard time processing this highly improbable success and an even harder time imagining that there is another black swan about to take flight from the Apple labs, especially with no Steve Jobs around to sit on the egg.

Black swans come out of nowhere, unannounced, but their impact may be long-lasting. The wildly successful “i” gadgets dug a formidable moat around Apple.They created the most valuable and still most inspirational brand in the world, funded an enormous research and development effort, enabled huge buying power (Apple locks up supply and pays much lower prices than many of its competitors for parts), filled out a mature product ecosystem and stuffed Apple’s debt-free balance sheet with $137 billion — half the market capitalization of Microsoft. The moat is wide, deep and unlikely to be breached any time soon.

One reason the psychology of owning Apple stock is so difficult: its high price.(Note: I am talking not about its valuation but purely about its price.) Apple has had only one stock split since the late ’90s, when it was trading in double digits, and it now changes hands at about $450 (down from $700 just a few months ago). Stock splits create zero economic value in the long run — absolutely none.Apple could split its stock ten to one and you’d have ten $45 shares, and nothing about the company or its business would change. But I’d argue that a 3 percent “slide” of $1.35 would grab fewer headlines than a $13.50 “drop” — there is a media magnification factor that is hard to ignore.

Is Apple a hardware or a software company? This is a very important question because Apple’s net margins of 25 percent are dangerously higher than those of Microsoft, a software monopoly that, with the minor exception of the Xbox and its new venture into tablets, sells only software, which has a 100 percent incremental margin.

Apple is either a smart hardware company or a software maker dressed in hardware company clothes. Take a look at the PC businesses of traditional “dumb” hardware companies like Dell and Hewlett-Packard Co. (I am not insulting these companies, I am just highlighting their lack of PC-directed R&D.) They buy hard drives from Western Digital Corp., graphic cards from Nvidia Corp., processors from Intel Corp. and an operating system from Microsoft, then they have contract manufacturers put together these parts in Asia and ship PCs all over the world. Dell and HP engineers design the PCs but contribute minimal R&D to their boxes; most of the R&D is done by the suppliers. Dell and HP are really asset-lite marketing and logistics companies — this explains their razor-thin margins. (Side note: Because of a lack of fixed costs, Dell and HP can remain profitable despite the ongoing decline in PC sales.)

On the surface, Apple’s personal computer business is not that much different from Dell’s or HP’s: It uses the same highly commoditized hardware and it also outsources manufacturing, but Apple spends much more on the R&D of its own operating system and creates distinctive, innovative products. Apple gets to keep a slice of revenue that would otherwise go to Microsoft for the operating system.Also, Apple is able to charge a premium (usually a few hundred dollars per PC) for the aesthetic appeal and perceived ease of use of its products.

However, when it comes to the “i” devices, Apple is a much smarter hardware company; its value added goes further than just basic design and software.Though there is a lot of commoditized hardware that goes into an iPhone or iPad, Apple’s skill at fitting an ever-growing number of components into ever-shrinking devices constantly increases. Add world-class touch and feel, superior battery life and durability, and you have a package that turns what would otherwise be commodity items into highly differentiated, and undeniably sexy, products. Apple has even gone a step further and is designing its own microprocessors.

But — and this is a very important “but” — as phones and tablets mature, processor speed, battery life and weight will tend to become uniform across all devices. It is arguable that the competition has already caught up with Apple in the hardware race. As the hardware premium goes away, there will be only two premiums left: Apple’s brand and its ecosystem. (I will go into detail about the “i” ecosystem and what it means for Apple’s margins and profitability in my second column, later this week.)

Note that I did not mention the software premium. Unlike Microsoft, which charges for the Windows operating system installed on PCs, Google gives away Android to anyone who dares to make a phone or a tablet. Unless Apple can maintain the operating system lead against Android, that premium will go away.Recently, I spent a few days playing with Nexus 7, Google’s Android-powered 7-inch tablet, which retails for $200 ($130 cheaper than Apple’s iPad mini). Nexus 7 is a good product, but I kept remembering that humans and monkeys share 98 percent of their DNA, and the Android operating system is missing the 2 percent that makes Apple iOS so special.

Next: I’ll explore the competitive advantage of the Apple ecosystem, insult some of its competitors and analyze what the company’s shares could be worth under different scenarios.

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

This article was originally written for Institutional Investor Magazine…. 

Of course soccer is the true football. I am not trying to go Russian or European on you; but after all, in American football players barely touch the ball with their feet, while in “soccer” that is all they do.   American “football” should really be called handball, but I guess that name was taken.  I digress.  Over the years, Mike has dragged me to a few CU Buffs games, and I have come to appreciate football more and more, especially watching a game in Boulder in the fall; it is simply magical.

After living in this great country for over 20 years I completely understand why soccer was never really popular in the United States.  Three letters: ADD (attention deficit disorder).  We (I am as American as apple pie in this) don’t have enough patience to watch a game continuously for 90 minutes, as very fit guys in shorts fool around with the ball and rarely score any points. No, we don’t have the patience for it; if there’s not excitement every 20 seconds we lose interest.  I tried to watch a soccer game recently, and while I appreciated the elegance of passing the ball from one player to another, it wore on me after 20 minutes.  American football perfectly fits the American lifestyle, too: the drama and excitement of a 20-second play, followed by nachos and beer while the teams regroup – we even get to take bathroom breaks during commercials.

Last year my family started a new tradition:  my wife, kids, and I go to my father’s house to watch the Super Bowl.  I don’t have TV service at home – I despise regular commercials and local news – so this is why we watch it at my father’s.  This year we were also joined by my aunt, visiting from Russia, and my brother Alex and his family.  Ironically, among the ten of us, I was the expert on football (this was probably my tenth game); while for almost everyone else it was either the first or second game they had ever watched.

We have rarely had so much fun together as we did watching this Super Bowl.  Since the Broncos were not playing, I really didn’t care who won. (To be honest, until the game started I really didn’t know or care who was playing).  So when I was asked who I wanted to win, I said “the guys in red jerseys.” Everyone else liked the color red better than black and blue, so everyone but my father was rooting for the ’49ers.  My father took the other side just to make it interesting.  So by the second half it was my father versus everyone else, even my aunt, who at 75 was watching her first football game, glued to the TV, rooting for the “guys in red” to win.

Traditions are important; through their recurrence they engrain our memories.  Many years will pass, my kids will remember how our big family, all three generations, got together to watch the Super Bowl.  They won’t remember who played or who won – in the long run those things don’t really matter.  But they’ll remember how being together, laughing and cheering made them feel.  That is all that matters!

To my surprise, despite its name, there is little that is “herbal” about Herbalife.I thought I’d see a lot of exotic plants reincarnated as wonder miracle supplements. What I discovered is that the majority of Herbalife’s sales come from its Formula 1 product, a meal-replacement supplement. If Herbalife’s products were sold at Walgreens or GNC, the story would be very simple, but it is not. The company’s business model is in question because investors suspect that its products are bought just as “trading sardines” (they might as well be bricks or wooden sticks). If at the end of the day its supplements are not consumed but instead rest peacefully in the garages of its distributors, Herbalife is nothing but a Ponzi-like scheme that will run its course — they always do.

Whether they are long or short Herbalife shares, investors have to have a clear answer to one question: Is Herbalife a Ponzi-like scheme? In our research, finding a definitive answer was very difficult. Herbalife is not unlike a typical MLM company that spends most of its time painting a picture of a Ferrari-embellished financial freedom that awaits you just around the corner if you sign up enough distributors to sell its products.

Herbalife claims that the bulk of its supplements are consumed on a daily basis at “clubs,” of which there are thousands around the world. Clubs are owned and operated by Herbalife distributors and are supposed to be social spots for Herbalife connoisseurs to meet, share their weight-loss war stories and, for about $6, down a shot of Formula 1 and swig some aloe vera juice.

We visited a nearby club a few times. What we found is that, though there were a few people replacing their lunch with Formula 1, it was mostly a place for distributors to peddle Herbalife’s products to one another. According to the club operator, selling $6 lunch substitutes did not cover operating expenses and rent. It is probably impossible for Herbalife to know for sure how much of its products are consumed at these clubs, but I doubt that it is as much as they claim. If people find that they like these shakes, they can just make them on their own.

We could not get comfortable with Herbalife’s main product, Formula 1. It has a lot fewer calories than your typical McDonald’s meal, but so does a cardboard box. If you keep replacing your lunch with Formula 1, you’ll very likely lose weight; but according to a nutritionist friend, if you want to stay healthy, you don’t want to consume Formula 1 on a regular basis. Also, Formula 1 is expensive — after all, lots of layers of distributors above you need to be fed from each sale.

Formula 1 reminds me of another product that, without serious financial incentives paid to those who sell it, would probably not exist today (at least not in large quantity): variable annuities. In some stripped-down, inexpensive form, variable annuities might be a good product, albeit one with a very limited market. However, they have been very profitable for financial institutions, which started paying huge commissions (sometimes 10 to 15 percent of the principal value), thus transforming the variable annuity into an expensive financial trap to be forced on the unsophisticated crowd. Similarly, if Herbalife sold its products in stores, or did not try to sell the American dream to its distributors, its products would be much cheaper but its sales would be a fraction of what they are today.

A few months after we did our research, Pershing Square Capital Management’s Bill Ackman announced his Herbalife short. I watched his presentation with interest. But unlike his other, brilliant presentations, this one left me unimpressed. Ackman’s three-hour-plus, 334-slide presentation did not answer the most important question: If Herbalife is a Ponzi-like scheme, why is its business still growing in the U.S. after 32 years?

It felt to me as if Ackman so despises what he believes is Herbalife’s deception that this short is a quixotic quest to right a perceived wrong. Regardless, in early January, Dan Loeb of Third Point revealed that his fund has an 8 percent stake in Herbalife, calling Ackman’s case against the company “preposterous.”

Ackman’s highly publicized short may turn into a self-fulfilling prophecy. It will definitely distract management from running the company. It will also increase Herbalife’s expenses as it defends itself against his accusations. Finally, the company’s success is dependent on its ability to sign up new distributors, and the negative publicity Ackman has created will not help those efforts. But then again, the U.S. accounts for only 20 percent of Herbalife’s total business.

There are thousands of stocks in the global universe. We need only 20, and there is no place for a stock about which we cannot comfortably answer this simple question: Is it a Ponzi-like scheme?

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

This article was originally written for Institutional Investor Magazine 

J.C. Penney Co. is a classic short-term pain arbitrage stock. There is a lot of uncertainty about what the retailer’s sales will do in the near future, but in the long run it looks like a very attractive investment.

A little more than a year ago, hedge fund manager William Ackman took a significant position in Penney stock. I don’t know if he had to resort to blackmail, but somehow Ackman pulled off a miracle: He persuaded Ron Johnson — the genius behind the Apple stores — to quit his job in Cupertino and become CEO of run-down Penney.

In the first quarter of 2012, Johnson unveiled a strategy to transform each Penney’s department store into a shopping mall with 100 small, branded shops. Each specialty shop will have a unique feel and be owned and run by Penney, but they’ll all be designed in collaboration with the brand owners (which are footing part of the remodeling expense). Everyone who has seen pictures of the prototype store in Plano, Texas, says it is amazing.

Johnson is also introducing at Penney those little things that made Apple stores so unique: Next to Disney and Carter’s shops, Penney will have Legos and iPad tables for kids waiting for their mommies to shop, while it will provide couches and coffee bars for the impatient husbands. So far, Penney has only introduced ten shops, but it will bring in 30 shops a year over the next three years, and by August 2013, 40 percent of Penney stores will have been redesigned.

U.S. consumers have an insatiable need to feel good about parting with their money. We don’t necessarily know it, but we want to be deceived: We want to buy things on sale; we want to feel like we took advantage of the retailer. The old Penney was the master of this game. It would inflate initial prices, then run sales. In fact, to overcompensate for its unexciting stores, Penney ran 500 promotions a year — 1.4 promotions a day. Serious brands did not want to be a party to this gimmickry, so Penney mostly sold its own, lower-quality brand.

The boldest move Johnson has made is to kill the 1.4-sales-a-day strategy and replace it with an everyday low price. However, promotions are like a drug for consumers and retailers alike, and the withdrawal process is painful. Once Penney stopped running promotions, customer traffic dropped 10 percent and sales 20 percent.

Before Johnson took over, Penney’s sales and earnings had stagnated for years. Sales per square foot were about $150, lower than Kohl’s Corp.’s $194 or Nordstrom’s $431 but still a high number considering how stale and unexciting Penney stores were. Now that figure is closer to $115, but there are definite signs that the new strategy is working, with in-store specialty shop sales running at $186 per square foot, double those in the rest of the store and 30 percent higher than before the stores were redesigned.

However, the current worry is that if total sales continue to fall, the company will run out of cash. It is very likely that Penney will have to offer promotions, but considering that its stores and merchandising are improving, the company won’t have to be nearly as promotional as it was in the past. At the end of 2012, Penney should have about $1 billion in cash on its balance sheet. It has an untapped $1.5 billion credit line that it can use at any time, and it can still monetize its assets. (Penney owns a third of its stores, and the rest are on long-term leases at $4 per square foot, giving it a competitive advantage, as it is paying a fraction of what its competition lays out for real estate.) Last, Penney doesn’t have to worry about the debt market for a long time: Its next debt maturity is $250 million in 2015.

The best thing about Penney is that the bar for success is set very low. Since he took over, Johnson has taken out $900 million in costs. Its sales per square foot should rise with every redesigned store. If Penney achieves the pre-­Johnson level of $150 per square foot and gets to keep $700 million of cost cuts, its earnings power will be $3 to $4 per share. If sales per square foot come back to the 2007 peak of $170, earnings will jump to $6 a share. Considering that Penney stock is trading at about $19, if your career can survive neutered theta in the short run, this is one cheap stock for the long run.

http://www.institutionalinvestor.com/blogarticle/3129752/Bargain-Hunting-at-JC-Penney.html?ArticleID=3129752&single=true

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

]]> http://ContrarianEdge.com/2013/01/16/burgain-hunting-at-j-c-penney/feed/ 2