Tag Archives: business

the A&P bankruptcy

July 21, 2015 By in Industry Analysis, Retail, supermarkets, working capital Tags: , , , , , 1 Comment

a Chapter 11 filing

The Great Atlantic and Pacific Tea Company has just filed for Chapter 11 bankruptcy protection.  According to the radio reports I heard yesterday, this is the second time in three years and the fifth overall bankruptcy filing for the venerable supermarket chain.

A&P said it did so in order to preserve the flow of fresh produce and other perishables into its stores.

In one sense, it’s not surprising that supermarket chains might be in trouble, given the relentless expansion of Wal-Mart into grocery over the past couple of decades, the rise of Whole Foods et al, and the change in lifestyle and consumption habits being spearheaded by Millennials.

A&P as a useful template for investors

A&P, however, is also an important illustration of how creditworthiness can deteriorate in ways investors seldom suspect.

the key:  trade creditors’ bankruptcy standing

The key to understanding what is going on is to realize that in Chapter 11, trade creditors go to the bottom of the list of who gets repaid.  They rank ahead only of equity holders, who as a general rule are wiped out completely.  Trade creditors usually fare little better, if at all.The amounts involved can be substantial.  In the A&P case, for example, McKesson is listed as a major unsecured creditor, owed $39+ million.

trade creditors defending themselves

Knowing that any outstanding bills will likely be voided by a bankruptcy court, suppliers of inventory and services watch the creditworthiness of their customers very carefully.  They hire third-party credit services to provide periodic reports, and they monitor any differences in customer payment patterns very carefully.

If a customer shows A&P-like symptoms (according to Bloomberg, A&P had been having net cash outflows of $14.5 million monthly during fiscal 2015), a vendor can take several related actions to lower its risk:

–it can send less merchandise on credit to the worrisome customer

–it can send lower-value or lower-quality merchandise, or only items that have an extremely short sales cycle

–it can refuse to extend credit; it will demand payment in advance.  This is a lot more serious than it sounds, since the customer may be depending on being able to use the cash from a sale for a week before paying the vendor.

(An aside:  I’ve even seen instances where a trade creditor has sued the customer for payment, knowing that a favorable judgment will force bankruptcy.  The idea is that some third party who doesn’t want a Chapter 11 filing–a bank or other long-term debt holder, or an equity holder–will settle the debt while the case in court.)

Of course, none of this is good for the cash-strapped concern.

reversal of form

Once the firm is in bankruptcy, the situation reverses completely.  Suppliers no longer have to worry about having unpaid bills nullified.  And the bankruptcy judge will ensure that trade creditors are put at the front of the line to be repaid.  So just as the flow of new merchandise into a cash-short enterprise slows down as Chapter 11 becomes a realistic possibility, it speeds up again once the company has filed.

 

 

Samsung and Elliott Associates

July 20, 2015 By in Asian economic development, Current Market Thoughts, family owned companies, Korea Tags: , , , , , , 1 Comment

I’m not an expert on Korea.  In fact, I think of Korea in much the way I think of India or Indonesia–or Japan or Italy, for that matter.  They’re all places where very powerful family controlled industrial groups have enormous economic and political power.  As a result, the rules of the stock market game are very different from those that prevail, say, in the United States.  Piecing them together can take an enormous amount of time and effort.  I’ve believe that, except in the case of Japan in the 1980s, the reward for mastering these markets would never be large enough to justify the effort involved.

In the case of Korea, government policy, both formally and informally, is heavily tilted in favor of a set of family controlled industrial conglomerates called chaebols (much like the zaibatsu/keiretsu of Japan).  In my view, these are not American-style corporations.  They care little for profit growth/maximization or for the welfare of ordinary shareholders–Korean or foreign.  I’ve found the laws and regulations that govern them to be bewilderingly complex and their financial statements (admittedly I haven’t read one carefully in well over a decade) unreliable.

Recently, Samsung, a major chaebol, decided that one affiliate, Cheil, would buy another, Samsung C&T, at what appears to be a bargain basement price. US activist investor, Elliott Associates, then bought a bunch of Samsung C&T stock and challenged the takeover.  Its objective was presumably either to have its stake bought out at a higher price by some other Samsung company or to compel Cheil to raise the acquisition price for everyone.

My initial reaction on reading this was that Elliott was fooled by superficial similarities with the US and didn’t understand the deeper political and cultural barriers it would face in Korea.  That has, so far, proved to be the case.  Shareholders have voted in favor of the acquisition as originally proposed.  Elliott is apparently continuing to sue to try to prevent/reverse this outcome.

The situation is a little more interesting than I’d thought, though, and bears watching:

–the Elliott effort to have Samsung C&T shareholders reject the takeover failed by only 3% of the shares voted.  This is a surprisingly small amount, in my opinion.  On the other hand,

–the deciding vote in favor was cast by the government-connected National Pension Fund, which ironically has previously been a critic of chaebol behavior.

My guess is that it’s ultimately Elliott’s foreignness that swayed the voting, particularly at the NPS.  Were a Korean equivalent to attempt the same thing, the outcome might have been different.  If so, there may be hope for investors in Korea after all.  I’ll continue to be on the sidelines until there’s more tangible evidence of change, however.

 

 

 

 

two aspects of securities analysis: quantitative and qualitative

June 29, 2015 By in activist investing, book value, from growth to value: the life cycle, growth vs value, mean reversion, stock market Tags: , , , , , 1 Comment

quantitative analysis

The quantitative aspect is easier to describe.  It, however, is much more complex and detailed and may take months to complete.  As a professional, I always thought part of the art of portfolio management was in deciding how much of this I had to do before I bought a stock, how much I could obtain from brokerage house securities analysts, and how much I could leave to fill in after I established a position.

The quantitive plan consists in a projection of future company performance–revenues, operating profits, interest, depreciation, general expenses, taxes…–for each line of business and for the company as a whole, over the next several years.  Creating spreadsheets this detailed is an ideal that’s striven for but seldom reached in practice.  That’s because companies rarely disclose this much information in their SEC filings.

Lengthy reports, called basic reports, issued by old-fashioned (i.e., “full service”) brokerage houses are the best example of what a quantitative analysis should look like.  Signing up for Merrill Edge discount brokerage will get you access to such reports.

The most important thing about them, in my view, is the analytical work, not necessarily the opinion.  I think the Merrill analyst covering Tesla, for instance, does extremely good work.  All the relevant issues and numbers are clearly laid out.  Last I read, he thought that fair value for the stock was around $75 a share.  Although he provides very valuable input, and he may ultimately be proven correct, I think he’s way too pessimistic about the stock.

qualitative analysis

This is the general concept behind an investment.  It’s extremely important–more important than the exact numbers, in my view–but it may be as short as an elevator speech.  In most cases, the shorter the better.

Examples, many of which are not current:

–Wal-Mart builds superstores on the outskirts of US cities with a population of 250,000 or less.  They offer better selection and lower prices than downtown merchants do, so they take huge market share everywhere they open.  There are a gazillion such towns left to exploit.

–J C Penney is trading at $25 a share. It owns or controls property that has a value, if rented to third parties, of $50 a share, plus a retail business that is making money.  The latte is worth more than zero as-is.  Let’s say $5 a share.  Taking control of JCP and breaking it up could double our money.

–Adobe is changing from a sales model for its software to a rental one.  This will eliminate counterfeiting, which is probably much more extensive than anyone now realizes.  We know from other industries that going from buy to rent probably doubles profits, even without considering eliminating theft. No one seems to believe this.   Therefore, ADBE’s profit growth over the next two or three years will be surprisingly good.

–Company X is a cement company.  It’s currently beaten down by an economic slowdown and is trading at 40% of book value.  At the next economic peak, it will likely be trading at 100% of book–which will be 20% higher than it is today.  Therefore, the stock should triple in price.

More tomorrow.

why selling is the most important for growth investors

June 26, 2015 By in from growth to value: the life cycle, growth vs value, mean reversion Tags: , , , , , , , , 1 Comment

Value investors make money by finding companies that are undervalued based on the state of their business today.  Their capabilities typically become undervalued because of bad management, a temporary misstep in judgment or a cyclical downturn.  Any of these factors will usually trigger an excessively negative emotional reaction by the market–creating the buying opportunity.

Growth investors like me, on the other hand, are dreamers.  We try to find companies that will likely be expanding their profits at a faster rate than the market expects, and for a longer time than the market expects.

Where the value investor asks “What can go wrong in the here and now from this point on?” and answers “Nothing that the market hasn’t already discounted three times over,” the growth investor asks “What can go right over the next few years that market is unwilling to pay for today?”

 

A generation ago, the classic growth stock was Wal-Mart (WMT), a company that built superstores on the outskirts of small towns with under 250,000 population and prospered by taking market share away from inefficient mom and pop local merchants.  It started in Arkansas and grew…and grew…and grew, for a long as there were new small towns to attack.

In this generation, we might think of Apple (AAPL) or Google (GOOG).  In the former case, it was the ability of a highly skilled management to resuscitate the brand and produce the iPod and then the iPhone that the market didn’t understand when the stock was at $25.  With GOOG, it’s the power of search that was vastly underestimated.

If a stock is going to reach, say, $100 a share–the growth investor’s dream–whether we pay $10 or $12 or $20 isn’t the crucial decision.   Getting on the train at some early stop is all that matters.

Selling at the appropriate point, however, is much more crucial.

How so?

what goes up…

Let’s say the market expects that a certain company is going to grow profits at 15% per year for at least the next several years.  The next quarterly earnings report comes in at +20% in profit growth; management says it thinks it can continue to grow at the higher rate.

Two positive things typically happen:

–the stock rises to adjust for the higher reported earnings, and

–the price earnings multiple expands, as the market begins to factor in the idea that the firm can grow more quickly than it thought.  In other words, the price rises more than simply the good earnings report would justify.

Let’s say that the quarter after that, earnings come in at +25%–and that management continues to make bullish comments about its future.

The same thing–two levels of upward price adjustment, higher earnings, higher multiple–happens again.

For a true growth stock, a WMT or an AAPL or a GOOG, this process of upward adjustment can go on for years.

At some point, though,

…must come down

…the stock market gets tired of being wrong on the downside.  It makes an emotional swing to the upside that can’t possibly be justified by the company’s fundamentals   …ever.

Typically, this is expressed as a sky-high price earnings multiple.

In addition, in my experience, the life span of a typical shooting star earnings grower is about five years.  After that, earnings growth begins to slow.  The crazy multiple expansion comes toward the tail end of the super growth period.

 

As the market senses that slower growth is in the offing, the process of upward adjustment goes into reverse.  The stock declines to reflect weaker than anticipated earnings, and the price earnings multiple begins to contract.

This is usually a very ugly process, with the stock declining much more than one might ordinarily expect.

 

The trick for a growth investor is to exit the stock, at least in large part if not totally, before this happens.

 

More on Monday.

 

 

 

surviving the next twelve months (iv)

June 12, 2015 By in bond market, Constructing a Portfolio, Portfolio management, securities markets, stock market, Strategy Tags: , , , , , , , , Leave a comment

what makes me optimistic

I’m a growth stock investor.  So I’m optimistic by nature.

More to the point, the two worries about thinking stocks will go sideways to up as the Fed normalizes interest rates are that:

–recovery in the US may continue to be sub-par..  

If so, the normalization process is going to take a looong time, since the Fed’s goal is to raise interest rates at a slow enough pace that the economy in unaffected.  Yes, the Fed may make a mistake, but the error it typically makes is to wait too long to raise rates, not to raise them too fast.

In addition, there’s serious discussion in economic circles that maybe the way we have measured economic progress in the US in the post-WWII era has passed its “use by” date and isn’t capturing what’s going on in an Internet-centric world.  After all, it took many years for government data to acknowledge that personal computers enhanced productivity and increased consumers’ well-being.  We’re now in the midst of a much greater period of change–the baton-passing from Baby Boomers to Millennials and the demise of the post-WWII corporation designed on the model of the 1940s Army.

Maybe the economy is a lot hardier than we now think.  If so, the strength of earnings growth may not be the issue the market perceives it to be.

–the rest of the world is a mess…

therefore the 50% of S&P 500 earnings that comes from abroad will  be a source of disappointment.

As far as commodity-based emerging economies are concerned, “mess” is probably an apt characterization.  But they’re (thankfully) only a tiny portion of the foreign 50% of S&P earnings.  The key areas for the index are Europe and Asia, especially China.

As far as Europe goes, there’s evidence that the worse of the recession is behind it.  The euro may have bottomed against the dollar, as well.  The EU is still struggling with the problem of Greece.  But that’s not because Greece is a key economic driver for the EU (quite the opposite), but because Brussels fears that allowing/forcing one member to leave the union will set a precedent, and encourage separatist political parties elsewhere.

I have no idea whether Greece goes or stays.  But I think that the negative economic consequences for Greece–Cuba is the only analogue I can come up with, and it’s not a very good one (Argentina?)–of leaving the EU will be so devastating for the country that Grexit itself will silence separatists.

There are also the first signs of economic stabilization in China.

So maybe the half of S&P earnings that come from abroad also won’t be as bad as the market now thinks.

an active strategy

areas to avoid–stocks whose main attraction is their dividend

areas to emphasize–Internet economy, firms catering to Millennials