WEEKLY COMMENTARY 3/6/17- 3/12/17
A Soriano Corp (Anscor) reported 2016 results. We recently initiated on Anscor with the key points to our thesis being:
- The company has a healthy balance sheet
- The company was in a number of highly competitive businesses, but
- The company consistently generated a return on equity (ROE) around 10% our discount rate for all companies.
- Despite the company’s healthy balance sheet and the consistency of the company’s ROE, Anscor trades well below its book value currently at 0.55 times its tangible book value and at 5.5 times cyclically adjusted earnings.
In 2016, the company maintained a healthy balance sheet with total liabilities twice the company’s cash position but less than half the amount of the company’s total securities. While the company’s businesses continue to be competitive, it was able to generate a return on tangible equity of 9.9%.
The company’s income before tax increased by 26% driven by strong results in all subsidiaries. Anscor’s largest subsidiary, PDPI grew its revenue by 8.3% due to a strong macroeconomic environment boosting construction activity. It was able to increase its net income by 30.7% in 2016. PDPI generated a ROE of 32%, the second year in a row over 30%. The company’s resort operations increased revenue and gross operating profit by 5.7% and 8.3%, respectively, generating a ROE of 34.0%. Anscor’s US nurse staffing business, Cirrus, grew revenue by 39% and net income by 70%. It generated a ROE of 35.9%.
Overall, the results reinforce our investment thesis of a company with a healthy balance sheet consistently generating a ROE close to its discount rate yet trades at a substantial discount to book.
Explaining a Paradox: Why Good (Bad) Companies can be Bad (Good) Investments! (Musing on Markets)
In an environment where finding high quality ideas with any margin of safety is difficult value investors often stray to the idea that any high quality company is worthy of an investment regardless of the company’s valuation as holding cash due to a lack of ideas is more painful than investing in high quality companies that are overvalued. Contrary to what is often heard, Professor Damodaran describes how high quality companies can be bad investments while low quality investments can be good investments. (link)
Rethinking Conventional Wisdom: Why NOT a Value Bias? (Research Affiliates)
This Research Affiliates article is from August 2016 but it reinforces what pretty much any research on value states that it is a investment strategy that consistently outperforms with less volatility. (link)
The Emerging Markets Hat Trick: Time to Throw Your Hat In? (Research Affliates)
While we are bottom up investors, there are a few top down investors enjoy reading with Research Affiliates being one of them. December 2016 article discusses the attractiveness of Emerging Markets equities. (link)
Additionally, we look at Research Affiliates expected returns for different asset classes on occasion. (link) Expected returns are not used in our investment process but we find them interesting nonetheless. We have thought about using the index expected returns as a discount rate. We view the discount rate as an opportunity cost rather than a specific cost of capital for a company. In our view, the marginal cost of capital is for a company does not relate to our acceptable level of return. There are other problems with using the marginal cost of capital as the discount rate including potential estimation errors and biases in the calculation as the marginal cost of capital changes from company to company. Rather than focusing on the marginal cost of capital of a company, we care about generating a sufficient return in each investment idea. Our current thinking is that the return on any investment in the long term equals the return on invested capital as any valuation discount or premium to the intrinsic value is insignificant over longer periods making the average return on invested capital (ROIC) a good starting point for the discount rate. According to McKinsey, from 1963-2004, the average ROIC excluding goodwill was 10%. (link) Triangulating the view that ROIC roughly matches the performance of a business over the long run is the returns of the S&P 500 geometric average from 1928-2016 is 9.53% and 1967 to 2016 is 10.09%, roughly equal to the average ROIC excluding goodwill. (link)
The thought of using expected returns of Emerging Markets as the discount rate makes sense as any recommendation or actively managed portfolio should outperform its index in the long run otherwise you are destroying value as an investor can just buy a low cost index of the asset class. The big problem is the expected return is very difficult to forecast accurately. Also, using expected returns leads to intrinsic values moving with the market direction rather than being the ultimate anchor for a value investor. We are using 10% as a discount rate for all investments.
Return Expectations Going Forward (Ben Carlson)
Ben Carlson discusses his views on forward expected returns. (link)
On the Valuation of the Indian Stock Market (Latticework)
Samit Vartak provides his thoughts on the current valuations in the Indian equity market. (link)
Trusting Management and the Limitations of Research (MicroCapClub)
Mike Schellinger writes about the limitations of research and assessing management. (link)
Where companies with a long-term view outperform their peers (McKinsey)
McKinsey studies the performance of companies with a long-term view and find they outperform on many measures. (link) There is a link to the full report at the bottom of the article.
Between ROIC and a hard place: The puzzle of airline economics (McKinsey)
McKinsey analyze the economics of the airline business through a ROIC lense with thoughts on what attributes lead to outperformance. (link)
Salvation or misleading temptation—low-cost brands of legacy airlines (McKinsey)
McKinsey provides a strategy for low cost airline brands under the umbrella of a full service carrier. They also discuss the differences in cost structure between the two. (link)
The economics underlying airline competition (McKinsey)
A short discussion on the difficulties of low cost carriers moving into long haul flights. (link)
Shipbroking and bunkering (Bruce Packard)
Bruce Packard compares two shipbrokers, Clarkson and Braemar. It is an excellent comparative analysis that may be useful in any investor’s process. (link)