Posts Tagged ‘recommended’

Get a Garmin

July 30th, 2009

An article today, over at MSN’s Top Stocks Blog, claiming to reflect a Buffet-like stock picking model, suggests Garmin (ticker: GRMN) as a strong buy.  I had actually been considering an article on Garmin for awhile, so I thought now would be a good time to discuss.

I have not had a chance to do thorough financial research on Garmin, so I can’t fully recommend it.  I have not done the research to find out of it is doing anything funny in its financial statements, or if its leadership seems open, honest, and capable.  With that caveat, my sense is that Garmin is likely a smart buy.

Financials

I will not go through all of the ratios that I usually do, because the article does a decent job of that.  In short, Garmin makes a lot of money, and does so very efficiently.  The stock is also valued very cheaply.  Why?

The Smart Phone Threat – A Fallacy

Apple’s iPhone, Palm’s Pre, and RIM’s Blackberry are all seen as potential Garmin killers.  As a result, investors have panicked from Garmin’s shares expecting its long-term demise.  This is a classic example of the market’s extreme short-term stupidity.

The GPS market is growing.  There are billions of people who have not yet touched a GPS device or benefited from its substantial society-changing effects.  It is true that the smart phone makers stand to profit enormously from this growth, but so does Garmin.  Not everyone will get a smart phone, and even if they do, Garmin’s devices are far more powerful than a smart phone GPS.  GPS devices are also not just used by regular joe’s.  GPS devices are integral to aviation, and all forms of commercial and freight transport.  These applications require specialty devices with robust capabilities that Garmin makes.

Garmin stands to benefit enormously over the long-term from this trend, and Garmin is the name in GPS.

Ignore Panicky Idiots

The idiotic punishment of stocks in favor of hot companies is nothing new.  Recall 1999 when insurers and other traditional companies lagged and even declined behind dot-com and tech stocks rising to meteoric heights.  The old economy was dead, remember?  The dot coms tanked the following year, and the traditional companies rallied.  This situation is slightly different in that Apple et all are profitable and sustainable companies, but it is the same in that Garmin has been unfairly punished by the markets because of a false threat.

Do your research–I know I plan to–and consider buying Garmin while the market is stupidly planning its never-to-come demise.

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Value Pick: EnCana

July 19th, 2009

ECA_logoEnCana is a Great Value

After comprehensive research, I’d like to recommend EnCana (ticker: ECA on both New York and Toronto Exchanges) as an excellent value prospect.  While I can’t guarantee market success, EnCana has all of the elements of a great company and great value stock that should make this a profitable choice for a long-term purchase.

Detailed analysis follows:

Company Overview

EnCana, based in Calgary,  Alberta, Canada, is the largest producer of natural gas in North America, producing 3.8 billion cubic feet per day in 2008.  While the company also has some oil and shale oil operations, natural gas accounts for more than 80% of production.  With a current market capitalization of 38 billion based on today’s share price of 50.81 (US), EnCana is one of the largest natural gas companies in the world.  EnCana also enjoys considerable dormant potential with a land portfolio of 23 million acres and proven reserves of 19.7 trillion cubic feet. To understand the enormous swaths of land that the company controls, it is best to see a map of EnCana’s land holdings (PDF).

Value

EnCana is currently an excellent value.  Everywhere one looks there are good things to be found with EnCana, so I will just list them:

Measures of Value

  • EnCana is currently trading at a very cheap Price-to-Earnings (P/E) ratio of 5.6 and a price/book ratio of 1.63.  Taken together, this provides a P/E and price/book multiple (I call this a PEB) of 9.13.  Value-investing founding father Benjamin Graham believed that any PEB under 22.5 provided a margin of safety — in this case, the margin of safety is very large.
  • EnCana is also trading at a low price/sales ratio of 1.30.
  • The company is trading at an ultra-low P/E to growth (PEG) of 0.27 when dividends are included in the calculation (P/E divided by earnings-per-share growth plus current dividend yield).  Current dividend yield is 3.15%.
  • Current price/cash flow is a low 3.50, or about 31% less than the industry average of 5.10.

High Growth and Superb Margins

  • EnCana boasts a superb 16.2% return on invested capital (ROIC), a measure of management’s savvy at wisely putting assets to their best use.  Management has been consistent in keeping this figure above their target of 15% for the last several years.
  • Other measurements of return are equally glowing — with a return on equity (ROE) of 31.5%, a five-year average ROE of 22.1%, and a return on assets of 14.3%.
  • EnCana also enjoys the excellent margins necessary to profit considerably from its excellent returns — with a net profit margin of 23.23%, pre-tax margin of 32.20% and impressive gross margin of 64.84%.

Low Debt

  • EnCana enjoys a low debt-to-equity ratio of 0.40 and debt-to-earnings-before-interest-tax-depreciation-and-amortization (EBITDA) of 0.70.  This means that if the company dedicated its after-operations cash flow towards debt repayment, it could repay all of its debts in just eight months.

So Why is it So Cheap?

I know most people are cautious about the central premise of value investing — if I can buy a dollar for forty cents, then what is wrong with the dollar?  I think this is a healthy question, and all value picks must be carefully analyzed to make sure that it is not a value trap – a company that is cheap for a very good reason.

EnCana is cheap because it has been punished with the rest of the natural gas producers.  Natural gas prices are currently at an inflation-adjusted all-time low.  Natural gas prices in 2009 have drifted in the $3 and $4 range, down from a high above $13.  This shift obviously has profound impact on the earnings of natural gas producers like EnCana.  EnCana, however, will be able to easily weather this storm.

The company’s conservative financial management has put it in a stronger position than its competitors.  With its low-debt and strong cash flow ($2.3 billion net cash flow last year), EnCana has a substantially stronger balance sheet than its competitors.  EnCana has wisely engaged in heavy price hedging — two-thirds of its 2009 production is hedged at contract prices above $9 for natural gas, despite current prices below $4, and over half of 2010 production is hedged at prices above $6.  With contract prices more than twice current market price, EnCana is not feeling the pain of low gas prices that is crushing many of its debt-laden competitors.  In fact, EnCana’s guidance predicts 2009 net cash flow similar to last year — between $2 and $3 billion.  Should low gas prices persist through 2011, EnCana will have the cash flow and large cash reserves to continue healthy operations for some time while out-investing its competition for when prices return to higher levels.  The company also wisely avoids guaranteed supply contracts — giving it the flexibility to shut down a majority of its operations should continued low gas prices force the need to do so.  This allows EnCana to maintain high margins when prices are down.

Innovation and Culture

A poor corporate culture can stagnate a company and drive it into uncompetitiveness.  EnCana is not one of those companies.

By all accounts I could find, EnCana seems to pride itself on a robustly innovative corporate culture.  The company spends considerable resources on enhancing collaboration, communication, and innovation within its workforce.  The best evidence for this, besides its own claims, is in its technological developments.

For well over a decade, EnCana has been the pioneer of a major technological shift in oil and gas development.  EnCana (under a different name at the time) first began pilot projects for shale oil and gas extraction in the early 90’s.  While these technologies did not become in vogue until 2008, EnCana was well ahead of the curve with large-scale projects as early as 2003.  As a result of its considerable dedication to innovative new extraction methods, EnCana holds or is in the process of obtaining patents for a number of critical technologies that it developed for cheaply extracting oil and gas from shale, as well as other technologies for minimizing the number of rigs that need to be drilled to extract a resource.

Thanks to its early investments and research, EnCana is the world leader in shale oil and gas extraction.  This is supremely important given that EnCana has managed to reduce costs to where shale extraction is economical.  It is estimated that there is up to 2.8 to 3.3 trillion barrels of shale oil globally that were previously too expensive to extract, and shale gas is expected to account for as much as half of North American natural gas production by 2020.

Financial Statements

After examing EnCana’s financial statements, I found no red flags.  In fact, I was impressed by the high level of above-and-beyond financial detail that EnCana provided.  In my mind, this is one sign of a good company that understands its duty to the shareholders by providing all possible information to make informed decisions.

Leadership

I’m a big fan of EnCana’s leadership, which is largely grown internally (yet another indicator of a strong corporate culture).  CEO Randy Eresman has been a strong leader, and has guided the company to a smart model focused on its strengths in nonconventional extraction and on its home territory in North America.  Eresman has guided the company into the sale of its overseas properties — which included fields in Qatar, Brazil, and France — in favor of Canada and U.S. development.  This is a very smart play given the politically stable, natural gas rich environment in North America, and the lower costs of operating on a single continent. Mr. Eresman is also fairly young, and is likely to remain in charge for the foreseeable future.

CFO Brian Ferguson has also shown incredible savvy in his management of EnCana’s finances.  While his very-conservative management may have made him look like a dinosaur next to free-wheeling natural gas companies like Chesapeake Energy when gas prices were high, Mr. Ferguson has the last laugh.  His fiscal conservativism has left the company in a position to substantially best its competition in this difficult credit and low-gas-price environment.

Executive compensation has also been kept to reasonable levels, which shows strong corporate governance.  Mr. Eresman’s total compensation package of salary, grants, and stock options of about $10 million is reasonable given the large size of EnCana and his successful management.  Other senior executives’ compensation is also reasonable — in the one to four million range.  I am particularly impressed with EnCana’s judicious issuance of stock options, with only 3 million options issued out of 750 million shares outstanding.  I also like that none of EnCana’s executives have sold stock recently, indicating that they, too, believe in the company’s long-term potential.

Key Future Developments

One impending development of note is a proposed split of EnCana into two companies.  The proposed split would split the company into EnCana, comprised of all of EnCana’s current natural gas assets, and Cenovus, comprised of all of EnCana’s current oil assets.  Under the plan, shareholders would get one share of each company.  The proposal was originally slated for vote in May 2009, but has been taken off the table indefinitely until stability returns to the markets (corporate speak for higher prices for the Cenovus initial public stock offering (IPO)).  I am undecided about how I feel about the proposed split — it makes sense to allow the two areas of the company to truly focus on their core businesses, but I like the flexibility, and economies of scale provided by the current structure.  I am also hesitant about the division of a winning management team — Eresman would remain head of EnCana, but CFO Ferguson would become the CEO of Cenovus.  Given EnCana’s strong culture and leadership development, any leadership changes will probably be neutral.

Natural Gas Prospects

I like natural gas’ long-term prospects.  Not only is it incredibly abundant, and cheap to extract, it offers significant advantages over oil.  Natural gas burns much cleaner than oil-based fuels, with significantly less greenhouse gas emissions.  I believe that given its abundance and competitive pricing, natural gas will continue to be a growing source of energy well into the future.  Natural gas is positioned to be a key transition fuel, with the technology in place to easily switch from oil and coal burning to natural gas burning power, and combined with low carbon output, natural gas is a logical clean alternative to oil and coal.  Continued global focus on lower greenhouse gas emissions and taxing carbon output will be greatly in natural gas’ favor.

Summary and Additional Information

In short, EnCana’s stock is currently very cheap and offers excellent prospects.  Given that the company is Canadian, it also offers some diversification from US dollars and the US economy, which I would encourage all investors to strive for.  I intend to open a position, and intend to continue buying and renvesting dividends as the stock remains cheap.  I will also be proud to own such a fine company.

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Reader Response: Value in Microsoft?

July 15th, 2009

steve-ballmerReader John B. asked in the comments to my last post, Goldman at the Gates, whether or not I thought Microsoft (ticker: MSFT) was a good investment.  So, let us take a look.

I have not done a serious deep dive into Microsoft’s financials, so let me preface this discussion with a caution that anyone choosing to invest in Microsoft should do further research before making a long-term buying decision.  With that said, let us take a quick look at what is on the surface:

What I like at first glance:

  • Microsoft is one of the few major technology companies that pays a dividend – currently weighing in at 2.25%.  This is a major positive in my mind because of how few technology firms do this.  Microsoft finally realized a few years ago that massive piles of cash were not in its shareholders’ interest – I wish Google and a few others would take this lesson to heart.
  • Microsoft is in excellent financial condition with almost no debt — 5% of equity — and plenty of cash flow to weather any storm.
  • It has a long history of positive earnings growth, though growth rates have understandably slowed a bit in the downturn.
  • With a return on invested capital (ROIC) of 35.7% (anything over 10% is excellent) — a measure of management’s effectiveness at leveraging its capital in profitable ventures– Microsoft is outstanding at putting its assets to good use.  This also holds true for all of Microsoft’s margins – 42.47% return on equity, 25.86% net profit margin, and so on.

Honestly, none of this is surprising for a large tech firm these days.  From a sector-blind viewpoint, it is incredible that Microsoft has managed to mantain high, if declining, growth rates as such a massive company.  More surprising is another measure of potential value:

  • One method of looking at whether a high growth company such as Microsoft is a decent value is to look at its PEG ratio, or price-to-earnings to growth ratio.
  • This ratio measures whether a stock is undervalued relative to its growth (PEG less than 1) or overvalued (PEG more than 1).  I prefer to use a modified version that accounts for dividends so: P/E/(EPS Growth + Current Dividend Yield). 
    Microsoft’s dividend-modified PEG is currently a respectably low 0.64.

What I don’t like:

  • Using traditional measures of value, P/E and price/book ratios, Microsoft is very expensive.  While Microsoft’s P/E ratio of 13.37 is reasonable, especially for a technology firm, its price/book is not at 5.57.  This makes Microsoft’s so-called PEB ratio (my term – P/E times price/book) a stratospheric 74.47.  That is more than three times higher than my target of less-than 22.5.
  • Microsoft price/sales ratio is high at 3.36, but not outlandish.

Summary of Fundamentals

Based on the financials above, I would say that Microsoft looks like a moderate value for a high growth firm.  I am a bit hesitant to say it’s a substantial value given its very high PEB.  Alernately, high price/book ratios are no stranger to technology firms given that they have very little physical capital (such as manufacturing facilities), and this explains the very high PEB.  At the same time, I am always hesitant to make exceptions to good rules when there are plenty of stocks that have all of the glowing characteristics above and have low PEBs.  After all, some of the same arguments were once used to explain the dot-coms in the 1990’s, and airline stocks in the 1950’s – of course, unlike dot-coms or airlines, Microsoft makes money.

Corporate Culture

I believe that corporate culture is important, especially in a highly competitive industry like software.  It is a company’s key asset in retaining good talent, encouraging and monetizing ingenuity, and staying competitive.  This is one area where I am questionable of Microsoft’s competitive position.  Relative to its major competitors (albeit smaller) – Google, Oracle, Apple – Microsoft is downright stodgy.  Its overgrown, bureaucratic largesse is legendary in the technology arena — something that notably affected profits with the poor showing in Vista.  I recall reading an article about how something absurd like 30 committees were responsible for different elements of the shutdown/restart menu.

The verdict remains out though.  Bing suggests considerable marketing and development savvy, even though it is not likely to dent Google’s armor, but may hurt Yahoo and Ask.com.  Windows 7 looks like it is going to be what Windows Vista should have been, and in a fraction of the time.  These developments suggest that perhaps Microsoft’s management has shifted gears, injected energy, and streamlined the bureaucracy.

Behind the Curve?

Nevertheless, Microsoft remains behind the curve in many areas.  Its overwhelming revenue generators are Windows and Office — the same two products that were its major sources of revenue ten years ago.  In meantime, Microsoft has developed no major innovation, developed an advantage in any new market where someone else had not already beaten them to the punch or stolen any major profit potential from under their noses.  Examples abound — Apple with the mp3 player, Google with search, Apple with the smart phone, Google and Salesforce with cloud computing, and so on.  While Microsoft has profitable products in some of these areas, it has not provided any major innovation with its products that has led it to dominate any new market segments.

As a result of this continued behind-the-curve-ness, along with problems with Windows Vista, Microsoft’s brand image has suffered mightily.  Google can walk into a crowd of developers, especially on college campuses, anywhere in the world and get people on board to develop applications for its initiatives.  Microsoft on the other hand has a negative association among many young developers, and long-term, it is developers that make or break a software firm.

Leadership

Like culture, the verdict is still out on Microsoft’s leadership.  My read on Steve Ballmer is that he has taken the notion of injecting energy into the company literally — manifested by his unnervingly flamboyant and eccentric developer conference speeches.  I may be a bit unfair here, but I don’t think running around like a mad man on stage inspires anything but discomfort for those watching.  The proof of effective leadership will be when Microsoft shows that it can identify a potential market, create a truly great product, and set the tone for that new market.

As a quick aside, I also do not like the massive amount of stock options that Microsoft, most tech firms, and many other companies today issues its employees.  I will write about this at greater length in the future, but I fail to see the value added for the shareholder.

Crystal Ball

Very long-term, Microsoft may be in trouble if it cannot learn to reinvent stale product lines and develop effective new products early enough to matter.  Any continued image degradation will cannibalize Microsoft’s future developer pool and further reduce its competitiveness.  Microsoft may have also missed the boat entirely in some tectonic shifts in technology — principally smart phones and possibly cloud computing.  If these two technologies truly start replacing the Microsoft PC as we know it today, that could be the end for the company’s glory without new significant revenue streams.

I could be wrong.  Microsoft has been a successful firm for sometime, and all odds are in its favor for it continuing to be successful.

Invest or Not

Based on this look, I would say that it is worth considering investing in Microsoft.  I personally would prefer a more traditional value play (that high PEB really does unnerve me), but by most measures, Microsoft is an excellent buy at current valuations.  While there are several things I don’t like about how the company has been run in the recent past, there are signs of improvement, and buying in now could be incredibly profitable.

Assuming its financial statements do not reflect any major sources of concern, I would be confident buying a stake in Microsoft — reassessed annually — for up to five years.  Beyond that, I would have to have seen some major improvements in management and product development to continue my investment further in the future.

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