A couple of bargains
Note, 08/06/08: I made some horrendous editing mistakes in this piece. I’ve gone through it again and fixed up most of the mistakes. Sorry for the sloppiness, readers. In the future, if you notice them, leave a scathing note so I get sufficiently motivated to do better editing work.
Sorry for the dearth of writing lately. I haven’t had much time, nor have I found compelling pieces to write about. Thus is the fate of a long term, concentrated investor. Most of the time you’re just holding and waiting.
I am researching various companies, however, and I wanted to point a few out with some of my basic theses, hopefully giving my readers some research leads. Needless to say, I think there are some terrific bargains all over the place right now. Just look harder if you’re not seeing them. Remember that these are just leads, though. I don’t own any of them yet, besides the companies I’ve already written about. If you’re interested, keep digging away, because without the facts in your head, you will eventually lose the courage of your convictions.
Everything I’ve written about so far, or recommended, is still very cheap.
1. Sears (SHLD) has run up a little bit, it was up about $9 yesterday, but it’s still a very compelling and very cheap company worth buying. I believe it will take one or two years to reach full valuation, so I’m taking these upward and downward swings with a grain of salt. Anywhere under $110 or so, you’re still getting a terrific bargain. In fact, after a little reading, the brands are probably worth much more than I originally estimated, so my valuation should stand conservative.
2. Primus Guaranty (PRS) is still trading at stupidly low levels. Fortunately for you, all you non-owners, Primus still trades around with the other bond insurers. Primus is not a bond insurer like an MBIA or ABK is, but nonetheless the market, and indeed Primus’ own counterparties, are not differentiating between them. You’re still getting a company worth anywhere between $9-$12 or so, for under $4. If I had a Cramer BUY BUY BUY button, I might hit it right now. Of course, the risk of serious credit problems and spiking defaults is ever-prevalent with Primus, so tread carefully and do your homework. (Note: Primus reported this morning; blowout GAAP numbers due to the increased value of their credit swaps, which is pretty meaningless, but their ‘economic’ income was up year over year as well, to the tune of about 25%. Tangible Economic BV is now over $10/share. The stock will move today but anywhere under $6 is still an incredible bargain).
3. Steak N Shake (SNS) has hardly budged since naming Sardar Biglari Chairman. News has been slipping out week after week of closed restaurants, sold leases, capital projects being cut off mid-way through, and inexcusably bad executives finally being tossed. The stock sits around $7 and its still a very compelling bargain with a heavily incentivized Chairman, tons of free cash, and a real estate bank worth banking on.
4. Obviously, I still like Western Sizzlin’ (WEST) a whole lot. I don’t see the shares really going anywhere until Steak N Shake works out or sizzlin’ numbers come rolling in. (no pun intended) It doesn’t matter though, because Western Sizzlin’ is a company to hang on to unless its valuation becomes “‘99 tech.”
There are some other companies I’ve been looking at, generally good companies selling at cheap prices or undergoing change. I still have much work to do on most of these, and don’t own any of them quite yet. I’ll probably only buy one of ‘em, maybe two.
5. KSW, Inc. (KSW).
KSW is a magic formula stock which I’d glanced at earlier this year and passed on. After a recommendation by a friend and further consideration on my own, I’m snooping again. KSW is a mechanical contractor and trade manager. They install HVAC systems in new buildings and public works projects, and also act as a project manager on all the mechanical and electrical work done on these buildings. They no longer compete for bids, as you’d think a traditional contractor would, but rather their work is offered to them or found through personal sources. This isn’t immaterial, as it shows they have at least one unique element that competitors may lack. Market cap is $31mm, EV is $12.5mm, 6mm shares out.
The compelling points are such:
- KSW uses very little to no capital conducting its ongoing business. Returns on capital are almost non-calculable because they use so little capital. Last year, pre tax ROIC was 250% under my calculations. (IC = Net working capital + net PPE - excess cash
- KSW has been able to grow their revenues from $26mm in 2004 to over $80mm in the trailing twelve months. Admittedly, they did very poorly in the last economic slowdown. However they’re doing great in the current one, as their project backlog is at all time highs and the last quarter was their strongest ever. This bodes well for their prospects.
- With a $31mm market cap, KSW has $18mm in cash and no real debt. EV is ~$13mm.
- On valuation, the company trades for about 2x EV/pre tax earnings, defined as EBITDA - maintenence capital expenditures (which are obviously almost nil). It’s worth at least 8x based on the quality of the business and some growth. Also trading around 15% EV/Sales.
- CEO and Chairman Floyd Warkol owns 12% of the company.
- They paid a .20 dividend in Q1, on a $5 stock, so that amounts to an annual yield of about 16%. The question here is whether they will keep paying that dividend. At .80/yr, that’d be ~$4.8mm, which is doable but a little high (remember $4mm in annual free cash flow $18mm bal. sheet cash).
So obviously the thesis is viable at first glance.
Risks? Well, I’m having a little trouble deciding how solid those earnings truly are. We’re paying a premium to liquidation, so it’s an obvious concern when searching for a margin of safety. If the earnings are sustainable this is a home run investment, a real no brainer. What if KSW hits trouble and can’t find new projects? What happens in the backlog gets cancelled? What will they do with all that cash? What are the probabilities of these scenarios? These are the (somewhat) unanswered questions for me at this point. Any clarity from a reader with an interest in the company would be terrific.
So, the thesis: High ROC company, terrific price, shareholder aligned management, sparkling balance sheet, growing revenues and backlog.
6. ePlus, Inc. (PLUS).
ePlus is an IT company, for all intents and purchases. From what I can glean so far, they buy equipment from large tech companies (Cisco, Microsoft, et cetera), and lease it out or sell it to middle market companies along with proprietary software and, obviously, support systems ranging from installation to troubleshooting. They take on non recourse debt, which means the worst case scenario is that the lessors could seize the collateral assets, but can’t go after ePlus. This is another company that trades at a seemingly unbelievable price. Market cap is about $107mm, EV$48mm due to $59mm in cash and no recourse debt. 8.25mm shares out.
The points:
- ePlus is tainted. I like taint. They’ve gone through legal troubles and an options related restatement in the last 3 years, and this has obviously hurt the stock price big time. The legal issues have been good and bad for ePlus. On the bad side, they had to pay out $10mm to Bank of America and GMAC relating to a company called Cyberco that was fraudulent. Cyberco had leased equipment from BoA and GMAC, with ePLUS as an intermediary, but it was a scam and they went bankrupt. BoA and GMAC went after ePlus for what looks like material mis representation, and they were awarded a victory. On the plus side, ePlus successfully sued SAP for patent infringment and received $37mm. Then, last year, ePlus made an agreement to license out these patents to SAP legally and got another $17.5mm there.
- Re: stock options, the company has had to restate a few years worth of financials and this process has eaten up a chunk of cash. The company is finally up to date on their filings, but lost their NASDAQ listing in the process. They trade OTC, but should be re-listed very soon now that they are up to date. This presents a viable catalyst.
- Earnings have been masked by the legal issues and accounting and lawyer fees due to the restatement. Once you pull all of those gains and losses out, earnings have showed a steady rise over the past 4-5 years along with revenue. I estimate that EBTDA - maint capex was about ~32mm in the last fiscal year. This is a little shaky, I’m still figuring out maintainence capex, but if true, EV/ EBTDA - maint. capex is a whopping 1.5x. If anything, my maintenance capex is overstated so that’s a relatively conservative number. I think 5 or 6 is a better multiple, which would value the company at $26/share or so (adding back cash), with shares currently around $12. These are normalized earnings.
- Tangible book value is $137mm or so. With a market cap of $100mm, PLUS trades at 72% of tangible book. This is mostly cash and lease paper, very solid assets.
- Insiders own 35% of the company, and a financial focused hedge fund with board members owns another 15%. This keeps alignment intact and dials down my worry regarding the legal issues and options restatement.
- Revenue has grown consistently YoY for the past 5 years, and they’ve had only 1 operating deficit in their history, to my knowledge. In fact, even when tech was smashed in 2000-2002, business held up and they stayed profitable.
- ROC is not high. If my free cash number is right, ROTC is only about 12% after tax. The lease paper they hold sucks up a lot of capital, but the good news is that Tangible Capital [net PPE + Net Working capital + lease investments - excess cash] is now less than in 2003, and returns have been rising in that same period as well.
- They’ve shown the willingness, before the options trouble, to buy back stock in hordes. They just announced a small buyback program last week.
Here’s a company where I see multiple safety margins (very, very cheap on both annual free cash flow and saleable assets, with a solid balance sheet). I see a growing business with a very viable model, tainted by scandal and the general malaise over tech stocks right now, with identifiable catalysts in a NASDAQ re-listing, uncovering of real earnings, and growth. I need to dig here, though, to straighten out their future prospects, some accounting aspects (try and understand their cash flow statement, I dare ya), and look closer at comps.
There are some great Value Investors Club write ups on ePlus, so I’d recommend reading them if you’re interested. Here’s one.
7. Here are other names I’ve considered but not done any work (or much work) on yet:
- Trident Semiconductor (TRID). Selling at net working capital right now, less than net cash, beaten up stock, formerly very profitable. Main questions come from cash burn and future profitability.
- Borders Group (BGP). Very cheap looking at sum of the parts, cheap on past free cash flow, possibly selling below liquidation value. Pershing Square is their major owner, one highly incentivized to push them towards value creation. They’ve put themselves up for sale and won’t go for less than $8 I believe (Pershing owns 15mm warrants at $7/share). Another catalyzed investment opportunity.
- Office Dept (ODP). Depressed, beaten up, cheap. Selling for only a few times fully taxed normalized FCF. Again, a look at their competitive position is really needed to make sure not too much permanent damange has been done to normal free cash flow. ROC is high (on a normalized basis) for ODP as well, and their CEO is a former Autozone CEO adept at capital allocation.
- IAC (IACI). Splitting into 5, count ‘em 5, units via spinoff. I figure at least one of these things is going to come out cheap, but it will take some serious work to value all these parts and pick one that is very cheap. I bet the work will be rewarded, though. You’ve got Ticketmaster, which is a great franchise, Home Shopping Network, and a few other units. The spinoffs should occur in a month or so.
- Clear Channel (CCU). By December their much publicized buyout should be complete. The interesting part? There will be publicly traded stock in the LBO. You get to participate, tit for tat, with the buyout firms. The more interesting part? Management is staying on and participating, not only operationally but financially. Two top managers are getting options on 4% of the company, each, plus exchanging many of their current shares for shares in the LBO. The risk here is extreme leverage to the tune of 8.5x EBITDA I believe. That’s big time debt.
- American Express (AXP). American Express hasn’t seen these type of multiples in a long, long time. Even if profitability is a little on the high side, normalized earnings still come out with a 13 or 14x after tax multiple. This is a terrific worldwide franchise with years of 8-10% growth ahead and a fantastic manager in Ken Chenault. See VIC write up.
Well, I’m exhausted. This is the current crop of ideas I’m considering, and I’m confident that at least of a few of these companies are going to see their stocks double and triple, and a few will be duds even though they look great at first glance. I’ll probably write more extensively about one or two of these ideas in the future if I buy them. I also own another stock that I’ve yet to write about, and I promise I’ll get around to doing so. With a portfolio of 6-8 stocks and an average holding period of 2.5 years or so, you have time to be patient and figure out the companies you own.
One more note: I’d recommend trying to ignore all this noise going on right now. There is prognostication left and right in the financial media, economic forecasting, talks of bottoms, etc. Pick a few cheap and good companies and buy them. It’s in times like these that even smart value investors forget how bad human beings are at forecasting the future of a complex adaptive system such as the stock market. The only prediction I can confidently make is that most of the commentators in the media and in the money management world will be wrong. There are unforeseen events that we cannot predict, ones that will alter our thinking and even cause us to believe we predicted them. You can either try to predict when and where the rain will fall or build a nice big ark just in case. I’d go with the latter.
Disclosure: Long PRS, SHLD, WEST, SNS.
Was wondering where you were…….
Anyway, quick note on KSW. KsW currently has a market cap of 30 mill. But, from Jan 1, their backlog has grown by 70 mill or 2x the companies worth.
I saw that in their recent press release. The backlog is something like 2x their annual revenues right now, which looks terrific. My question is, beyond another year, will they still have these backlog levels and profitability? Probably, but I need to be sure before I move forward there. Thanks Alex.
BTW, in general I’ll probably be posting a little less frequently, or in bursts.
I am curious to know if you or any of your readers have dined at any Steak N Shake restaurants lately. Any comments on the dining experience, including service, food, prices and cleanliness, would greatly be appreciated.
I personally have not, I live in the Northeast and Steak N Shake is a midwestern chain. What (now) Chairman Biglari, VP Cooley, and various board members said at the Western Sizzlin’ annual meeting was that there tends to be a wide disparity in the quality of the restaurants. Some restaurants are being run very well, are clean, and the hybrid model works very well. There are quite a few restaurants, on the other hand, that have suffered cleanliness issues and have failed to execute on quality service.
The menu is a whole ‘nother issue. The menu selections are a “top down” choice, made by corporate management. Over the years, Steak N Shake has done tremendously well with their Steakburger concept and what seem to be fantastic milkshakes. The price point on these items is above a fast food restaurant but generally below the price at a casual dining chain. That concept remains their cornerstone. Problems have arisen as SNS has tried to introduce chicken, salads, and other “healthier” items. They are costlier to prepare, more complicated to prepare (the staff has had trouble preparing the new items in a timely fashion), and less popular with the Steak N Shake crowd, to my knowledge.
If any of my readers have indeed been to a Steak N Shake, please let us know.
Thanks,
Jeff
Hi Ryan and Jeff,
I’m Indiana Born and raised, so I’ve plenty of Steak n Shake experience. As a kid SNS was a huge treat. Their Burgers are a notch above anything else you can get drive thru. I still go into Pavlovian meltdown at the thought of their Friso Melt! In fact I stopped in there after along absence about a year ago and re-experienced the frisco melt. I paper place mat informed me they were publicly traded and I’ve been following the business ever since. They have a wide selection of sandwiches and sides, that I personally agree could be cut down. There burgers are too good to imagine getting anything else. I’ve also heard from some of my none beef eating friends that the other sandwiches are so so. I tried the new breakfast melt an liked it but thought it was pretty heavy for breakfast. They also have a fairly unique french fry, which they serve the thin cut, maybe 1/2-1/4th the thickness of a McDs Fries. I’ve heard a lot about cleanliness issues. One friend claims that a roach ran over his foot in the restaurant. I personally have never had a problem.
Hope this helps alittle.
PS: Interesting after hours announcement. Sidhar is now CEO.
PPS: Amazing Post!
I am in Chicago and visit SNS quite often (at least once a month). Local store is pretty clean, but I have noticed the execution issues over the past year, as in: tables need to be bussed, and service can sometimes be slow. One time my food came in 5 minutes but it took another 10 for the shake to come.
They have introduced salads, and the house salad side choice is pretty good. Haven’t had the full size dinner salads, cause when I go its always for a burger and shake. My kid gets chicken fingers, and I must say they are quite tasty.
This is a healthy brand that has good inertia to survive, IMO. It is unique enough, and good enough, and inexpensive enough, not to be a trendy flash in the pan. Hopefully Bigs can start molding this thing into a better cashflow performer.
[...] Circle of Competence presents some potential bargains [...]
Thanks Travis and Hogan, much appreciated.
Ryan, I hope that helps you out.
-Jeff
Thank you to Travis, Hogan and Jeff for your input and experiences with SNS.
Jeff your continuous hard work and devotion to your blog is paying dividends to your readers. Thank you.
Great! Glad we could help. Also very glad you’re enjoying the blog. I hope my readers get as much out of it as possible, because I know I am personally.
Thanks,
Jeff
BTW, KSW’s dividend has been annual, so .20/5 = 4% annual yield.
It is my largest holding. If you back out the cash, and project their earnings on the current backlog of 130 million, you can buy this one for only one year’s earnings.
That strikes me as absurd; New York City will always need HVAC service; KSW has no trouble finding work. If I had enough coin, I’d have tried to take this thing private by now.
It would seem absurd, Chad, but remember that in the last slowdown, from 2001-2003, KSW bled some serious cash. Revenues slowed down and took a hit, operating costs weren’t covered by gross margin, and they were losing money.
It doesn’t seem that the above is the case now, but it’s a looming possibility that needs to be considered. The co. won’t “disappear” but if they lose backlog and revs. get hit, they will bleed cash again. I don’t view this as a likely scenario, but a plausible one nonetheless.
I would argue that KSW is in a different competitive position now than in 2001, given its recognition among peers for engineering energy- and cost-efficient systems.
Regardless, you are getting compensated for risk here. If they can continue to earn and carry a 6 multiple going forward (after backing out cash), you get a double. If they go stagnant, they fall maybe 40%, to the cash on hand. As risk/reward, that provides a solid margin of safety for me.
Chad,
Thanks for the comments. Where do you have evidence for your first statement: “recognition among peers for engineering energy- and cost-efficient systems.” Just curious.
Thanks,
Jeff
I believe that they use language like that in their quarterly and annual reports, but mostly a well-considered judgment from talking with people in the industry and the CEO.
Can you tell us a little about your conversation(s)? I’m sure readers (and myself) would love to know what you’ve heard first hand.
Thanks again,
Jeff
I’m not sure that I could relay private conversations without making it reasonably obvious who made the comments and the company they represent, so sorry…
The 10-K from March does read as follows:
“For the past few years, the Company has focused on the favorable New York City private construction market and has been successful in obtaining projects from private owners and construction companies by utilizing its value engineering and trade management skills. Many of these projects are obtained from repeat customers, who invite the Company to participate in the project while the project is still in the design phase, or to assist in bringing a project’s budget in line with the customer’s requirements.
The Company provides value engineering assistance, whereby the Company uses its experienced staff to recommend economical changes to streamline HVAC and process piping systems. These changes reduce costs, but still yield the same results as the original plans. The Company’s ability to provide this service has become increasingly recognized in the industry and has resulted in the Company’s ability to secure projects without competitive bidding. The Company believes that this service will provide additional opportunities in the future.”
I would also suggest looking into Sycamore Networks (SCMR). I am conducting some preliminary research on the company. TAVF recently purchased it for its value fund. It currently trades slightly above the cash amount, net of liabilities.
Ryan
Can you provide your thesis on PRS given their recent announcements on having exposure to Lehman and susequent decline in share price? Do you see a value proposition or anticipate further declines?
Roman,
Those are really two questions, built into your last question. So I’ll answer all three.
1. PRS is still in good shape. They announced the Lehman notional was a mere 80M. Losses on that will probably range from 30-50%, or between 25-40M or so. The rest of their stuff is protected from loss, for example the tranches they have sold swaps on that include Lehman. The thesis might taken another hit with an AIG bankruptcy, but again I think Primus would be fine in that scenario. If you assume they have the same amount of exposure to AIG as they did one of the GSE’s, that’s about 110M or so, causing perhaps another 50M in losses. Worst case, I see about 100M in losses coming from this meltdown.
They still have 875M in capital, supporting 24B notional amount of swaps outstanding. Economic Book value sits around 450M. If they took the full hit, 100M, book value would be 350M, or $7.70/share. Then you have at least another 8 bucks or so in unearned premiums. That would add a present value of another few dollars. So even if you argue it’s only worth .8x BV or something, the shares are still worth over 7/share.
So at 2.20/share, Primus represents a cheap stock. A real Armaggedon might take them under, and certainly what has happened so far has impaired value, but that’s why the concept of margin of safety was invented. I believe the company will hold up, their business model was built to sustain events such as these. Having the flexibility to not be required to post collateral is huge.
Further Declines? Maybe. I have no idea what the market thinks right now, how people feel about Primus, all I see is extreme fear out there. It might go down quotationally, but the value in relation to the stock price still exists. There is risk inherent, but I feel the price reflects that and more so.
Jeff,
Thank for your reply. The reason I asked the question was the fact that I am a fellow investor in WEST and have been following your blog for some time now. I am a big fan! With that said, I couldn’t disagree more with your assessment of PRS and the risks associated with the company. While I agree what PRS does is fairly straightforward (the business model that is), its underlying holdings pose serious concerns. After a careful review of the MD&A section of the 10Q and a brief review of the fin. statements, I came across a table that provides a telling example of the lack of transparency that killed LEH, BSC and I believe will have the same impact on PRS. On page 33, the company presents a table in which it breaks down its Level 1,2 and 3 assets and liabilities. It is amazing that 100% of the company’s liabilities fall in Level 2 and 3 categories. I realize that it would certainly be difficult to predict the impact of of another LEH like scenario, but I would be very curious to find out how you arrived at your worst case $100 million scenario given that LEH bankruptcy alone caused $25-$40 million cash payout. If 100% of the liabilities are either level 2 or 3, what makes you think that this number will not be much higher. If we assume a modest 4% of 24B in notional amounts of CDS were to default, it would wipe of all of the company’s capital. I think it is safe to say that CDS contracts for LEH were on some of LEH’s Level 3 assets which are at best real estate debt and at worst CDO leverage. How much debt of other esoteric instruments has PRS “insured.” Who knows, but I am placing PRS in the “too difficult” pile. Please let me know if I am missing something. I look forward to your reply.
Roman,
When I said “worst case” I meant in the current Lehman, AIG mess. The “worst case” is that a whole ton of companies begin to default, at above historical rates, and Primus gets murdered. This is a very low probability event but it could happen. Turns out AIG will survive, and this Primus’ exposure there is safe, for now. So the total expected loss at this point is 30-40M, from the Lehman swaps.
Let’s look at those Lv2 and Lv3 assets:
“The Company’s U.S. government agency obligations, commercial paper, single name credit swaps and interest rate swap are categorized within Level 2 of the fair value hierarchy. The interest rate swap is included in other assets in the condensed consolidated statements of financial condition”
So the fair value of all of their single name swaps, their government bonds, and the small amount of CP they own are in Level 2. Nothing scary there. Their entire portfolio of CDS is broken down quarterly, you can view its composition from various angles (rating, industry, country, etc.)
They own a little bit of CLO exposure, the ones they manage, and that’s about 14M. So most of the “esoteric instruments” are just the swaps they’ve sold. I’m not sure why the govi’s are in there, but alas they are considered Lv2.
The level 3 liabilities are:
“Level 3 liabilities, which include our credit swap sold on ABS and tranches were $546.2 million, or 55% of total liabilities measured at fair value at June 30, 200″
We know there isn’t much in there in terms of ABS stuff. If you go through the conf. calls and such the notional ABS is probably 40M right now. So most of that is the tranche exposure, again broken down in the IFS.
My point is that these assets constitute Primus’ entire business. They sell swaps. Being, sometimes, opaque obligations, swaps do lie in realm of Level 2 and 3. If this is too disconcerting, it is fine to pass on Primus.
But Primus’ assets and liabilities are well laid out in the SEC filings, their supplements, and the conference calls.
Another thing to mention is that the swap business, inherently, relies on leverage. Primus is at 35x, and could go to 45x and remain AAA(counterparty rating). They won’t but they could do so. The CDPC model allows them this freedom due to the fact that the only event that damages PRS is a default. Even with spreads blowing out to high hell, PRS can hold on. I don’t believe a huge wave of investment grade defaults are coming, but this event would impact Primus.
Let’s look at your 4%. What would it take to wipe out book value?
Primus has 19B of single name swap notional exposure. That represents about 590 names. That means, on average, each ref. entity is 32M of exposure. So let’s say they lose 30M on Lehman. That leaves about 420M in book.
To be more conservative, let’s say that every further default represented 60M in exposure, on average. So some of their slightly larger exposure. Further, let’s say they can recover .50/dollar on average, so they lose .50/$1 for every default, or on average 30M per 60M notional. 420M in equity, with 30M per default, implies 14 defaults. That is a lot of companies whiffing.
Their tranches are senior in posture so even more than that would have to occur for them to take a hit on those. Even the Lehman BK isn’t going to cost PRS any money on the tranche PRS had sold swaps which held Lehman. Remember, Primus is not selling swaps on CDO’s and MBS and all that stuff. They are corporate entities.
So far, Lehman and FRE/FNM are the only ones to hit a credit event, triggering the swaps. And those are pretty much the toxic of the toxic. AIG is ok. FRE/FNM won’t cost them more than about .08/dollar. Merrill has been bought. Wamu will likely be bought. If Wamu did go under, it might cost them another 20M or so.
Thus even if you apply a low absolute % to their notional exposure, you have to consider the implications. 4% of 24B, with again an average recovery of .50/dollar and an average notional (per entity) of 60M which we established as very high, implies 32 new defaults! That’s a whole heck of a lot, and doesn’t assume that book value grows from future premiums. (which it will)
All of that said, there is clearly risk inherent. I would not be thick enough to disagree with that. If you’re not comfortable with the risk being taken in relation to price paid, you are 100% correct in staying away. I’m even considering doing the same after much thought. So while I don’t think you’re “missing anything,” I just want to frame your thoughts correctly. Your idea of putting it in the too hard pile is maybe one I should adopt. At this point, I have faith in the risk management capabilites on Tom Jasper and Co, and Primus doesn’t represent a huge position in my portfolio, merely one with an attractive risk/reward proposition.
-Jeff
“I’m even considering doing the same after much thought.”
Say it aint so! You just walked through one of the most gut wrenching weeks in most people’s lifetimes, took one manageable hit, and now there is some real hope that all of us taxpayers collectively will pay up to stop the panic, so perhaps that 13% exposure to financials is safer than we feared.
PRS at 2.00 seems a great risk/reward, as you point out, unless they take bigger hits, this is probably a $10-15 value, and IF they somehow emerge to the point of continuing their business (ie if anyone will do new biz with them in the future) then it could be higher. During the depths of despair a couple days ago I was buying PRD even though PRS was below $2 at one point - but my fear drove me to pay up for the seniority of the preferred. Gets me an extra chair to stand on during the rising floodwaters. And it spits out some cash to boot.
However I am still tempted to round up with a little more PRS - yes it will be first to lose, but could end up being an 6x-8x winner. Its high risk but I think offers high potential return, and it won’t take 10 years to get back up there. Just don’t make it 100% of your portfolio (unless you are a true risk lover)
Hogan,
I still own Primus, but I did sell some near my average cost today (about 3.30), to make room for other bargains.
Primus is definitely a high potential reward play but there are capital market risks associated with the company. The investment makes sense, but as you said, it shouldn’t be a huge position. There are some other bets out there right now with lots of upside and less risk than Primus. Their business model is great and it works, but it isn’t bulletproof. The more I think about the company the more risks I come up with.
That said, at these prices the bet still makes sense but there are lots of other compelling ones out there too.
Sounds like the week’s events, and the price action on Primus, got into your head a bit. You saw lower lows amid the panic, and then when the stock headed back up, you thought to take some off the table. This is not a criticism as the same thoughts happened to me. While I know they can easily handle LEH hit, as the craziness ensued and it appeared that nothing remained sacred (AIG about to file bankruptcy? etc) the fact that even with my stress modeling, etc, I could realistically see a string of events that could quickly and painfully gut me on this one - that was sobering. That’s why I was buying PRD this week and not more PRS, by definition when PRS is at 25 cents in a meltdown, PRD should be at $25.00.
PRD/PRS is less than 5% of my portfolio. I am also working in more SNS and would like to build a nice position there. With SNS I think the risk of violent and speedy loss is much much lower, and over time the reward could still be a 3, 4, or 5 bagger depending on the hold period. I just think PRD could be a 4 bagger in a shorter time if we get some calmer markets and step past these financial landmines. I believe that the financials are the key reason PRS/PRD trades where it does, as otherwise people are totally overestimating higher defaults on industrials. Take out those perceived risks and this should head up. Plus you earn back 6% of your principal investment every 3 months that you can stay alive…..
What other things are you finding with more upside and less risk?
Hogan,
There were lower lows and equal volatility in July, we’ve been through this with Primus before.
It’s not that my thesis on Primus has changed, it’s merely that I currently see lots of other things out there with plenty of upside and less risk (capital markets risk, rating agency risk, default risk being the big ones). I don’t want to make it sound like I’m changing my stance on Primus as an investment. I’m certainly not and I still own the company. PRD isn’t something that attracted me because if Primus really gets in trouble, the preferred will be in trouble too. I don’t want to cap my upside in the scenario that Primus makes it out as well as I think they will. The opposite to my argument could be made soundly, though.
However, as new information comes in and I am able to find other bargains I’m always willing to re-assess. Part of a good investment process is replacing bargains with better ones if you find them. I have done so! I own 3 more stocks today than I did 3 months ago, and I’m still looking for cash to buy more.
I hesitate to start recommending stocks here without a chance to fully write about the companies and defend my reasoning. So I won’t.
I hear you on PRD - if they get nuked then PRD is done too. My logic is that if PRS takes several big hits, it is likely they will get downgraded, and then its probably game over in terms of new business going forward. So you can then sketch a scenario where PRS true equity value may only be worth $5 per share, for example, with no likelihood of future business. However unless there are $500+ million of hits, PRD is worth $25. It has an actual face value while the equity does not, and it has a 25% yield now. So on the “very few hits and continue writing new business once they emerge” scenario I agree the stock has more upside. On the “take $2 billion of hits” scenario they are both wiped out. But on the middle scenario, PRD could still have 4X upside while PRS might not.
I look forward to hearing about your new finds, either on the board at a later time or in backchannel email. Take care and good luck out there, these are times filled with risk but opportunity I think.