Ideas

Does Your Portfolio Need A Drink?

As if there weren't already enough problems to worry about in the world today. Uncertainty reigns supreme as the media presents us with the threat of global terrorism, a slumping global economy and the punishing effects of climate change. Yet, there is one problem that I believe we are not talking enough about, and that is the growing scarcity of freshwater. First the problem will be outlined, and then several interesting investment opportunities will be explored.

For starters, it is important to remember that the water we drink today has probably been around in one form or another for hundreds of millions of years. This is due to the fact that the amount of freshwater on earth has remained constant, as the earth works as a large desalination plant, regularly recycling freshwater through the atmosphere (evaporation) and back towards our faucets (rainfall/snow). Yet, at the same time, world population has been growing exponentially. What this has caused is an ever-intensifying competition for access to clean water for drinking, bathing, cooking, growing crops and manufacturing.

In fact, 70 percent of the world is covered by water, and only 2.5 percent of it is fresh. The rest of it is saline, and just 1 percent of the world's freshwater is easily accessible, with much of it caught in glaciers and snowfields. Strikingly, only 0.007 percent of the planet's water is available to fuel and feed its 7 billion people.

To make matters worse, humans are inefficient with their water use, water is even more scarce due to geography and climate change, and with population thought to grow to around 1.8 billion by 2025, it is estimated that around two-thirds of the world's population will live in regions where freshwater is scarce.

In the United States, many states are facing freshwater shortage issues and expect this to continue in the future. In addition, unconventional sources of demand, such as hydraulic fracturing for oil & gas exploration, may exacerbate shortages. Each well that employs hydraulic fracturing uses large amounts of water, and only a small percentage of this water can be reused. These facts beg the question of what is being done to combat the freshwater problem. The picture begins with desalination.

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4 Can't Miss Industry Trends With High Growth Potential

If you can tune out the barrage of negative news regarding the state of the world economy, there are many reasons to be optimistic given the incredible amount of game changing innovation going on right now. As a small example, there are at least 4 significant industry trends that are sure to change our lives for the better in the near future.

These 4 industry changes are tied to companies that are attempting to target non-consumption by developing technologies, products or services that solve problems currently lacking a solution. In a global marketplace where consistent top-line growth is becoming more difficult to identify, these investable trends and the star companies that go along with them should be on your radar.

1) Manufacturing Gets More Automated

Artificial intelligence stories dominate headlines, yet people underestimate the massive impact of more simple robotics and 3-D printing. Robots like UR10 from Universal Robots and Baxter from Rethink Robots are driving down manufacturing costs in the United States and Europe, making manufacturing in China less economical. In fact, the cost of operating such robots is less than the cost of human labor and also less of a headache (think employment contracts, and health and safety requirements). These robots can work 24/7 and are becoming so sophisticated that they can perform most human jobs. Yet the disruption doesn't stop here.

The hype surrounding the 3-D printing industry has cooled off as of late, yet in the future expect even robots to be replaced by powerful 3-D printers that may even allow us to design and print our own devices. Imagine being able to 3-D print electronics like your own TV or watch.

Companies to consider:

iRobot: (NASDAQ:IRBT)

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Could Your Grandma's Favourite Jam Be Made By One Of The Strongest Companies On The NYSE?

On June 18th 2004, The J.M. Smucker Company (SJM) based out of Orville, Ohio reported fourth quarter earnings and the numbers were shockingly poor. Fourth quarter earnings fell nearly 5% on restructuring costs and lower sales of some of its largest brands like Crisco shortening. Moreover, net income fell to $22.2 million, or 44 cents a share, from $23.2 million, or 46 cents, a year earlier. Sales in the quarter ended April 30 declined 1.1% to $325.4 million, the first drop in more than three years.

The market showed Smucker no mercy and shares of the company fell $2.15 to $46.50 on the NYSE and over the next year and a half, shares of the jelly and jam maker fell 14.62% to close at $39.70 on March 31st 2006.

But as the going got tough, the tough got going.

With solid management and a great business model intact, sales started to rebound, new brands were acquired and new products were rolled out. The company invested in innovation and in more efficient production methods. The company grew organically and through acquisitions, acquiring brands like Folgers from P&G and Sara Lee from Hillshire. Margins were expanding and free cash flow was growing at a robust pace.

Results? Over the next 8 years, the company's share price surged 144.69% (18% annualized excluding its 2 and change dividend yield). The company with $22 million in quarterly net income in 2004 grew to a sizable $166 million in net income in its most recent quarter with over $1.4 billion in sales.

Why is any of this important?

After performing a close analysis on this company over the last 7 months, I believe that this family-managed company is going through a situation not so different from 2004. Over the last 6 months, shares of SJM have fallen nearly 8% due to lower volumes, lower sales and lower than expected earnings results. Guidance for the company has been revised downwards. Further, the company has locked in certain commodity prices for a long period of time which could affect their ability to seize margin opportunities in the short term. The company has also seen a 4% increase in SG&A costs and has passed on certain cost savings to the consumer, leading to lower revenue growth (for example, the company took an 8% list price decrease in oils earlier in the year). Over the last year, shares of the company are down 0.22% while the S&P has risen 18.78%. Needless to say, the company has experienced significant headwinds and is in the competitive, low to mid-single growth non-cyclical food sector.

In light of recent market history, it has been and remains difficult for investors to find opportunities to buy quality, value-oriented American companies going through hard times. I believe SJM is one such opportunity.

What exactly makes this a great opportunity?

Quite simply, I believe SJM is trading well below intrinsic value based on what it is worth in the long term. SJM is a cash generating, compounding machine with over $2.4 billion in annual profits and over $10 billion in revenue as of FY 2013. The company is largely focused in the US, Canada and Mexico and last year the company had over $649 million in free cash with a free cash target of $850 million by FY17. Over the last 3 years the company has repurchased 12% of shares outstanding and has issued a free cash flow target of $600 million after certain capital expenditure goals for FY14 (which it will easily hit). Excluding special project costs, earnings per share were $1.66 this quarter and $1.47 last year, an increase of 13%. The growth in EPS was partially driven by gross profit, which excluding special project cost, increased $11 million or 2%. This resulted in gross margin improving to 37.4%, an increase of nearly 300 basis points over the prior year. Moreover, for the current fiscal year, the company has achieved its target of introducing 100 new products and has further product and growth initiatives planned for fiscal 2015.

The company has tremendous scale and commands premium 'center of the store' presence in any supermarket given its roster of dominant brands and innovative products. Furthermore, the company has made large investments in logistics and production ($80 million facility expansion in Kentucky). It makes intelligent and timely brand acquisitions and investments at the right price for the long term (Enray Inc. and Guilin Seamild Biologic Technology Development Co., Ltd. In China) and enters into value add joint ventures with competitors (Keurig Green Mountain Inc.). Concomitantly, the company is committed to its "long-term growth algorithm": 6% increase in net sales, 3-4% increase in organic growth, and 2-3% through acquisitions, leading to an annualized estimated shareholder return of 11% per year. All in all, Smucker has margin growth which fuels organic growth, has seen earnings rise consistently year over year and is devoted to growing its business through new product and brand development. These are signs of a dynamic company managed by a team (the Smucker family has been involved with the company since its founding in 1897) which has demonstrated its ability to decisively deal with temporary problems.

In fact, it is management's culture of ambitious goal setting that really impresses me. Not only does it focus the company and filter out excess noise along the way, but it enables the company to handle any setbacks by reinforcing a culture of forward progress. This is not to say SJM will certainly hit all of its targets since markets are often unpredictable, but given their business model, history, scale, fantastic marketing capabilities and quality management techniques, I am confident in SJM's continued ability to create long-term generational wealth.

 

The Curious Case Of BUD

Could BUD be more than just the king of beers in 2014?

At present we find ourselves in the middle of a secular bull market - equity premiums have risen and multiples are expanding. Many prominent managers are saying that the market is overpriced and the growth in earnings is not keeping pace with valuations. Revenue is no longer beating expectations and gone are the days of 2010-2012 when companies were expanding margins, trading at ridiculously low PE ratios and holding tons of cash out of fear, all while beating earnings estimates. Some analysts have projected that the S&P may even reach a historic high of 2000 in 2014.

Bushwhacking through the jungle of such information, every once in a while, a savvy investor is offered a unique opportunity. An opportunity to conservatively more than double their money over the next decade from a relatively safe, boring, global company that has maintained a predictable track record of increasing shareholder value. That company is the European heavyweight Anheuser Busch Inbev SA, commonly known on the NYSE as BUD.

What is the thesis on BUD?

Let's for a second take away your quick traditional equity valuation for BUD. I can give you BUD's economic profit (derived by multiplying capital charge and NOPAT (net operating profit after tax) discount it for 10 years at an average mid-to-high single digit growth rate and cost of equity with the 10 year Treasury at 5% (you know, just to make it more interesting). Additionally, let's slow the company down to a low to mid-level growth rate thereafter, find its terminal value, discount that, add the invested capital today and come to a range of estimated firm value figures that is much higher than what the company is worth today.

However, let's instead look at some recent news.

In its last quarter, core profit at the company rose 13% to $5.2bn, net profit surged 47% to $2.52bn, revenue increased to $11.71bn from $10.29B and normalized EPS grew 32.7% to $1.46 when consensus was $1.31. The company is expanding margins drastically (the current operating margin of 58.6% is a 5-year high point) and consistently increasing revenues year over year. BUD generated a 3 year average annual EPS growth of 15.34%, and has unbelievable scale and marketing capabilities. This is all happening despite the company trading at just 12 times earnings when the industry average is 19.2 times. Although BUD generated a ratio of cash flow from operations/total sales of $8.9 billion (down from $10 billion the previous year), the 5 year comparison shows that the firm has been able to maintain certain stability in its free cash flow with 2012-2013 being very robust years.

A comparison with other great 'operators of capital' helps to really put things in perspective. Let's compare BUD with KO (Coca-Cola), a company with similar scale and operations that has been consistently creating shareholder value for over 110 years. BUD made 20% more operating income than KO last year, EBIT in its most recent quarter is half the size of KO's EBIT year-end and yet this company is trading at a market value that is cheaper than KO. This takes into account the recent problems KO is experiencing with flat global volumes, lower soft drink consumption in mature and emerging markets, and dietary changes of the North American consumer. BUD is a monster operator of capital: the company made more operating income last year than TD Bank, Canadian Imperial Bank of Commerce and the National Bank of Canada, jewels of the TSX and the Canadian economy - combined.

This is not to say that BUD doesn't have its own problems or any headwinds. Recent beer consumption in emerging markets (i.e. Russia, Brazil) has slowed and volumes and sales in North America are flat. Prices of soft commodities are rising which may squeeze margins, and most concerning, recent growth in fixed assets has been rising as rapidly as revenue growth (which makes for a larger future capital charge and increases the risk of lower ROA growth). Moreover, there is still a lot of uncertainty with regards to new excise taxes imposed by governments worldwide which could hamper demand.

However, I feel that the problems presented above provide the perfect buying opportunity as they are simply the catalyst behind BUD's depressed valuation. Volumes will slowly rise with population growth, the rising middle class in emerging markets and untapped potential in 'new' emerging markets (i.e. Africa, Indonesia etc.). Consumer spending in mature markets will increase (i.e. Europe and NA)), new products will be rolled out, costs will be passed on to the consumer and brand recognition and scale will expand through investment. New brands and companies will be acquired as evidenced by the recent acquisition of a South Korean brewer and American craft brewer Blue Point brewing. All of these factors will cause revenue to rise faster than the investments made in fixed assets today. Nevertheless, time and strong management execution are prerequisites.

At the end of the day, I am so confident in the vitality of this company that even if the headwinds outlined above come on strong I remain long BUD. Furthermore, a safety net is in place given the company's excellent track record of increasing shareholder value and its sound use of capital. I can't predict the future, but I think BUD presents an opportunity to buy a wonderful company at a great price.

Disclosure: Logos LP is long BUD.