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Sunday, February 27, 2011

FASCINATING SLIDE: Emerging Economies Leading World Expansion; Insights from Navios Maritime and the Dry Bulk Trade

In our last "FASCINATING SLIDE" in January, we shared The Power of Compounding - P&G's 54 Consecutive Years of Dividend Increases. Here, we highlight economic growth in emerging markets and the dry bulk trade with help from Navios Maritime Holdings (NM).

We have no position in Navios or any other "dry bulker" given ongoing risk related to excess supply of vessels, but we are keeping tabs on Navios for general insights into the global economy. The company often includes very interesting data in management slide decks. For example, we mentioned Navios and shared content from the company in July of last year in Energy Demand and China: One Picture is Worth a Thousand Words. In this case, the "picture" was a slide illustrating a massive upward shift in Chinese coal imports.

Navios reported financial results last week and included the following slides - growth in emerging economies and contribution to global growth:

And, for additional context, we include one more slide - increases in the global dry bulk trade over time:

These slides reveal a very clear trend: despite potential or actual "bubbles" in certain parts of emerging economies such as China, the multi-year/decade secular shift in emerging regions is powerful. As we've said before, the train has seemingly left the station. In our view, the trend tells a story that likely has long legs, even with turmoil in Libya/elsewhere and inflation risks. For discussion of certain risk factors, please see this 2/26 NYT's article Suddenly, Emerging Markets Look Complicated Again.

With regard to the overall trend, Navios management commented in its 4Q10 release:
  • Ms. Frangou continued, "The shipping industry is going through transition at a time when there is healthy underlying demand for mineral and grain commodities and crude oil globally. While we are cautious about the near term, and continue to monitor closely the supply of vessels, we see continued demand for commodities from the urbanization of emerging markets."
SO, as the dry bulk industry works through its ship supply/demand imbalance and Gadhafi battles his people, the world keeps turning, and, quickly, too. For additional insight, please see our December post, Investing in Global Shifts: Brazil, Latin America, the Container Trade, and More.

Per our Global Shift and other posts, one way we expect to benefit from global growth is through our container shipping companies Seaspan (SSW) and Global Ship Lease (GSL). In both cases, we continue to see incremental upside and expect a growing dividend income stream over the medium term.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SSW, GSL.

© 2011 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Thursday, February 17, 2011

Weight Watchers (WTW): Instead of "Boom Boom Pow," Stock Just Goes POW! Single Day Revaluation Like No Other We've Seen

We mentioned in our post the other day how shares of Bidz.com (BIDZ) went Boom Boom Pow (borrowing from The Black Eyed Peas).

It's one thing for shares of a microcap company to surge (or decline) 20, 30, 40% in one day since trading in smaller companies is often illiquid, catalyst driven, and can have a mind of its own. But, it's quite another thing for a mid- or large cap company to see such extreme share price moves in a single day.

However, today, Weight Watchers International (WTW) surged by 46% to $65 per share on the back of favorable 4Q10 results and an earnings forecast that blew Wall Street consensus (and our) 2011 estimates out of the water: the company guided to $3.50 - $3.85 per diluted share versus a consensus estimate of $2.77:

Commentary from Weight Watchers' press release:
  • "I am gratified that we were able to deliver full year 2010 EPS of $2.56 per fully diluted share, above the original 2010 earnings guidance range we provided at this time last year," commented David Kirchhoff, President and Chief Executive Officer of the Company.

  • "Looking at 2011," added Kirchhoff, "we are seeing terrific enrollment volumes in our North American and UK meeting businesses and further strengthening in our WeightWatchers.com business. We are providing a 2011 earnings guidance range of between $3.50 and $3.85 per fully diluted share."

AND, here's the one-day chart from Google Finance:

AGAIN, rarely does such a move happen for such a large company ($3+ billion market cap prior to move). We've really only seen such a move as a result of M&A activity, sometimes via unexpected, hostile takeover bids that -- at least from the Market's perspective -- seem to come from left field.

What happened? The company's very positive surprise brought an extreme positive revaluation from the Market. The Market now sees that, not only is the "coast clear" from a fundamental standpoint, but the business model's operating leverage is substantial and was -- to this point -- largely unappreciated. Amidst a massive upward earnings revision, more people can immediately see the positive WTW thesis we've been talking about since late 2009: Weight Watchers owns and operates high-quality, high-margin, high-ROIC business model with a powerful, difficult-to-replicate franchise.

Why such a gigantic move? We generally believe a 20 times price-to-current-earnings multiple (5% earnings yield) is fair for high quality businesses. With near-term earnings power now approximately one dollar above expectations, the Market suddenly sees an additional $20 of upside (at a 20 times multiple) and, amazingly, awarded this amount today.

What's the fair value now? In our most recent WTW discussion, Just Like Clockwork, we pegged Weight Watchers' fair value in the $40-50 range, unaware that we would see such tremendous operating leverage in 2011. If earnings power is now $3.68 (midpoint of range), 20-times this figure brings us to a fair value of $74 (*based only on a P/E valuation; overall, we prefer a composite valuation approach). Of course, in four to five months' time, the Market will begin looking to 2012. We've not had time to review our model, yet if fundamentals remain solid this year, 2012 estimates might reasonably be $4.00 per share, implying an $80 fair value at a 20 P/E (still below historic multiples awarded to the company).

Wow. What a stunning revaluation on the back of solid execution and results by Weight Watchers. Now, those who were negative or cautious on the name will likely now change their tune. Yet, although we see incremental upside and potential for dividend hikes over the medium-term -- to risk stating the obvious -- the best time to buy WTW was long before today's feeding frenzy.

We can reiterate a recurring theme shared in our January "Clockwork" post: history indicates that the greatest returns are generated by swimming against the tide and accumulating ownership stakes when everyone else is running scared. Of course, normal human psychology makes the mental decisions to purchase out-of-favor companies inherently difficult.

How best to beat demons of the mind during those periods and increase the odds of handsomely outperforming the Market over time? Remove emotion from the process through a disciplined, rational research and valuation framework.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long BIDZ, WTW.
© 2011 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Tuesday, February 15, 2011

Bidz.com (BIDZ): Finally Catching a Bid as Shares Go Boom Boom Pow! Who On Earth Wants to Own Bidz.com?

On the heals of Blue Nile's (NILE) better-than-expected sales results last week, shares of Bidz.com (BIDZ) are finally catching a bid on significant volume. Here's the five day chart from Google Finance:

AND, the one year chart from Yahoo Finance (we captured over the weekend, before Monday's jump -- didn't finish our post):

In our Happy New Year post, we mentioned that our position in the online jewelry/fashion retailer had not worked out to-date, but said that we'd been adding to our position because we still saw value from several different angles.

Why on Earth would anyone want to purchase [more] shares in Bidz.com?

We can think of at least ten reasons, starting at the top and counting down:

10) Most key Bidz overhangs removed. A summary from a management deck last spring:

9) Per our original Bidz long thesis, jewelry can be a very good business over time and, fortunately, industry fundamentals stabilizing. Of course, following a period of margin compression, Bidz.com needs to demonstrate an ability to drive sustainable mid-single digit (or better) operating margins.

For a view on fundamentals, this December Bloomberg article is worth a read:
Two points from the article:
  • U.S. consumer confidence reached a six-month high, an economic report showed last week. Consumer spending may rise an average 2.6 percent in 2011, compared with a 1.7 percent increase this year, according to the median estimate of 56 economists in the latest Bloomberg monthly survey.
  • Almost 4,000 U.S. jewelry retailers and suppliers went out of business between the start of 2009 and the end of November, or more than 10 percent, according to the Jewelers Board of Trade in Warwick, Rhode Island.
8) Favorable long-term secular trends, also noted in our initial thesis. People like to shop, especially for jewelry and other accessories. From our original post in August 2009:
  • People like to shop – while the average American consumer is struggling, we submit that Americans will always be consumers, with some arguably addicted to purchasing products from TV channels such as QVC.com (LINTA) and HSN.com (HSNI), as well as Web sites like Bidz.com. A growing middle class elsewhere in the world also brings more consumers.
  • More commerce will gravitate online over time – although e-commerce growth is lagging amidst the recession, sales are holding up better than offline retail sales. comScore reported 1Q09 online sales flat Y/Y versus overall retail sales down 5% Y/Y.
7) International business is greater than 41% of total revenue and growing at 11% Y/Y (9M10). From latest Form 10-Q (click to enlarge):

6) Meaningful relative discount - from Yahoo Finance (before Monday's jump):
  • Bidz delivers higher gross margins than Blue Nile but currently operates at a loss. Still, Blue Nile's ten times price-to-sales (P/S) premium appears rich, in our view, and the gap should narrow at some point. If Bidz garnered the same P/S multiple, shares would be at $16.
  • Another potential "comp" (not pictured above) might be online retailer Bluefly (BFLY), which has struggled to generate profits since formation and carries an accumulated deficit (the opposite of retained earnings) of $152 million (9/30/10). Bluefly trades at 0.93 times sales versus Bidz.com's 0.26 (prior to Monday). If Bidz garnered the same valuation, the stock would trade north of $5 per share.
5) Bidz.com's established brand, supply chain relationships, E-commerce know-how and scale are difficult to replicate (e.g. we couldn't do it). Bidz invested significant money to build its brand and develop an E-commerce platform that operates at scale. A $100 million plus annual revenue business is non-trivial. Also, major face lift to Bidz.com's Web site is coming soon -- beta version available now:

4) Embedded call option on growing Modnique.com fashion business. No value at all is being awarded to this start-up business entirely self-funded by Bidz.com's core business. We briefly discussed this business and competitive landscape in our post last August.

3) Significant insider ownership - greater than 60%. From last year's proxy (click to enlarge):
  • We know that management wants to generate wealth for themselves and for ALL shareholders since they own more than 60% of the business.
2) Historic track record of profitability (pre-crash) and protecting shareholder value (e.g. see retained earnings, through downturn) with NO DEBT and ample cash generation to fund growth. Shareholders' Equity from Yahoo Finance over the past twelve months (most recent 3Q10 quarter on left side - click to enlarge):
  • No accumulated deficit and fairly stable net tangible assets through tough operating conditions.
AND our number one reason:

1) Who doesn't like free stuff? Like our Parlux Fragrances (PARL) and FLY Leasing (FLY) (click for prior posts) purchases, the entire Bidz.com business including Modnique.com was being given away for less than free.

Until Monday's big move, Bidz.com was offered below net tangible book value (e.g. liquidation value). Given reasons (2) through (10) above, we thought this made no sense whatsoever, particularly for a self-funding company with no debt that was no nowhere near bankruptcy. Bidz was/is not a "cigar butt" as discussed in our initial Parlux post last fall.

We tweeted the discount back on February 3rd:
Hence, the Market gave us an excellent opportunity to purchase Bidz.com at approximately 0.80 times net tangible book value. We took advantage of the apparent disconnect and significantly reduced our average cost basis in the company.

While certain questions remain, we are pleased to see renewed Market interest in Bidz.com. As we've noted previously, when Market sentiment turns, it can turn on a dime. Borrowing from The Black Eyed Peas, we could say that things sometimes go Boom Boom Pow:

Even with the recent uptick, we believe fair value remains meaningfully higher since the business is now only trading equal to net tangible book value. Reproduction cost is certainly not zero, nor is the value that would be assigned by an informed private market buyer. Further, if management can deliver renewed revenue growth with margin expansion, we could again consider EV/EBIT and P/E valuation metrics that might bring us back to our original mid- to high-single digit fair value estimates.

Like Bidz.com, we are also looking for our 1-800-Flowers.com (FLWS) to go Boom Boom Pow! We just don't know exactly when the shift might occur. Near-term timing is unpredictable.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long BIDZ, PARL, FLY, FLWS.
© 2011 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Sunday, February 6, 2011

1-800-Flowers.com (FLWS): Is Fannie May Confections Gaining Market Share from Berkshire Hathaway's See's Candy?

On Thursday 1/27, we were pleased to see 1-800-Flowers.com (FLWS, $2.76) post better-than-expected results and regain at least some favor from Wall Street. For some time now, we've been highlighting the value inherent in the company's diversified portfolio of businesses and expecting Wall Street to again embrace the company.

In our Just Like Clockwork post early last month, we said:
Well, following the results, Goldman Sachs moved to a "Neutral" rating from a "Sell" rating, which is a step in the right direction. We've not seen the report, but presume the firm is happy that fundamentals are stabilizing and that the coast is seemingly more clear than previously.

Of course, we all remain aware of nagging economic concerns and that "Selfish" Discretionary Spending is outpacing "Gifting" Discretionary Activity. For these reasons, Goldman Sachs possibly held off moving all the way to "Buy" rating and may also want to see positive Y/Y growth for the company. Per our prior discussion, many analysts are afraid to stick their necks out until the coast is entirely clear.

However, let's revisit what Warren Buffett pointed out in his October 2008 NYTs Op-Ed, Buy American. I Am. - emphasis added in last sentence:
  • Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.
We continue to believe this is true for 1-800-Flowers.com. By the time Wall Street fully embraces the company, the stock will already be meaningfully higher. Hence, the best time to acquire shares is when they are discarded in the waste bin.

Moreover, assuming a stable to better U.S. economy, we think 1-800-Flowers.com may begin to show positive Y/Y comparisons in the coming quarters. We can point to reasons from the company's earnings release:
  • The Company said the 1.3 percent [revenue] decline reflected reduced wholesale order volume in the mass market channel as well as the loss of approximately $1.4 million of high-margin revenues associated with a third-party marketing program which the Company ended in December of 2009.
Here's the good news: going forward, the company has now "lapped" both the third-party marketing program and particularly steep declines in its wholesale basket business. As a result, delivering Y/Y growth is now easier, especially as other, growing business segments such as chocolates and cookies become more significant contributors to the company's revenue mix.

This finally brings us to the main point of today's post: is 1-800-Flowers.com's chocolate business gaining market share from See's Candy? Last December, we shared 1-800-Flowers.com (FLWS): Is "Moat" Shallow, Shrinking, or Nonexistent? In that post, we referenced our Nestlé Kit Kat series, which alluded to the strength of 1-800-Flowers.com's growing chocolate business, Fannie May. We also shared this 11/27 AP article:
  • The Associated Press — CHICAGO — A half-dozen years ago iconic chocolatier Fannie May, loved by Chicago candy devotees who passed down their affections for mint meltaways, caramels and vanilla buttercreams from generation to generation, was all but finished.
A large part of our thesis is that the "Market" is ignoring hidden value in the company's portfolio of brands, particularly Fannie May Confections and Cheryl's Cookies. We see these higher margin, growing, branded businesses as durable, consumer packaged goods (CPG)-like operations. It's worth noting that the historical long-term stock performance of many CPG companies is very positive. For reference, please see Jeremy Siegel's books Stocks for the Long Run and The Future for Investors: Why the Tried and True Triumph Over the Bold and New.

Now, let's look briefly at Fannie May Confections (FM). The AP article included a number of interesting tidbits, particularly an updated annual sales figure for the business and production volume:
  • "a brand approaching $100 million in revenue annually"
  • "produces about 10 million pounds of chocolate a year"
We can take the sales figure and combine with our analysis:
  • 1-800-Flowers.com purchased FM in April 2006. At that time, the company's trailing twelve month sales were approximately $75 million.
  • Our understanding is that revenue was approximately $90 million two to three years ago.
  • According to the article, revenue is now approaching $100 million, which implies a five-year CAGR of 7% per year versus a flat to down North American chocolate market.
  • While the overall market probably grew along with the economy in 2010, here's backup data for the flat to down market from an LMC International presentation entitled the Outlook for Cocoa Demand (October 2010):
  • The overarching conclusion: if FM is growing revenue 7% per year, on average, in a flat to down market, FM is gaining market share!
  • Plus, the business has excess production capacity -- our understanding is that FM has current capacity in place to produce 15 million pounds of chocolate per year. Put another way, volume could increase by 50% with out incremental capital investment in physical plant and production equipment.
  • Also noteworthy is FM's stable, committed leadership: David Taiclet remains at 1-800-Flowers.com as head of FM. He was the head of Alpine Confections, which bought FM out of bankruptcy, successfully reincarnated the business, and later sold to 1-800-Flowers.com.
NOW, to address our lead question - is FM gaining share from Berkshire Hathaway's (BRK-A, BRK-B)?

Sorry to disappoint: the honest answer is that we don't know since -- to our knowledge -- the last reported financial figures for See's Candy were in Berkshire Hathaway's 2007 Annual Report:
  • 2007A revenue of $383 million with $82 million of pretax earnings (= 21% pre-tax margin).
To see whether or not See's is maintaining, gaining, or losing share, we need updated revenue figures. Admittedly, as a shareholder of both Berkshire Hathaway and 1-800-Flowers.com, we're rooting for both businesses. However, we do know this: a well-run chocolate company makes one for one heck of a business AND there aren't too many of them around.

One this point, Mr. Buffett has long praised See's as "a dream business" and included wonderful discussion in Berkshire Hathaway's 2007 Annual Report* (please click to enlarge):

*We are taking liberty by lifting this directly from the AR without express permission, yet suspect this is okay given the life-long propensity of Messrs. Buffett and Munger to educate and share key investment principles.
We recommend reading the text, as well as the balance of the shareholder letter. In a nutshell, this particular section makes very clear the benefits of owning "asset-light" businesses that possess pricing power and generate lots of excess cash flow. Also, Mr. Buffett notes that there simply aren't many "dream" businesses since most companies require significant capital expenditures to expand operations over time.

While Fannie May Confections is not as well-known or profitable as See's Candy, the businesses both specialize in old-fashioned, premium quality, gourmet chocolates. Fannie May actually pre-dates See's by one year -- founded in 1920 and 1921, respectively -- and established a wide following in the greater Chicago area. We know that FM's products are also excellent and, in some cases, very different and incredibly tasty. For example, Pixies and Mint Meltaways:

Based on our own experience and feedback from others, we're confident that the quality of FM's products and service is very high. Some people we know in Chicago even claim FM's chocolate is better than See's. We recommend trying them both and highly recommend FM's Pixies.

For sure, See's management team made deft operating decisions through the decades that enabled the company to grow into a business with (1) approximately four times the revenue and (2) potentially eight to ten times the pre-tax income by (3) selling only three times the annual volume of chocolate (measured in pounds). HENCE, the management teams of 1-800-Flowers.com and Fannie May have their work cut out for them. HOWEVER, we can safely say that by growing 7% per year in a flat to down market environment, management is clearly making some favorable decisions. Leveraging the "Flowers.com" significant Web traffic is no doubt a large part of the company's success over the past five years.

Here's where things get really interesting: with estimated contribution margins in the low teens (not reported), the private market value of Fannie May Confections could reasonably represent a significant component of 1-800-Flowers.com's current $177 million market capitalization and $217 million enterprise value (MC + net debt). Here's what we mean:
  • Assuming $100 million in annual FM revenue with a 9% pre-tax margin (estimate) produces $9 million of pre-tax income.
  • Assuming corporate taxes of 40% yields net income of $5.4 million (*if the company could somehow build an international business, taxes might be lower; chocolate consumption is growing rapidly in Latin America; however, such an expansion effort would involve capital investment, management time, and various risk factors).
  • Applying a 20 times earnings multiple (5% yield) for a difficult-to-replicate, growing franchise brings us to a $108 million valuation for the business.
  • Note: variable margin and multiple assumptions create wide valuation swings.
Add to this figure a reasonable private market value for the company's growing Cheryl & Co. cookie business, and the Market is awarding very limited value to the company's other businesses.

On this basis -- even amidst the weak discretionary environment -- we arrive at a meaningful margin of safety that should mitigate key risk factors such as competition, macroeconomic conditions, and a U.S.-centric revenue footprint. We believe shares could fairly trade at double current levels *today* and even higher assuming a stable to better economy that supports revenue growth and margin expansion.

Accordingly, we happily acquired shares on weakness in early 2010 and again late last summer into the fall as some investors threw in the towel. We believe those selling the stock, as well as those who remain on the sidelines today, are missing tangible hidden value inherent in the company's diversified, durable portfolio of businesses.

In particular, the notable success of Fannie May Confections through the downturn tells a very positive story and provides much on which to hang our hat. In this sense, the company's record of growth and share gains should enable the Market to see the forest through the trees.

But, alas, as Mr. Buffett writes, some prefer to "wait for the robins."

Happy investing,

Jeffrey Walkenhorst

Disclosure: long FLWS, BRK-B.
© 2011 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer