“…you can buy your own stock (with borrowed funds) at a 14% return with a negative or zero or 1% to 2% cost of capital for at least a 12% spread.” Larry Haverty, Gabelli Multimedia Trust

“The Barron’s excerpts below (from the most recent issue) are just two examples of the market distortions caused by the Fed’s easy money policies. There is no growth going on here (S&P 500 revenues aren’t even up 3% in the third quarter of 2013). There are no jobs being created here. In fact, these activities; issuing debt and selling assets (especially to foreigners) to pay dividends and/or buy back shares, probably costs jobs and increases corporate risk. There is no long-term shareholder value being created here. This is just temporary financial arbitrage pure and simple.” Mike Perry, former Chairman and CEO, IndyMac Bank

“Valuations, especially relative to interest rates, are low, and earnings and cash-flow growth are quite reasonable. At the same time, there is an extraordinary situation in terms of allocating capital. The really strong market performers for the past few years in the consumer-discretionary sector…media, entertainment, and retailing….are companies that have been significantly repurchasing their stock. That should be the case for the next few years, too. For a company trading at a multiple of seven times pre-tax cash flow, its pretax cash-flow return is 14%. If the company has a 2% dividend yield and you adjust that dividend on a pretax basis, the yield is closer to 3% assuming a 33% tax rate. Many companies can borrow at less than 3% or slightly over 3% at the margin. So you can buy your own stock at a 14% return with a negative or zero or 1% to 2% cost of capital for at least a 12% spread. Companies that have been engaged in this form of arbitrage such as CBS, Viacom, and DirecTV have been really stellar market performers.” Larry Haverty, Portfolio Manager, Gabelli Multimedia Trust, Barron’s, December 9, 2013

Relevant Excerpts from Barron’s “Buy the Asset Sellers”:

“The Standard & Poor’s 500 index is up 27% this year, but its underlying revenue increased just 2.9% during the third quarter. Companies that are increasing revenue at a double-digit pace go for a median of 20 times this year’s projected earnings.”

“However, fast growth isn’t the only path to handsome stock returns. Companies can increase their profit margins, boost their overall growth rates or reduce risk by selling assets that have been holding them back, and putting the cash toward debt reduction or larger dividends. The results are often lucrative for shareholders.”

“WHEN SELLING ASSETS, it helps to have buyers who are willing to overpay because their motivations extend beyond profits. Countries such as China, Indonesia, and South Korea are keen to reduce dependency on foreign oil and diversify savings away from low-yield Treasury bonds. So far this year, government-controlled energy companies have scooped up assets worth $94 billion, JPMorgan reported in late November. That’s 12 times what they spent in 2006 and 78% higher than last year.”

Feature

SATURDAY, DECEMBER 7, 2013

Buy the Asset Sellers

By JACK HOUGH | MORE ARTICLES BY AUTHOR

Revenue growth may be hard to come by these days. Look for companies with assets to sell or businesses to unload.

It’s not easy to find bargains when U.S. stock prices have soared while revenue growth has slowed, especially since companies that are still growing quickly look expensive. One solution: Look for companies that can grow by shrinking—companies that can fetch higher stock prices by selling off underperforming assets and putting the cash to good use. Consider Dow ChemicalRoyal Dutch ShellGeneral Electric and Time Warner .

The Standard & Poor’s 500 index is up 27% this year, but its underlying revenue increased just 2.9% during the third quarter. Companies that are increasing revenue at a double-digit pace go for a median of 20 times this year’s projected earnings. Weed out those whose revenue is up on acquisitions or rebounding from depressed levels, and what’s left are true fast-growers with much higher prices, like Chipotle Mexican Grill(ticker: CMG) at 50 times earnings; Whole Foods Market (WFM) at 33 times; and Netflix (NFLX), Amazon.com (AMZN), and Salesforce.com (CRM), all more than 100 times.

image

Stuart Goldenberg for Barron’s

Investors can improve their prospects by seeking out reasonably priced companies with assets to sell.

However, fast growth isn’t the only path to handsome stock returns. Companies can increase their profit margins, boost their overall growth rates or reduce risk by selling assets that have been holding them back, and putting the cash toward debt reduction or larger dividends. The results are often lucrative for shareholders. A 2008 study published in the Journal of Finance found that over the long term, U.S. stocks in the market’s bottom decile ranked by recent asset growth outperformed those in the top decile by 13 percentage points a year. A 2012 paper that focused on international markets reported similar findings. So while rising stock valuations may be better news for sellers than for buyers, buyers can improve their prospects by seeking out reasonably priced companies with plenty to sell.

For instance: Last week, Dow Chemical (DOW) announced it will sell chlorine, epoxy and other commodity businesses with revenue of $5 billion, or nearly 10% of total revenue. Since 2009, Dow has already sold businesses with revenue of about $10 billion. After the latest divestiture, three-quarters of the company’s revenue will come from high-margin businesses, according to Deutsche Bank. The sales have reduced payroll costs and helped Dow more than double its spending on dividends and share repurchases over the past three years. The stock yields 3.3%. Earnings per share are expected to increase 21% this year, to $2.29, and to grow even faster next year, hitting $2.84. That puts shares below 14 times next year’s earnings.

WHEN SELLING ASSETS, it helps to have buyers who are willing to overpay because their motivations extend beyond profits. Countries such as China, Indonesia, and South Korea are keen to reduce dependency on foreign oil and diversify savings away from low-yield Treasury bonds. So far this year, government-controlled energy companies have scooped up assets worth $94 billion, JPMorgan reported in late November. That’s 12 times what they spent in 2006 and 78% higher than last year.

Meanwhile, many big oil firms remain stuffed with under-developed assets ripe for spinning off. Royal Dutch Shell (RDS.B) has targeted $15 billion in sales over the next two years, or 7% of its recent stock market value, but JPMorgan says it holds twice that much in non-core assets that could fetch good prices. Shares of Royal Dutch go for nine times earnings and yield 4.9%.

[image]

In September, Barron’s wrote that General Electric (GE) shares look likely to shine after more than a decade of underperformance, based in part on the company selling off financial operations that don’t directly relate to its industrial businesses (Sept. 23, “GE: Not Too Big to Grow“). Last month, the company said it will sell up to 20% of its North American consumer finance business in an initial public offering next year and distribute the rest to stockholders. Shares of GE are up 12% since our story, versus 6% for the S&P 500. They still look affordable at 15 times next year’s earnings forecast. One reason is the 2.8% dividend yield. Another, according to Barclays, is that changes in profit margins are one of the best predictors of stock performance for industrial companies, and GE leads its peer group by that measure. One of its goals is to drive operating margins for its industrial businesses 0.7 percentage point higher this year to 15.8%. Last quarter, it reported a 1.2 percentage-point increase.

It’s a worrisome sign when companies build grandiose headquarters; think of the Sears Tower in Chicago, now called the Willis Tower, finished in 1973, before a long decline for the retailer. It’s probably a good sign, then, that Time Warner is reportedly unloading an ultra-posh retail and office development in Manhattan that holds its headquarters—to a group that includes Singapore’s sovereign wealth fund. The company also plans to spin off its publishing business next year. What’s left will be lucrative television and film properties, including Home Box Office, Turner Broadcasting System and Warner Brothers Entertainment. After the sale, about 35% of revenue will come from subscriptions and only 20% from advertising, and earnings per share should grow by 15% a year on falling corporate overhead and rising fees from TV affiliates, according to Morgan Stanley. Shares go for 16 times next year’s earnings forecast.

Posted on December 10, 2013, in Postings. Bookmark the permalink. Leave a comment.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: