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Market leader in diabetes medication hits two-year low; Novo Nordisk (NYSE: NVO) shares reach $34

In Investment ideas, Uncategorized on November 7, 2016 at 7:38 pm

 

By any metric, Novo Nordisk (NYSE: NVO) , the world leader in diabetes medication, is an outstanding company. It commands a 28% global market share in diabetes drugs, one of the largest buckets within specialty pharma. Returns on shareholder’s equity last year was a whopping 45%.

The company is also growing fast. Over the last decade, annual growth rates for revenue and operating income were 15% and 23%, respectively.

Novo is very focused on just four disease areas: diabetes (79%), obesity (<1%), hemophilia (10%) and growth disorders (11%).

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Diabetes is clearly its major focus. Diabetes is a medical condition that has affected mankind for millennia. It is currently experiencing rapid growth due to the lifestyle factors associated with modern urban life: western diet and lack of exercise. Type 2 diabetes, also known as adult onset diabetes, makes up 90% of the diabetes market. There is no cure for this condition except purchasing expensive insulin products from Novo, Sanofi and other drug companies.

As India and China urbanize and develop a middle class, there could be a large pool of new customers. Even the United States is a great growth opportunity; according to the American Diabetes Association and the CDC, if current trends continue, 1 in 3 American will have diabetes by 2050.

Novo is highly profitable. Last year, gross margins were 85%. Operating margins were 45%; that is an incredible number and beats almost anything I’ve seen (Coca-Cola’s is 20%, Starbucks’ is 19%, Walmart’s is 5%).

Due to pricing pressures in the US and European markets, management has reduced long-term revenue and operating income targets to 5% from 10%. This is a very sharp reduction and has led to a steep drop off in the share price. Shares reached a two year low today at close to $34.

At this price, the trailing 5-year P/E is 22x (a little pricey) and the forward 2016 P/E is 15x (quite reasonable). The shares sport a 2.79% dividend yield.

Based on my analysis, long term total returns on common shares (share price appreciation plus dividends) are expected to be 10-11% going forward. However, if shares are purchased below today’s prices or growth exceeds the new 5% target (quite possible), your results could be even better.

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Despite setbacks, Deere will recover

In Investment ideas on September 23, 2016 at 1:11 pm

john-deere

They say nothing runs like a Deere. Established in 1837, John Deere (NYSE: DE) is the market leader in agricultural equipment. Due to a challenging environment for farm incomes over the last few years, Deere’s sales and earnings are down. As a result, Deere shares are cheap. The Company has seen its sales trail downwards from a peak of $36.1B in 2012 to $28.8B in 2015. Due to low crop prices, farmers don’t have the money to buy new tractors and gear.

Deere generates 69% of its revenue from the sale of agricultural and turf equipment. More than half of that is in North American market. It has a dealer network that is unmatched in North America with around 1500 dealerships. This is a big competitive advantage because it means that customers who need equipment serviced can do so quickly and conveniently. I experienced this firsthand purchasing a ride-on lawnmower for a commercial property I managed in rural Nova Scotia, Canada. We chose Deere because of the local dealership’s proximity for service repair in addition to the brand’s reputation for quality. Another big competitive advantage for Deere is its large in-house financing department.

Deere enjoys high returns on equity with ROE averaging 20%+ over a 20 year period. Over the same period (1996-2015) the company never reported an operating loss in any year. The company is also remarkably shareholder friendly, returning more than 100% of owner income (CFO-capex) to shareholders in the form of dividends and share buybacks over the same 20 year period. Due to buybacks over that period, share count was reduced by 36%.

Management (CEO / CFO) have long tenure with the company as do other senor executives. And all senior managers (dozens of key people) are required to maintain large personal shareholdings in the Company, which is unusual.

Crop prices will rebound at some point in keeping with the agricultural cycle. In addition, tractors and other equipment wear out and will need to be replaced at regular intervals; thus most sales can be delayed but not entirely foregone. Also interesting, new technological advances (self-driving tractors) could mean a greater demand for next generation products.

Berkshire Hathaway bought some Deere stock ($1.7B) around $80 per share in 2015. At $84 per share, Deere has a market capitalization of $26B and around a 3% dividend yield. This price represents a 11x multiple on 5 year average EPS. Deere’s sales are expected to recover in 2020 to about $45B. At this time, EPS could be about $11/share. At 12x P/E ratio, this will result in a share price of $132. Total returns – share price appreciation plus dividends – could be 44-96% for an approximately 5-year holding period.

Berkshire’s A Bargain

In Investment ideas on October 18, 2011 at 2:14 pm

For those of you who have been waiting to buy shares of Berkshire Hathaway, now might be a good time to consider it. The shares are trading at a historic low in relation to book value. Book value (or the accounting value of the firm’s assets less its liabilities) is a metric Warren Buffet himself uses to measure the performance of the company and gauge the price level of its shares.

Over the last decade, the price to book ratio of Berkshire shares has ranged between approximately 1 and 2 times. Currently it’s trading at 1.11 times (current share price – $109,649, book per share – $98,716). In fact, the shares are so cheap right now that Berkshire has gone the unusual step of initiating its first share buyback plan in many years.  The Company will use excess cash to buy back shares if it can manage to do so at any price below 1.1 times book.

There is a reason why Warren Buffett is the world’s third richest man.  His investment approach has outperformed the overall stock market by a wide degree.  As measured by book value, shares of Berkshire Hathaway have grown by a compounded rate of 490,409% since inception in 1965 versus merely 6262% for the S&P 500 index.  In dollar terms, this means $1000 invested in the S&P 500 in 1965 would be worth around $63,000.  That same amount invested in Berkshire would be worth $5 million dollars.

1965 was a long time ago so let’s look at more recent history.  How has Berkshire performed lately? Looking back at just the last decade – 2000 to 2010 – Berkshire’s book value increased 251%.  The rate of return for the S&P 500 over the same period? A mere 105%.

Like every investment, Berkshire shares aren’t without some risk.  The most obvious one is management.  Warren Buffett is 81.  Vice-chairman, Charlie Munger, is even older – 87!  The company has announced transition plans but nothing has materialized.  This understandably makes investors nervous.  Will new management be able to run this massive company and make the same types of savvy investment decisions Buffett did? Add to this the fiasco with David Sokol, long thought to be Buffett’s successor on the management side of the Company, and people start to worry.

Regardless, Berkshire owns dozens of great operating companies and publicly-traded investments in diverse industries ranging from carpet manufacturing to utilities to soda pop. These businesses have all been handpicked by Buffett to meet his tests of durability and ability to earn superior returns on capital.  Berkshire is the kind of stock you can buy and forget about.  It is well worth your time to look at.

See also my blog post from 2009: Buy Now, Buy Buffett

One Large Double-Double, a Dozen Timbits and a Case Study in Restaurant Valuation

In Investment ideas on July 29, 2010 at 4:03 pm

Not many restaurant chains can boast a location in war-torn Kandahar, Afghanistan. Tim Hortons can. The iconic coffee and donuts purveyor is so vital to the daily routine of a Canadian soldier that the army asked the company to open an outlet for troops stationed there.

Tim Hortons (TSX:THI) retails coffee, baked goods (donuts, pastries, muffins, bagels), sandwiches, soups and other products in cities across Canada and in parts of the U.S. The company has grown from just shy of 2000 stores at the start of this decade to 3578 at the end of 2009.

The company was started in 1964 by NHL hockey player Tim Horton. It wasn’t an immediate success. The company struggled in the beginning until Ron Joyce, the Ray Kroc of donuts, came along. The two became partners and with Joyce’s natural abilities, the business turned around. New locations were opened and Joyce then began franchising the concept. It grew by leaps and bounds stretching from coast to coast. The company was acquired in 1996 by Wendy’s International and then spun off in an initial public offering (IPO) in 2006.

Tim Hortons is held out as a shining example of a Canadian success story. The company boasts a market share of over 40% of all quick service restaurant (QSR) visits in Canada and more than 40% of its customers visit four or more times per week. Ownership of a franchise location in Canada is well known to be a cash cow like no other. And as any morning visit can evidence, the line-ups are always long.

The company has also been a very strong performer financially. Revenue has increased from $1.5b in 2005 to $2.2b in 2009. Earnings have grown from $191m to $296m over the same period. Returns on shareholder equity have been consistently around a whopping 25%. And dividends have increased three times since the IPO to $0.52 per share in 2010.

Despite this, however, the Company’s stock price has languished since its IPO day close price of $33.10 on March 24, 2006, more than four years ago. At time of writing, the shares currently trade around $35. And, due to buybacks, there are less shares now than there were in 2006. So, are the shares a good value? Is this a good time to buy? Let’s take a closer look.

The method that I like to use in valuing a business is the discounted cash flow method. As I have explained in earlier posts, I estimate the owner earning in the future and then discount them back to today’s value. Owner earnings are defined as cash flow from operations less capital expenditures.

The key to any valuation are the assumptions used. I use pretty conservative assumptions. I have assumed a discount rate of 12% – that’s the rate I would like to earn on this investment. I also made my own assumptions of new store openings. The most important assumption in the case of Tim Hortons is how many stores they will open and what annual increases one can expect in same store sales. It seems to me that the company’s home market in Canada is pretty much saturated. The big question on everyone’s mind is how successful the Company will be in its expansion into the United States.

All the evidence and rationale I have looked at tells me that the chain is unlikely to have much success there. Here are the reasons:

  • The U.S. market is a lot more competitive with not only the usual names such as McDonalds and Starbucks but also other competitors including Dunkin Donuts, Panera Bread, Peets Coffee, Einstein Bros. Bagels and many more. Consumers there have many more choices and don’t have a history with Tim Hortons.
  • In the seven years of data available on operating income in the U.S. market, operating profit has been breakeven at best.
  • Tim Hortons’ nostalgic Canadiana branding is no benefit and possibly a turnoff in the US market.

Based on that rationale, I have assumed new store growth for 2010-2020 of only 1000 stores in Canada only, starting with 200 stores in 2010 and dropping each year due to saturation. I also assumed modest increases in same store sales (SSS) falling to a rate in line with inflation.

Admittedly, my model is crude and doesn’t incorporate all of the inputs that could be used. I also give no weight to the introduction of Cold Stone Creamery ice-cream concept into the stores which is in test stages now.

Regardless, based on my conservative valuation (email me for the full spreadsheet), I calculate an intrinsic value of $14.66 per share. This is less than half of the current share price. It’s too bad, I would have liked to add this stock to my portfolio.

Related Links

Keg Serves Up Rare Dividend Yield

In Investment ideas on August 14, 2009 at 2:35 pm

Last year, when we lived in Vancouver, I organized the Vancouver Value Investors meetup. We held our monthly meetings at the Keg Restaurant downtown. “Steak and Stocks” was our slogan and I enjoyed savoring a slab of prime rib and garlic mashed potatoes while we discussed investments. Little did we know that sitting under our noses was an interesting investment opportunity: the Keg Royalties Income Fund.

The Keg was started by Albertan and Harvard MBA graduate George Tidball. Tidball was the entrepreneur responsible for introducing McDonald’s restaurants into Canada in the 1960s. Having made a success of that, he started what was to become the Keg in 1971. His goal was to have a chain of casual dining outlets that were lively and fun.

Today the Keg has carved out a niche for itself as a place to enjoy top quality steak and prime rib at reasonable prices and in a fun and relaxed environment. It is the name for steakhouses in Canada and it is starting to make inroads into the much larger U.S. market. It is now run by the experienced and capable restaurateur David Aisenstat.

The Keg Royalties Income Fund (KRIF) trades on the Toronto Stock Exchange under the symbol KEG.UN. The entity is an income trust unit that pays a whopping 13%+ dividend (based on the current unit price of $9.70).

Unlike many income funds that may not be able to sustain their payouts, KEG.UN is different. It is a unique security that earns its income from two sources:

  • A 4% royalty on the sales of all Keg restaurants in the royalty pool.
  • Interest on a loan to Keg Restaurants Limited (KRL), the private company that owns and operates the actual restaurants.

KEG.UN has no direct exposure to the operating profit and loss from the operation of the restaurants. This exposure plus most of the benefits from opening new locations goes to KRL. As well, KEG.UN has no responsibility for capital expenditures or working capital needs of the restaurants. Thus it can continue to pay out 100% of its earnings without any issues.

As an income trust, KEG.UN currently pays no corporate tax. Due to changes in Canadian tax law, income trusts will be required to pay taxes on their distributions beginning in 2011. The tax rate will be about 30%. So this will reduce payouts by the same amount.

However, despite this tax increase, I believe that KEG.UN deserves closer inspection. This is because its earnings and dividends will grow with increases in sales at its restaurants. For KEG.UN this benefit will come from year over year increases at existing restaurants.

Based on my math, at a price of $9.70 the units offer a compounded annual rate of return of a little over 13% based on discounting the expected dividends to present value. This valuation assumes the current annual dividend of $1.28 will grow at 2.5% annually and taxes of 30% will begin in 2011.

For investors looking for a respectable return with most of that in the form of income, take a look at KEG.UN

Related links:

KEG.UN Trustees and executive

Rare Breed – BC Business

David Aisenstat Profile – Business In Vancouver

Buy Now, Buy Buffett

In Investment ideas on March 18, 2009 at 1:33 am

With the dramatic fall in equity prices since the Dow peaked at 14,066 on October 1, 2007, stocks have fallen to attractive price levels. The Dow closed at 7217 on Monday (down 48.7% from its peak). Given these circumstances, many think that now is the time to buy equities.

Warren Buffett, the world’s most famous investor, echoed these sentiments in his October 2008 letter to the New York Times: “I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.”

Given that Buffett is out there buying, why not buy Buffett?

Buffett’s masterpiece, Berkshire Hathaway, is one of the world’s largest holdings companies. Berkshire is made up of wholly owned subsidiaries (including Dairy Queen, GEICO, Benjamin Moore, Larson-Juhl) and shareholdings in publicly traded companies (Wells Fargo, Coca-Cola, Kraft, Procter and Gamble, etc.).

Berkshire has historically provided superior returns compared to the market. Since 1965, the company has earned an average annual return on equity of 20.3%. During that same time period, the S&P 500 index returned an average of 8.9%. Taking the compounding of interest into account, a $1000 investment in Berkshire at book value would have turned into $3.4 million 44 years later. The same investment in the S&P would have yielded a mere $42,580.

Berkshire’s 60+ operating businesses and numerous investment holdings are varied and range from carpet manufacturing to utilities to soda pop. These businesses have all been handpicked by Buffett to meet his tests of durability and ability to earn superior returns on capital.

And Buffett works virtually for free. He and vice-chairman Charlie Munger are each paid a $100k salary and do not have any stock options. Unlike a hedge fund, investors are not charged a management or performance fee. Buffett and Munger even reimburse the company for personal postage and telephone expenses.

As with any investment, there are of course some risks. Buffett and Munger are both up in years at 77 and 84, respectively. Management has outlined a transition plan for the company but it is yet untested. An official successor to Buffett has not been named though Lou Simpson, who manages subsidiary GEICO’s investments appears to be the front runner.

Due in part to Berkshire recording its worst results ever in 2008 (book value fell 9.6 percent) the stock recently hit a 5 ½ year low of $72,400 per share on March 5, 2009 ($2300 per Class B share)

From a fundamental perspective, this is the best time to buy Berkshire in many years. The business can be hard to value and analyze as it is composed of so many different pieces. Thus, I look at three high level valuation metrics in my assessment of the company: Price to Book, Price to trailing 5 year average earnings and Price to Sales.

Price to Book – Buffett uses book value as a rough gauge for measuring Berkshire’s increase in value. The range over a 10 year period to 2008 is 0.96 to 2.82. It is currently at 1.16.

Price to trailing 5 year average earnings – Using a 5 year average smooths out ups and downs (especially as insurance and investment results can be lumpy). The 10 year range has been 16.54 to 55.87. It is currently at 13.98.

Price to sales – this is a rough metric as it does not take into account the changes in businesses owned or investment holdings and it ignores changes in capital structure. Regardless it is still useful as a high level check. The 10 year range is 1.03 to 9.55. Currently it is 1.17.

I don’t know what the stock will do next week or next year, but for a long term investor this is a great buy.

Disclosure:
Aly Mawji is the proud owner of Berkshire Hathaway’s class B shares.