Jewett-Cameron’s segment revenue in two graphs

After my short post on Jewett-Cameron Trading I received some comments that by basing my valuation on net operating profit I was missing what was going on within the various segments, and this was certainly true to some extent. The graph below shows how Jewett-Cameron’s revenue mix has evolved the past ten years, and as visible it is fair to say that the company is now in a completely different business than a decade ago:

Jewett-Cameron revenue mix

Note that the column labeled 2014 is in reality the TTM and includes one quarter of 2013, but that’s something I’m unable to fix in Google drive. While the lawn, garden and pet segment has grown to be a very large part of Jewett-Cameron’s business the absolute growth of the segment hasn’t been that stellar. Revenue increased from $24.8 million in 2009 to $33.4 million today, representing a 6.5% compounded annual growth rate. If we don’t pick the lows of 2009 as starting point but the previous high of 2008 the compounded annual growth rate drops to 3.2%: not bad, but not great either.

Jewett-Cameron lawn, garden & pet segment revenue and profitability

The reported segment earnings before taxes also show few signs of operating leverage. Earnings before taxes grew at a 4.0% rate if we start measuring from 2009 and just 1.7% if we start at 2008. With those kind of growth rates just taking the average operating earnings of the past five years or so seems a pretty reasonable approach to me. You need a little bit of nominal growth to keep-up with inflation anyways.

I do agree that there might be some positive optionality if the industrial wood segment recovers. I don’t want to call this a free option since the segment has shown declining sales for five years in a row and is a bit below break even. They also do have some excess real estate that they will be able to monetize at some point in the future. But don’t think this is enough to revise my previous conclusion that the company is currently fairly valued.

What’s basically the case is that the lawn, garden and pet has been such a big part of Jewett-Cameron’s business for an extended period of time that drilling deeper doesn’t add a whole lot of value. What’s happening in the other segments is almost irrelevant now.

Disclosure

No position in Jewett-Cameron Trading

Boom Logistics market update

Boom Logistics released a market update yesterday to give some insight in what to expect when the FY14 results are released next month. The company will post a big loss, but mainly because all goodwill has been written down to zero. What is more interesting is what we can learn about the companies asset value from the latest developments and impairment charges. Boom Logistics recognized an A$4.5 million impairment on assets held for sale. With $15 million in assets held for sale after this write-down this implies a 23% discount.

A 23% discount is great at current prices, but the asset value is likely even higher because Boom Logistics has a history of writing down assets for sale and consequently booking profits on sale. The second half of 2014 wasn’t an exception:

Quote from Boom Logistics trading update

Also note that part of my initial thesis here is confirmed, namely that the company would be able to sell its equipment internationally. A crane that can be used world wide will maintain Its value even when business sucks in Australia. A small impairment of fixed assets in Western Austrailia also confirms that the equipment value is still there:

Quote from Boom Logistics trading update

What’s also positive is that net debt has been reduced A$102.0 from to A$89.5 million the past six months. It’s not only good news though. The company spent $16 million in 2014 on new equipment which seems a bit excessive given the amount of idle equipment they presumably already have, and the fact that there have been no share repurchases is also a negative. Doubt if that’s an optimal allocation of capital…

Disclosure

Author is long Boom Logistics

Jewett-Cameron Trading: a cannibal at fair value?

Jewett-Cameron Trading (JCTCF) ended on my research list after I noticed that they repurchased more than 10% of their outstanding shares in the latest quarter. This wasn’t the first time either that the company bought back stock: in the past five years the number of outstanding shares has dropped with more than 40%. Companies that aggressively repurchase their shares are in my opinion very interesting. It usually says something positive about the capital allocation and shareholder friendliness of the management team, and if it’s done below intrinsic value the share repurchases can create a lot of value. Before trying to figure out if this is also the case for Jewett-Cameron some numbers:

Last price (Jul 17, 2014): 9.29
Shares outstanding: 2,749,678
Market Cap: $25.5 million
Net cash: $4.2 million
P/B (mrq): 1.40
P/E (ttm): 10.88
EV/EBIT (ttm): 5.65

Valuation

Jewett-Cameron is a pretty straightforward business to understand. They operate four segments: industrial wood products; lawn, garden, pet and other; seed processing and sales, and industrial tools and clamps. The lawn, garden and pet segment is by far the biggest and accounts for almost 80% of revenue. The company writes in their latest 10-K that this segment is less sensitive to downturns in the US economy than the market for new home construction. While that might be true the company’s revenue dropped significantly in 2009 and has never really recovered since. But thanks to lower expenses operating profit is back to roughly the same levels as before. See the table below for some historical financials:

Historical financials Jewett-Cameron

The favorable impact of the shrinking share count is clearly visible when we look at earnings per share. Despite little progress in the business itself earnings per share have almost doubled compared to 2008. When we look at the development of the revenue numbers it’s also clear why the stock has been a poor performer for the past three quarters. Revenue is almost back to the 2009 level, and it now appears doubtful that this company can grow at a meaningful rate in the future.

Because of that I think the most appropriate valuation is to simply take the average operating profit from the past 5 years, apply the average tax rate, throw a 10x multiple on it and adjust for the cash held by the company. This generates the following picture:

Jewett-Cameron valuation

As is visible this valuation indicates that the company is trading at roughly fair value, and the implication is of course that the share repurchases aren’t generating an above average return on capital. It’s in my opinion still an excellent use of cash. Buying your own stock at a 10x multiple basically means that you are generating a 10% return on your money. That’s a lot better than having it linger in a bank account like so many other companies are doing.

Conclusion

Jewett-Cameron is a very interesting company, but unfortunately not very cheap and that significantly reduces the value that is created by buying back shares. Buying back fairly valued shares is in theory a neutral transaction, except that it is usually better than a lot of alternatives (hoarding cash, growth acquisitions and dividends depending on tax situation).

Luckily Jewett-Cameron is not expensive either, and at the current prices it will probably generate a fair return for shareholders. Perhaps that it could be a great idea when you have some specific opinion on how the housing market in the US will develop, and how that will impact Jewett-Cameron. But that’s not a prediction I want to make or can make, and since there is not much of a margin of safety at current prices I’m staying at the sidelines.

Disclosure

No position in Jewett-Cameron Trading at the time of writing.

How I generate my ideas

How I generate my ideas is probably the question I get asked the most. So I figured I should do a blog post to answer this once and for all. The honest answer is that I usually don’t really generate any idea’s: I simply wait for someone else to write-up a convincing thesis. I thought that this was pretty obvious because a lot of my write-ups start with something along the lines of “Previous week blogger X took a look at company Y…”. The handful of blogs that are displayed at the right-hand side of this post are a major source of inspiration, and I follow another 50 blogs or so as well using Feedly.

Blogs are of course not my only source of ideas. I also follow a bunch of authors on Seeking Alpha and I follow even more people on Twitter. There are also a couple of funds that I follow (again using Feedly) and the great thing about running a blog yourself is that people often e-mail interesting idea’s as well. Like minded investors are in my opinion a great screen for potential idea’s.

Buffett is known for advising people to simply start with the A’s and look at everything while a stock screener is also a popular method to find potential interesting companies. I rarely do this. I have no doubt that this can be successful as well, but I doubt that it is a time effective method. When you look at everything you also spend a lot of time looking at stuff that isn’t even remotely attractive. When you use a screener you often run in data quality issues for micro caps and foreign stocks, and another problem is that usually the cheapest stocks don’t show up on a screener. I’ll happily let my fellow investors do the heavy lifting.

The number of ideas that I can research is limited, and by mostly looking at stocks that like minded investors find interesting I think I’m significantly increasing the odds that I’m looking at a company worth investing in. You don’t get points for originality as an investor. The only score that matters is the risk-adjusted return that you are able to achieve.

I also think that a lot of investors have a bit of a misplaced believe that they need to buy something that is truly undiscovered, and that going through all stocks or using a screener is a way to accomplish that. But the reality is that a stock is almost never undiscovered. Unless you are buying in an IPO there is always a group of people that already know the stock and own the stock. Doesn’t matter how obscure a company is: there is probably someone out there that has owned it for years and knows everything there is to know about it.

What should be noted is that while I almost always borrow my ideas from someone else I never invest without doing my own research 100%. When I find a potential interesting company I always start my research from scratch. If you don’t read the annual reports yourself you don’t know what someone else might have missed, and when you don’t built your own valuation model you don’t know what kind of assumption were exactly used. It’s in my opinion critically important to fully understand the investment thesis. If you don’t it will be hard to interpreted news releases and to decide what to do when the price changes. Do you have the conviction to buy more when the price drops but intrinsic value remains constant? Is it even possible to know what happened to intrinsic value without fully understanding your investment? Seems like a though task to me.

Half-year portfolio review, 2014 edition

Since it’s the first of July it’s once again time to take a look at the performance of my portfolio. A double digit return in just a half year is a pretty solid result, but I have no illusions that this is sustainable. A bad year will be inevitable, and you have to remember that what matters is not a high arithmetic average return, but a high geometric average. You are not going to get a high growth rate if you also have large negative outliers in your returns. But obviously the results so far are encouraging, also compared to the benchmark:

YearReturn*Benchmark**Difference
201218.53%14.34%4.19%
201353.04%17.49%35.55%
2014-H123.08%6.86%16.22%
Cumulative123.27%43.55%64.14%

* Return in euro’s after transaction costs, dividend withholding taxes and other expenses
** Benchmark is the MSCI ACWI (All Country World Index) net total return index in euro’s

While I’m happy with the overall performance of my portfolio I’m less pleased with how this result was achieved because things would have looked significantly different without my position in Conduril, and I think I made a couple of mistakes that I shouldn’t have. The graph below shows how my various positions contributed to my year to date performance:

Performance attribution 2014 H1Conduril accounted for a whopping 66% of my profits the first half of 2014. If we would exclude the results of this position the gain of the portfolio would still have been a respectable 11.1%, but that’s a result that’s a lot closer to the benchmark. On one hand it’s good to see that what I perceive to be my best idea is also my best performing position, but on the other hand having a large number of positions/idea’s that appear to be slightly above average is not so great. But that’s probably the reality that I should expect. Great idea’s will be rare to find, and a portfolio that manages to outperform the market with a couple percentage points is nothing to sneeze at. My portfolio currently looks as follows:

Portfolio overview 2014 H1

The position that immediately catches the eye is of course Conduril that is almost crossing the 30% level. It was already a pretty big position at the start of the year with a 22% allocation and thanks to the gains in the first six months of 2014 it got only bigger. There has to be a point where I need to start selling simply to manage my risk, and unfortunately it can’t be too far away from the current size. I really hate the idea of selling my cheapest stock with the most potential for further appreciation, but it’s also important to recognize that there are always risks that you and/or the company cannot anticipate and control.

With regards to my mistakes – and I realize this is going to sound very results oriented – but I think my biggest losing positions weren’t that great. I don’t mind that I lost some money on WSP Holdings in the failed merger arbitrage, but there were a lot of opportunities for me to lose less. I could and should have entered in the beginning of the year at a lower price (or not at all), and I probably should have exited earlier as well. I did get the position sizing right though: it was small and as visible in the performance attribution graph the loss is very manageable. But that might also have been a factor in why I neglected the position a bit.

I sized my bet in Clear Leisure a bit bigger, but in this case I also recognized that it was a speculative and risky position. The stock simply might have been a bit too speculative anyway, and I also failed to properly consider how crappy trading and liquidity on the AIM market is. I should have set a higher hurdle to jump over for an idea where it’s hard/expensive to act when you change your mind.

Disclosure

Author is long almost every name in this post except for positions sold during the year