Wednesday, 27 April 2016

H&R Block Down 15% Today, Good to Cancel Order Hit at $20.48

Quick post on HRB.  Maybe I'm a sucker because I'm an accountant and I'm letting the nature of my work obscure my ability to objectively judge the characteristics of exceptionally good businesses.  Or, maybe, there is no such thing as an exceptionally good business, there are only good businesses that get bid-up stupidly as a result of perception (or expectation) of exceptional characteristics or get sold off stupidly as a result of perception (or expectation) of unexceptional characteristics.

As a retail nobody, managing my own money with no hidden agenda, I can only offer the following insights:
  • I want to be a buyer when I perceive a temporary rift between what I believe to be sustainable good business characteristics vs. public perception of a sustainable good business as lousy
  • My definition of good is characterized by my own analysis of normalized sustainable earnings power and free cash flow on an ongoing basis.  When good gets cheap enough, I have to find the courage to act.
  • My evaluation of a temporary situation does not resolve itself instantaneously.  Temporary can last a lot longer than any participant has the patience to deal with emotionally and psychologically.  I'm no exception.
  • Sometimes, a prevailing or overriding theme or belief motivates participants to make decisions which turn out to be irrational, but which make perfect sense in the moment.  With respect to HRB, I believe the current prevailing or overriding theme or belief is fear over the future impact of the proposed free tax preparation and filing bill...per Elizabeth Warren (link here).  Coupled with filing delays and overall decreases in filing stats, the result among participants seems to be sell first no questions asked.

On the subject of HRB's free cash flow and sustainable normalized earnings, I've been tracking HRB pretty regularly over the last month as it's shown up on my 52 week low list a number of times.

Here were my most recent thoughts from April 1 when it showed up on the 52 week lows:

My notes to myself at the time:

"Almost cheap.  $18.60 = +15% MOS & 11% PT Cap rate"

What did I mean by this?

If, the price got down to $18.60, my estimate of sustainable free cash flows to the firm of $608M / 8% (no growth perpetually)  = $7.6B vs. EV at $18.60 of say, $6.5B, there would potentially be a situation whereby an investor can purchase a perpetual cash flow stream of $7.6B for $6.5B.  $7.6/6.5 - 1  = +17%.

Caveats to the above;

Is FCFF correct?  Is $608M sustainable?  Based on today's news of a further drop in tax filing, maybe $608M should be chopped in half?  I don't personally believe this much of an adjustment is necessary, but it's certainly within the realm of possible.  Maybe I should have modelled out $3.75B / .08 this case, I get a target EV of $4.7B vs. current EV of $6.76B.  Not great.

So how likely is $3.75B?  Here's the free cash flow over the last 22 years:


  • The above chart of FCF's (per gurufocus) encompasses all previous years whereby HRB included HRB bank and all bank related activity.  HRB today is a different entity than it was 20 years ago, and it's a different entity than it was 2 years ago
  • Gurufocus FCF is not FCFF.  My adjustment to FCF to get to FCFF includes an add back of after tax interest expense.  If current FCF is $500M, my adjustment for AT interest expense is $2.5B x 5% x .65 = $81M.  
  • Excluding 07/08 when HRB got directly hit by the subprime mortgage business, FCF's have increased steadily since the early 90's.  Is a baseline closer to $500M before after an tax interest adjustment reasonable?  I think so.

On the subject of having the courage to act.  I have to admit, if it's not obvious to any readers by now, I'm somewhat of a chartist.  I use long term charts to attempt to map out constructive entry and exit points. Often-times, I'm completely out to lunch and price deviates so much from what I expected based on charting, that I feel foolish.  Sometimes, everything ties together nicely.  Here's what I saw in HRB on a weekly and monthly basis (before today):

Monthly through April 26:

And here's the monthly updated through today:

What a difference a day makes!  Remember these are monthly charts!

I had a good to cancel order in for 50 shares at $20.48, thinking it might take a few months to get hit, and I'd strategically place the order just above the 100 month simple moving average.

Well, it got hit today, in for a penny, in for a pound.

Thursday, 21 April 2016

Algoma Central vs. the Rest of the Commodity Complex

Most of my recent posts have been observational in nature.  I'm not finding much to do in terms of opportunities, but there is plenty to observe and remark on.

Quick thoughts on Algoma Central as I don't have much time this morning.  They operate a fleet of Great Lakes  / St. Lawrence, and ocean waterway bulk & product carriers.  Their largest segment is dry bulk.  They also have a commercial real estate arm which they are looking to sell.

Here are a few slides from the Q3 conference call illustrating what they do in a nutshell:

They are highly commodity sensitive.  Viz:

On the subject of the Real Estate holdings, from the Annual Report:

The real estate is shown as discontinued operations on the balance sheet, as follows:

If (and I say if with a warning that I have not analyzed the real estate segment beyond reading the annual report), the real estate net operating income is close to $11.96M, and I assume a 10% cap rate, I'd get $120M.  10% is pretty high for a cap rate, considering that other publicly traded REIT's use between 6% and 8% to fair value their properties.  Let's be ultra conservative and assume that $82M as reflected in discontinued operations is the best they're going to get.

On a liquidation basis, cash of $210M + assumed net proceeds of real estate of say $72M = $282M vs. total liabilities of $308M before collecting any receivables.

Here's the recent performance of the equity over the last year:

And here's the performance of Teck Cominco over the same period as a proxy for the iron ore complex as it has recovered from the February lows.

(Side note, Algoma may (or may not) have exposure to Teck Cominco directly in terms of dry bulk shipping)

My overall observation: one of the biggest producers of the products Algoma has the most exposure to in terms of shipping has rallied 250% off of it's February lows while Algoma hasn't budged.  And these same producers whether Teck, or BHP, or Vale are massively indebted and are anything but safe!  Teck is levered up 2:1, BHP 1.33:1, Vale almost 3:1.

So I'm left wondering what's going on.  Surely, if there was any hope of an actual sustainable recovery in the commodity markets themselves which the equities of the most levered up producers are already reflecting, shouldn't some of this euphoria trickle down to bulk shippers such as Algoma?

Obviously, this analysis is simplistic, because I haven't researched the economics of dry bulk shipping in depth.  Perhaps the answer is, dry bulk shipping is fiercely competitive and lease rates among shippers competing for bulk load haven't shown any signs of rebounding.

Concluding Thoughts

I believe that Algoma seems like a less risky proposition for consideration than exposure to the equities of the producers themselves which have already had huge moves off of their February lows. My guess is that this a function of too much money chasing the same trade, and the easy money has already been made.  In the case of Algoma, the company has a series of 6% convertible debentures due March 2018 which trade at par, which comprise about 30% of overall debt, and which the company should have little trouble redeeming at maturity.  The strike price on the debentures is $15.40 vs. $12.60 currently, so if  any recovery in the commodity complex does flow through to Algoma, at par you're basically paying nothing for the imbedded out of the money call.

As far as the rest of the commodity complex goes, it will be interesting to see what happens for the rest of the year.

Saturday, 16 April 2016

Gluskin Sheff (again)

After I wrote my initial piece on Gluskin Sheff, I got to thinking, apart from the obvious "$185M" reason for current under-performance while the rest of the market has worked itself into a frenzy, is there anything else I'm missing here?

Here's a 7 year weekly study comparing GS vs. the Dow Jones US Asset Managers Index.  Up until February, there certainly appeared to be a close correlation between the %ge returns between GS and a proxy for US asset managers:

And here's the same study over just the last year:

Fairly closely correlated from my point of view with the exception of the last couple of months which I'll attribute to concern over how much the eventual settlement will end up costing.  Which begs the question, why the overall weakness in not just GS but all US Asset Managers over the last year while the broader market (measured by the S&P 500) is knocking on heaven's door?

Believe it or not, I don't have the answer (no one does).  I can only observe that for now, while the broader market as measured by the S&P500 sits about 2% removed from eclipsing it's all time highs made in the summer of 2015, the US asset manager index is 17% below it's 2015 high, and GS is almost 45% below it's 2014 high!

And I begin to wonder whether asset managers are a leading or a lagging indicator.  Surely, if the S&P500 takes it's 2015 highs out, shouldn't asset managers on balance, benefit?  Shouldn't exposure to asset managers be a logical consequence of a market making (or approaching) new highs as they theoretically benefit from fresh fund flows looking to buy (or chase) new highs?  Again, I don't have an answer.

All I can do is try and focus on determining whether GS makes sense as a possible candidate, or not.  So, on this note, here are some further observations on GS.

On the subject of AUM, I performed the following analysis vs. both management fees and performance fees to get a feel for how lumpy overall fees are, and to get a feel for how AUM have grown.

Overall observations:

  • AUM have grown, by virtue of both regular fund inflows, AUM appreciation during a generally uninterrupted period of rising markets and by virtue of acquisition (GS acquired Blair Franklin in 2014)
  • Base management fees seem like the bread and butter of the business, but by no means can they be counted on for growth.  As a %ge of AUM, base management fees have come down from 1.47% in 2008 to 1.24% last year.  Given the proliferation of low fee ETF's, my guess is that base management fees will continue to come under pressure.
  • The real icing on the cake are the performance fees, but, you can get a feel for how lumpy performance fees are.  In some years, GS does really well (see 2014), other years, not so much (2012, 2009).  I wonder if 2014 was an anomaly type year as the huge bump in performance fees correlated pretty closely with GS' all time high (it's been downhill ever since).  So my question...what the heck happened in 2014 to juice performance fees, and is it repeatable (a point for further research, below).

Here's what scares me about a retail nobody, I have no idea what they're doing in terms of their AUM program internally.  I can get an overall picture of the distribution of AUM by program from the AIF (see below), but at first glance I really don't know what they're doing within each program.  I note that around 30% of overall AUM are run through fixed income / alternative strategy programs, which makes me start wondering about potential leverage employed concomitant with running a hedge fund (or funds).  And if hedge fund strategies are employed, does this make GS more or less comparable to (or riskier than) other Canadian Asset Managers?  The correlation of price performance since the 2014 highs with the drop off in performance fees since 2014 could be symptomatic of investors not believing that 2014 is repeatable, but, I also note that part of the push up to $30+ in 2014 was likely due to speculation that GS was on the sale block.

I believe that any investment thesis for owning GS must be predicated on the belief (or leap of faith) that 2014 was not an anomaly year in terms of performance and that such potential future performance is being under-priced by the market and is being obscured by the current worries over the eventual settlement amount.

So here's what happened in 2014:


And here's what happened in 2015:

And here's what's happened in 2016 through Dec 2015:

From the 2014 annual report re: 2014 performance:

And from the 2015 annual report re: 2015 performance:

So overall, pretty vague comments about specific drivers of performance, but from comparing 2015 vs. 2014, it sounded as as if they switched gears from Canadian exposure to bump US and International exposure, while remaining cautious.

Concluding Thoughts

Personally, I think that any attempt at valuation here has to conservatively discount performance fees as there's no way of knowing when (or if) they're going to repeat 2014.  I've already attempted one method of valuation previously on an expected free cash flow basis.

I suppose another way of getting a handle on valuation is to treat current AUM x average fees excluding 2014 of say, 1.9% and treat the cash flows as a perpetuity with no growth.

In this case, quickly, I get $8.5B x 1.9% = $160M, less salaries, G&A & occupancy (assume 55% of $160M) = $160M - $85M = $75M (pretty close to my free cash flow estimate), and discount this perpetually at say, 10%:

$75M / .1 = $750M

At 12%:

$75M / .12 = $625M

At 15%:

$75M / .15 = $500M

Current EV = $460M, so even in the worst case, with a 15% discount rate, my rough estimate of perpetual no growth all in fees produces a theoretical $500M value compared to $460M currently. This is before any bump in performance fees due to outperformance, and not counting any possible premium attributable to GS if it became a takeover target.

The caveat here is that AUM don't drop precipitously due to overall market weakness.  I note that in 2008/2009, AUM's dropped 20%, so GS certainly wasn't immune to the effects of the crisis, even if the drop wasn't attributable to actual redemptions.

Monday, 11 April 2016

Gluskin Sheff

A quick post on Gluskin Sheff traded on Toronto.

GS came to my attention recently because it's been weak, and upon further inspection, there's a story behind the weakness as follows, link here (copyright Globe and Mail):

Here's the most recent balance sheet:

So, the story goes, the two ex-founders are seeking $185M.  The company says $12M max.  No one knows what the heck the two ex-founders are going to end up with, but let's assume the worst case is a $185M settlement.

They have current liquidity of say, $23M (after netting current assets less total liabilities, a bit rough, but conservative), and I couldn't find much in the way of disclosure (quickly) in the 2014 audited financial statements regarding unused credit facilities, but if push came to shove, I'd hazard a guess that if the company absolutely needed to do another equity offering or a debt offering, they could.

So here's my thought process:

  • The company has an asset light business model, in return though, they are remuneration heavy (as is the norm for asset management firms)
  • The company's results are lumpy, they had about $8.5B of AUM as at June 30, 2015, which generate ongoing fees, and every few years, they make a lot of money in terms of performance fees.  
  • If they have to settle for $185M, the amount will outstrip shareholder's equity by 1.5x.  
  • I took the last 4 years of reported operating cash flows, deducted the fixed cost investment from the audited financials, and attempted to model out a range of theoretical firm values across a range of different WACC rates (in this case, WACC should be pretty close to Re b/c there's no debt, as capital structure is 100% equity).  I found that for discount rates up 10%, there seems to be a theoretical margin of safety relative to current enterprise value in the worst settlement case, as follows:

Worst case, they settle at $185M, and they need to tap the capital markets to fund the shortfall.  And after all is said and done, they continue to do what they do, generate FCF's of close to $70M per year (some years less, some years more), and they use these FCF's to either buy back shares issued in the case of shares, or service the debt in the case of debt.

$185M / $70M = 2 2/3yrds of FCF?

In any case, I thought it was an interesting idea.  Here's the monthly chart: