Category: Portfolio Management

From Up Above

Published on:
July 14, 2019
Last Update:

Revenue

Beasley is in advertisement. That is to say, advertisers pay the company to broadcast their ads. So the simple math to generate revenue is the number of advertisements times the price Beasley charges the ad companies. The trends are positive

In 2018 the company reported on $257.5 million in revenue compared to $58.7 million in 2014. Pre-tax income increased to $29.3 million from $3.8 million during this five-year period. Over the past decade, the company did not report any losses. The lowest earnings per share was in 2009 at 15 cents per share. The highest earnings per share were in 2017 at $3.14 per share but over $2 of that was related to a one-time charge related to the U.S. tax code.

Expenses

Beasley burns about 80% of its revenue before it pays lenders. Of the reported revenue of $257.5 million in 2018, $45.3 million was left to service the debt obligations of about $16 million.

The ratio between gross operating income and interest expense was 2.8 times in 2018 and 2.20 times in 2017. It is a thin margin.

The annual capital expenditures expense was $4.2 million over the past two years and about half of that over prior three years. After capital expenditures expense, Beasley reported positive net cash flow in each of the past five years.

BBGI earnings over past decade

Assets

Broadcasting rights are 80% of the tangible assets. These contracts are typically negotiated every eight years. They are renewed if Beasley operates within acceptable practices as deemed by the FCC.

Net tangible assets, defined as total assets less intangible assets less total liabilities, were $246.8 million or $8.96 per share in 2018. So at $3 per share, the stock trades at about two-thirds discount to net tangible assets.

Liabilities

To finance the acquisition of radio stations, Beasley borrows money. And as the company’s appetite for acquisition increases, so does its leverage ratio, which increased from about 25% to 35% over the past few years.

The current $252 million in term loan will mature on November 1, 2023. The company is paying interest based on Libor index plus an interest rate spread, which amounts to 6.5%.

And as any borrower soon realizes, borrowing someone else’s money comes with conditions. It is no different here. Beasley’s lender, U.S. Bank, limits the amount of leverage the company can take and monitors its dividends policy. Not necessarily a bad thing.  

BBGI's balance sheet

Stock biography

Over the past 10 years, the stock traded hands as low as $1 in 2009 and as high as $18 in 2017. The 10-year average range in earnings multiple was between 7 and 20 times the earnings per share.

While management grew the pre-tax income by over 50% compounded annually, it did not dilute shareholders to do so. Beasley had 22.9 million outstanding common shares in 2014 and $27.5 million in 2018, a compounded dilution of less than 5%.

This behavior, of increasing pre-tax earnings while the number of outstanding shares is invariably the same, is because management is heavily invested in the company. The Beasley family owns 59.4% of the outstanding shares.

George Beasley Inducted into the Pennsylvania Association of Broadcasters Radio Hall of Fame
This year George Beasley was inducted into the Pennsylvania's Radio Hall of Fame

Peer Group Comparison

I sifted through the operating performance of five competitors: Saga Communications (SGA on Nasdaq), Ascent Capital (ASCMA on OTC), Emmis Communications (EMMS on Nasdaq), Salem Media Group (SALM on Nasdaq) and Townsquare Media (TSQ on Nyse.)

Key findings: ASCMA and EMMS ratio of total liabilities to net tangible assets was 1.28 times and 2.03 times respectively. Beasley’s ratio was 0.65.

Both ASCMA and EMMS reported losses last year.

The pre-tax income to net tangible assets ratio was 10% and 13% for SALM and SGA compared to Beasley that averaged between 18% and 15% over the past 5 years.    

Most comparable company to Beasley is SGA. It has a lower leverage ratio of 41% and reported on 13% ratio of pre-tax income to net tangible assets. Its profit margin is higher than Beasley at 14% compared to 10%. Yet it is an expensive stock. Its pre-tax income per share - $2.8 - was valued at 12 times (the stock trades at $34). Beasley pre-tax income was $1.06 and it trades hands at about $3.

Risks

Investors in Beasley (yours truly owns shares) should be wary of five risks. First, between the period June 2019 and April 2022, as the company will renegotiate its broadcasting licenses, the stock price is likely to be volatile.

Second, advertising is considered a discretionary expense. Read: at times of downturn, revenue will decline. Third, the company has a balloon payment due in November 2023.

Fourth, Boston, MA, Philadelphia, PA and Tampa, FL serve 60% of the company’s revenue, making Beasley highly dependent on the wellbeing of these markets. Fifth, to partner with the Beasley stock is to have a leap of faith in the Beasley family.

Thesis

Readers of this blog know that I only buy stocks that I expect to double in price. If I am right, then within five years, the expected return is 15%. If I am right within three years, the expected return is 25%. This range is my ultimate desired rate of return in Beasley. (If within 2 or 3 years my thesis is wrong, I typically sell the stock.)

I am uncertain why Mr. Market is bearish on Beasley. I also could not understand why the stock price halved over the past year. I will leave that discussion to others.

My investment thesis is that Beasley is a well-managed company, with shareholder-friendly management that sells a service that I can reasonably estimate its future cash flow.

The 2019 Scorecard

Published on:
July 7, 2019
Last Update:

In 2009 I began to write a weekly journal so that I could have a better appreciation of the present and a greater sense of direction for the future.

But until this week, I never took the time to look back at my actions in the stock market. So this week's essay is a summary of these activities. Not unlike a horse race, below is my scorecard.

The stock portfolio

I now own the common stock of 21 publicly-traded companies that operate in various industries; from airlines (Hawaiian Holdings) to specialty retail (Signet Jewelers); from media companies such as Beasley Broadcast Group to Carriage Services, a death care company.

Some are large companies - L Brand market capitalization is $7 billion for example - and some companies are small (Lifeway Food, the maker of Kefir milk, has market capitalization less than $50 million.)  

Practically all my positions are less than a year old; Patterson Companies is the only company I've held for 14 months. Over the past year, on average, I bought two positions every month and reduced my position in three companies: Diversified Restaurant Holdings, Lifeway Food and ARC Documents Solutions.

A screenshot of positions I now hold

Not unlike the Russell 2000 index, my portfolio market price dropped in May of this year and in December of last year. In May, the portfolio lost 6% in (unrealized) market price compared to 8% in market loss for the Russell 2000. In December, the portfolio market price fell by 11% while the Russell 2000 lost 12%.  On an annual comparison, my portfolio is down 7.6% while the Russell 2000 is down 6.4%.

Down 7.6%

The reason for the drop in market value is due to two positions The first is Orchid Paper, a position with which I started with 4,000 shares in July 2018 and then bought 6,000 more shares in October 2018. Orchid filed for bankruptcy in May of this year. While I did not sell my Orchid position, I "wrote down" to zero the value of this position. This was an unforced error on my part. Click here to read why.

Frontier Communications was the second reason for the market loss. I bought 2,500 shares in July of last year and then bought 5,500 more shares in November. My cost basis is $4 and the market price of the stock is now 70% lower. I am holding 8,000 shares, but I am uncertain where Frontier will be in two or three years. I am certain, however, that today I would never have bought Frontier in the first place.    

The 2019 Noam

I learned more about stock investments over the last 12 months than I did over the past decade. As with many other things in life, there is no substitute for actual, real world experience (can you imagine learning to ride your bike by  reading about it?)

Last year, I generated stock ideas mainly by observing price movements; today, I research what other value investors are buying. Last year, I was watching the list of 52-week low; today I watch daily the market price of over 50 stocks and built stock screens.

I also think on the portfolio-level. While a year ago I had 8 positions that represented 55% of the portfolio, today the entire 21 positions represent 52% of the portfolio (the rest is in cash). A year ago, I was running a very concentrated portfolio. Today, no stock represents more than 5% of the portfolio.    

Tracking the portfolio

So I evolved. Because I used to follow the adage that "investing is not looking at the market price of the stocks;” - I never tracked the portfolio's value. But as preparation for this essay, I reviewed the portfolio and found the process valuable.

It now takes less than 20 seconds to answer questions, such as how did the portfolio return compare to the benchmark return in December, and which stocks performed best or worse during that month?

A screenshot of the last 12 months

Accomplishments

I invested over 750 hours over the last year in screening, researching, reading, analyzing, reviewing, comparing and thinking about stocks. If we assume that my hourly rate is $60, then I could have earned $45,000 pre-tax had I bought an ETF that tracks the value of the Russell 2000 instead of hand picking stocks myself.

But I expect at least 5 stocks to double in price over the next three years. Should that be the case, it will make up for the $45,000 in "opportunity cost,".

Some of these names include Hyster-Male, a lift truck company, Superior Industries, an aluminum wheel manufacturer, Gulfport Energy, a natural gas company and Flexsteel Industries, a furniture company.  

That is just the economic side of the things. There is no price, or perhaps it was priceless, to find a craft which I am passionate about.

In a recent meeting I attended, my greatest strength was assessed as a passion for study - stock investing is one of the most enjoyable avenues to exercise this skill.

Similar to physical exercise, over the last year I overcame hurdles and now feel mentally stronger. For example my stock portion of the portfolio dropped by 40% in December of last year (but because I had reserved cash, the total effect on the portfolio was less than 10%). Not only did that not scare me, I bought Seritage Growth Companies and Voxx International during that month.

In short, tracking the portfolio allows to live with the past, not in the past.

Selling SAUC

Published on:
June 24, 2019
Last Update:

This week I sold 10,000 shares of Diversified Restaurant Holdings (SAUC on Nasdaq) at $0.73 per share. As I type these words, two days after my first stock sell in 2019, SAUC climbed to $1.03. So not only did I lose money since as my cost basis was $1.40 per share, but also I lost $2,500 by trading on Tuesday instead of Thursday.

I have zero regrets. I sold the shares because I was wrong in buying shares in SAUC in the first place. In this week's essay I explain why.

The lure of SAUC's historical price

Between 2013 and 2018, SAUC traded as low as $2 and as high as $4. So when I bought the stock at $1.40, I assumed that price was low enough to serve as a margin of safety. I was wrong. A closer look at the publicly available financial statements would reveal that SAUC in 2018 was not the same company it was in 2016. This was because 26 of Dave and Buster's restaurants were no longer part of the company.

Score: Noam: 0. Mr. Market: 1.

Ignoring the market capitalization

I did not factor in SAUC's minuscule market capitalization of $25 million. Mistake number two. Companies with less than $100 million in market capitalization are riskier than larger capitalized companies. This is because it is tougher for pygmy companies to obtain debt or equity financing without diluting shareholders. Another risk is that small cap stock is usually off the radar screen of larger capitalized stock. So, unless the market readjusts the small cap stock valuation, the investor has no exit strategy.

As a rule, if a billion in market capitalization is selling at 10 times the earnings per share, then 25 million in market capitalization stock, given the risks detailed above, should sell at no more than 4 times the earnings the per share. But I had not discounted for size.

Score: Noam: 0. Mr. Market: 2.

Buying the stock at par

SAUC owns 64 franchises of Buffalo Wild Wings. I estimated that the value of each franchise was $2.5 million. This value was based on how much it would cost to build and open a Buffalo Wild Wings franchise and based on the price franchises were selling in the market place.

So, the replacement cost was $160 million. With total liabilities of $118 million I estimated equity to be $40 million or $1.38 per share. I paid about par of the net asset value which dear valuation. Purchasing the equity at 50% - 80% would be sensible according to Marty Whitman, founder of Third Avenue Management. But not only did I disappoint one of the masters of value investing, I overlooked the right of the balance sheet.

Score: Noam: 0. Mr. Market: 3.


SAUC's right of the balance sheet

"The company cannot conclude that it is probable that it will secure a credit facility," warned management on page 29 of its latest 10-k filing. "This raises substantial doubt that the company's ability to continue as a going concern."

SAUC may not be a company a year from today. Management had agreed to debt covenants that raise two problems. The first problem is that SAUC's debt is variable. It is based on LIBOR plus a margin that depends on the company's leverage ratios. This condition is a two-edged sword because as operations deteriorate, the cost of capital will increase. The combination of two will tarnish earnings.

The hidden liabilities are the second problem. When SAUC spanned off Bagger Dave's it continued to guarantee the leases. In the event Bagger Dave's decided to give the keys back to lenders, SAUC will be liable for the rent. This is like selling your home and then guaranteeing tax authorities that if the buyer is not able to pay the appropriate taxes, they can come after you.

Score: Noam: 0. Mr. Market: 4.

Management      

SAUC’s senior management is invested in the company but lacks disclosure to shareholders. Michael Ansley owns 2.2 million shares, Jason Curtis 1.1 million shares and David Bruke owns 580 thousand shares. Together, the shares represent about 20% of the available stock. Yet they are not reporting enough about the company operations.

To understand the performance of the restaurant business, you need to understand more than revenue and profit trends. All shareholders of a company should know what the guest satisfaction is, what the hourly compensation costs are and how the cost of food affects margins. But management provides none of this information.

Other industries, such as the airline industry, share information on a granular level (read my recent purchase of Hawaiian Airlines as example). It was a mistake to buy shares in a company that does not value transparency.

Score: Noam: 0. Mr. Market: 5.

***

In A Senseless Market Capitalization for Diversified Restaurant Holdings link, I wrote that:

"Animal Spirits may explain why an investor would prefer to franchise a Buffalo Wild Wings restaurant as opposed to simply purchasing Diversified Restaurants Holdings stocks."

I was positive that Mr. Market was wrong and that I was right. That I was wrong is obvious and not worthwhile to further mention. What is important, though, using the game of tennis as an analogy, is to highlight that all the mistakes were unforced errors.

The 5 mistakes highlighted above were not due to unforeseen changes in industry or by remarkable performance of competition. Investing in SAUC was a mistake that could have easily been avoided.

As a resolution I began this month to spend an extra 10 hours reviewing an “unforced error” checklist. During this review, I answer questions such as: Does the company have variable or fixed rate debt? Is management sharing with shareholders how they evaluate business performance? For every dollar of retained earnings over the past year, has management increased the value of the company? Hopefully, going forward, this will improve my scorecard against Mr. Market.

Patterson Companies Update

Published on:
June 15, 2019
Last Update:

In investing one group cheers while the other fears. When Patterson Companies (PDCO on Nasdaq) was delisted from the S&P 500 index, in the course of 90 days, Patterson’s common stock price dropped by 42%, to $22 from $38. Shareholders were disappointed.  

The S&P 500 composers replaced Patterson with three companies. The first company was SVB Financial Group (SIVB on Nasdaq), a bank holding company. Take-Two Interactive (TTWO on Nasdaq), whose business is video games, was the second company. And Nektar Therapeutics (NKTR on Nasdaq), a pharmaceutical, was the third. Shareholders were pleased.    

It is unconventional to buy the stock of a delisted company - not only has the stock lost momentum, pundits argue, but also the delisting follows some deterioration in the business fundamentals. "The results we report today clearly do not meet our expectations," said Patterson's boss, Mark Walchirk, a year ago. "They fall short of what we know the business is capable of achieving."

The original investment thesis

I wrote about Patterson Companies in May 4, 2018. My original thesis was that while the company's operating performance was poor over the second quarter of 2018, if investors had saw the company's operations over the prior decade, a different view would emerge – that the company had materially improved both its market share and operating performance.

PDCO earnings over past decade
A 10-year outlook on PDCO's earnings

One of the reasons I bought Patterson was that employees are shareholders of the company. In the 2018 proxy statement, on page 23, management reported that employees of the company owned 11.7 million shares, about 12% of the outstanding stock.  

Another reason for buying Patterson were tailwinds of the two industries in which Patterson operates in - veterinary and dental products. Its website  summarized the bull case for the dental and animal industries: "95% of adults say they value keeping their mouth healthy. 68% of U.S. households own a pet. And 200 million tons of protein will need to be produced by 2050."

I estimated that management would restore the operating margins. The average pre-tax income to revenue ratio was over 10% between April 2004 and April 2012. It steadily declined over the following 7 years. The most recent ratio reported was a minuscule 4%. In addition, the pre-tax income on tangible assets over the past decade was greater than 10%, a reasonable ratio for a company in the distribution business.  

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Last year

With no corporate restructures, major refinancing efforts or corporate shakeups, it is little surprise that Patterson's stock price has not moved since May 2018. Patterson is trading at the same price it traded hands a year ago, at about $22 per share. Over the past year, the stock climbed to $26 in November 2018 and dropped to $19 in December 2018.

PDCO Stock price over past year
PDCO's stock price over past year (Screenshot from Google)

Mark Walchirk has been the President and Chief Executive Officer since November 2017. Don Zurbay has been the Chief Financial Officer since June of last year, effectively when I began to buy the stock, and Kevin Pohlman has been running the animal health division since July 2017. The only new addition to the executive team is Eric Shirley who began to head the dental division 5 months ago.

In regard to financials: as of the third quarter of this year, Patterson reported on $1,472 million or $15.77 per share in equity compared to $1,461 million or $15.65 per share in 2018. Revenue is $4,137 million or $44.31 per share for the last 9 months ending in January 26, 2019 compared to $4,065 million or $43.56 the prior year. The main shortfall is that pre-tax income is down by $79 million because of an increase both in cost of sales and in expenses.  

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In a year or two

Unless Patterson's stock trades hands at over $30 per share a year or two from today, I will sell the position. The reason for the $30 price tag is that over the past decade, investors paid between 15 to 20 times for one dollar of pre-tax income per share. At the time of this writing, given the lackluster operating performance, investors are paying less than 10 times one dollar of pre-tax income.  

Should Patterson's financial performance improve, so will its stock price. But when - and if - the increase will happen is unknown to me. Since my return objective is 15% to 25% each year, unless the stock appreciates to $30 in two or three years the position will be sold for "time is money" reasons.

***
In business, random, short-term driven decisions have a long-term impact. A friend of mine recently described his work environment as akin to a tank, in that senior management was reacting to obstacles along the way without any strategic thought. This was eroding the company's culture.

What appear to be random decisions also affect prices. The S&P 500 composers believed replacing Patterson with three companies would be a boon for the index over the long term.

Yet, collectively, the stock price of the three companies tumbled by 25% over the past year. SIVB traded for $320 a year ago and now trades for $213. NKTR traded for $53 a year ago and now trades for $37. TTWO fell from $120 to $109 over this period.

Judged by the rules of the stock market, that prices are paramount, replacing Patterson with a trifecta of a pharma company, a video game company and bank was a mistake. And owners of the S&P 500 index would be better off  had Patterson never was delisted. But then I would not cheer for the stock.

Burying my head in the sand

Published on:
June 1, 2019
Last Update:

In Where the Financial Statements Reveal Little Economist Reality , I bragged that buying Frontier Communication was effortless. All one had to do, I proclaimed, was to compare the prior years price, which was in the triple digits, to the 2018 stock price of $5.

A year passed and the stock price more than halved - which issues a few lessons. In this essay I describe these lessons and explain why I am still holding the stock nonetheless.

The four lessons

The first lesson is that not all equity is created equal. What I failed to see last year was that the reported 2017 equity of $2,274 million consisted of $5,035 million in additional paid-in capital which was offset by $2,263 million in accumulated deficit (The remaining $497 million was related to treasury stock and OCI). What this means is that the equity balance consisted of proceeds from past stock issuances - not from profits.

The reported equity should have embarrassed management. But instead management had no problem diluting common shareholders by issuing additional shares. There were 66 million outstanding common shares five years ago. There were 78 million outstanding shares a year ago. There are now over 90 million outstanding shares. This 6% annual growth in common shares, likely to continue, is worrisome.   

The value of reported goodwill and intangibles assets is always questionable. But in FTR's case, these two accounts were no assets at all. In 2016 goodwill and intangibles were $12,336 million. Management had written down these assets to $7,877 million by 2018, a whopping $4,459 million loss that was fully recognized in the income statement.

FTR's goodwill and intangibles are over a third of the value of the reported assets. And if we are to remove these accounts, as any bidder for the company surely would, we would be left with exactly nil - zero, nadir, nothing, zilch - in common equity. FTR's tangible assets, which exclude the goodwill and intangibles accounts are $15,782 million or $17 per share. FTR's liabilities are $22,059 million or $24 per share. Since the liabilities are worth more than the assets, the common equity is worthless. The omission of thought related to the intangibles is lesson number two.

The third lesson was the lack of margin of safety. Even at $5 per share, which was historically low, FTR had too many concerns. To name a few: (a) the fixed coverage ratio was deteriorating. The ratio was over three times in prior years and is now less than two times; (b) leverage, defined as total liabilities divided by total assets, was historically at 75% but is now at 93%; (c) pension liability increased from $1,055 million in 2012 to $1,750 in 2018. And there is no sign of this liability but to grow; (d) the percentage of employees under labor agreement increased from 23% to 64% and (e) the wireline telecommunication industry is doing bad.

Practically all telecommunication companies’ stock prices dropped. Anixter (AXE on Nyse) now trades at $57 compared to $99 five years ago. Centurylink (CTL on Nyse) now trades at $10 compared to $37 five years ago. See the table below for more examples.  

How telecommunications companies are trading nowadays

That I bought too much stock is the fourth lesson. I started to buy FTR in March of last year, when the stock traded at $7.76 per share. Then I bought twice as much stock, at $4 per share in November. I finished 2018 with 8,000 shares at a weighted average cost of $5 per share. The FTR position represents 8% of my portfolio while no stock represents more than 2% in comparison.

Why I still hold FTR

Admittedly, I bought too much stock and was careless, too. Reviewing FTR's latest public filing, I was ready to sell the entire position and to recognize the loss. But I found enough reasons (or excuses) to keep it.

There is - and I project will be continued - a reasonable pre-tax cash flow. FTR gathered $3,752 million in after-tax cash flow, after capital expenditures that is, since 2011. In two years the company showed a cash flow deficit: in 2016 the deficit was $227 million, and in 2015 the deficit was $31. But in 2018 the pre-tax cash flow was $687, and the 7-year pre-tax cash flow was $525 million.

The pre-tax cash flow matters. It allows management to change the capital structure by reducing the total liabilities (indeed, management reduced total liabilities by $551 million over the year and is planning to sell asset according to Barron's.) The pre-tax cash flow will allow the company to  compete better as well.

Plus the operating data improved over the past decade. FTR now has more customers in both the consumer and the business segments. For example it had no broadband or video subscribers ten years ago and now reports on 4.7 million broadband and video subscribers. In addition, the churn rate, the annual percentage rate at which customers stop subscribing to a service, is at normal levels.

FTR's Growth in customer base over the past decade


So FTR still meets the cheap, distressed criteria of a stock that trades at less than 50% of the net asset value and of less than 10 times the adjusted earnings per share. The reported book value per share today is $18 and the adjusted pre-tax cash flow is $7.  

***
My brother asked if I had a stop loss in place. Stop loss means that if a stock drops below a certain price, say a drop by 40%, then it is automatically sold to prevent the investor from future losses.

No, I said. Investors, especially investors who target distressed companies, expect - and should be ready - to see much volatility in market prices of their  holdings. May the case of FTR serve as a case in point a year from today.