50-Bagger Macquarie Infrastructure: Diversified Assets Focused on Bulk Liquid Storage and Private Aviation

Share price weakness creates opportunity for income investors – 8.1% Qualified Yield and 36% capital gains potential.

Macquarie Infrastructure (MIC) is an often-overlooked income opportunity with nice capital appreciation potential. While not the 50-bagger it was from 2009 to 2016, MIC offers attractive total return opportunities.   

For me, there is a back story of MIC.  In 2005, I was a shareholder of Macquarie Group (MQBKY), an Australian investment bank.  My interest in the bank was the compulsory retirement savings program instituted in 1992 by the Australian government, whereby all employers MUST contribute 9.25% of employee income to a third-party managed, tax advantaged account, similar to our 401(k).  The mandatory contribution is slated to rise to 12% by 2020.  Employers contribute into tax-advantaged retirement plans for virtually all employees age 18 to 70, with employees choosing where to invest the funds. Annual account income is taxed 10% as it accrues and a 15% capital gains tax on realized profits from investments held more than a year. But as with America’s Roth IRAs, retirement withdrawals are tax-free. Australians can begin withdrawing their money at 55, if they’re retired.

This program creates a very large pool of capital that generates substantial fees for managing banks.  In response to the flood of capital, Macquarie Bank started forming asset funds whereby, much like our MLPs, fund investors own hard assets, such as airports and toll roads, and hires the bank as business managers. However, there is no MLP-like tax advantages, and is considered as a different corporate structure. Macquarie Bank has been quite successful in generating bank fees for itself and income and capital gain returns for fund holders.

Management came to the US with a similar investment strategy.  Macquarie Infrastructure is an offshoot of similar businesses Macquarie Bank operates in Australia.   Due to buying assets with substantial depreciation factors, MIC is able to show substantially larger operating cash flow than taxable earnings.   MIC owns hard assets with long asset lives and high tax depreciation levels.

With the goal of dispersing a majority of operating cash flow, MIC offers a current yield of 8.11%.  MIC’s business model is to buy assets with high EBITDA and high depreciation supporting a high distribution.  Like REITs and MLPs, MIC should be viewed from a cash flow perspective and not the usual EPS viewpoint.

Shares came public in Dec 2004 at $30 a share and topped out at $40 in May of 2007. When share prices retreated to under $15 in Sept of 08, I took a starter position of 150 shares.   Then the preverbal hit the fan – in more ways than one.

The company’s assets at the time included partial ownership of bulk liquid tank storage facilities, private airplane flight services, partial ownership of 2 niche utilities, and a network of off-site airport parking facilities.   Of importance is the debt structure MIC maintains with each operating subsidiary carrying its own credit risk with little to no recourse back to the holding company.  This is a critical debt term which protects shareholders again subsidiary bankruptcy. 

The airport parking business took a real hit in revenue and profitability during the Great Recession, eventually this subsidiary filed for bankruptcy and was jettisoned from the holding company, MIC.     

With the slow demise of the parking business, and the overall market sell-off, share prices collapsed to under $5 by late 2008 and to under $2 by Dec 2009.  Thinking the market had overdone the risk of the parking lot subsidiary bankruptcy spreading to other parts of the company and the whole business imploding, I decided to buy shares in the $2.89 to $1.49 range.   Implementing my usual profit taking strategy, I had exited all shares by the end of 2012 at the highest price of $45.  If only my legs were longer to kick myself in the arse as shares continued to rise to another doubling. 

I have followed MIC since, and recently instituted another position. The decline of MIC shares over the past few months has been in sympathy to movements in the MLP markets.  

MIC currently owns 100% of its bulk liquid storage facilities, private airplane hangar and flight services, an interest in the Hawaiian gas utility, and solar/wind power generating facilities.   The bulk storage and aviation businesses generate the majority of EBITDA cash flow at 78%.

MIC owns International-Matex Tank Terminals.  Mainly located at shipping points such as export terminals (Bayonne, NJ is pictured above), the company operates 12 facilities, ten in the US and two in Canada.   The terminals handle primarily refined petroleum, chemicals, and vegetable and animal oil products for customers including refiners, commodities traders, and specialty chemical manufacturers. Customers retain ownership of the bulk liquids, as well as responsibility for insuring those products. MIC operates more than 45 million barrels of storage capacity. 

Management recently moved to expand their petroleum bulk liquids exposure with the purchase of privately-held Epic Midstream, adding another 7 terminals in the US and 7% overall storage capacity. 

These facilities utilize long-term, take-or-pay contracts which support long-term stability in in income and distributions.  Since 2007, capacity utilization has ranged from 92% to 96%, with a current reading of 92%, below management’s long-term goal of 94% utilization. 

The other large portion of MIC’s business is Atlantic Aviation.  Known as fixed-based operations, or FBO, Atlantic is one of the largest operators in the country, based on its 68 locations.  FBOs primarily serve the corporate and private jet segment of the general aviation industry. Services include terminal operations, refueling, de-icing, aircraft parking, and hangar storage services.  Atlantic is well represented in the economic and tourist hubs around the country.

Corporate-wide, management has guided to cash flow growth of 10-15% per year in 2017 and 2018. Consistent with this guidance, the company also expects to increase its dividend by 10% in both years.

While I don’t expect share prices to grow by 30 times as my previous position had, the 8.1% income is quite attractive. The best part of the income for many investors is: No K-1s and the distribution is qualified.   

Two factors may offer investors pause:  net debt and management performance fees.  Currently, the company holds $3.5 billion in debt vs a market capitalization of $5.9 billion.  However, much like the structure in the early years that saved the company from its bankrupt airport parking subsidiary, the holding company’s direct exposure is around $750 million with the balance being non-recourse to the parent.  As shown in the past, this structure offers protection for investors in the unfortunate event of a bankruptcy of one of its subsidiaries.   

The other concerning factor is the performance-based compensation for management services.  Remember, shareholders own the assets and contract out for management services to the Australian investment bank.    Management fees are set at $75 million a year, which is not a large amount on revenues of $1.7 billion.  However, performance fees are based on share price performance.  The performance fee is paid quarterly, with management taking 20% of the excess total return of MIC stock over the MSCI Total Return Utilities Index.  When MIC share price exploded from 2012 to mid-2015, management collected $526 million in performance fees:  $67 million in 2012, $53 million in 2013, $122 million in 2014, and $284 million in 2015. None have been paid since. 

To the benefit of shareholders, performance fees are reset quarterly and have a high-water mark. Given the poor performance of the stock since June 2015 relative to the utility index, MIC should pay zero performance fees until the stock gets back to almost $100 per share.  In the past, performance fees have been paid in stock rather than cash, improving cash flow but also diluting current investors.  MIC's total return can rise by 45% before the next “high-water mark” for performance fees is reached. 

Free Cash Flow per share has grown from $4.66 in 2015 to an estimated $5.70 in 2017. Next year, FCF/share should reach roughly $6.50 per share.  It is this FCF growth that will continue to reward shareholders.

The company just announced a $1.42 per share quarterly dividend, and a 2.9% increase from prior dividend of $1.38.  This rate equates to a forward yield 8.11%.  The dividend is payable on Nov. 16 for shareholders of record of Nov. 13 and an ex-div Nov. 10.  With the recent decrease in mandatory trade settlement days, it is advisable to buy shares before Nov 7 to receive the mid-Nov distribution. 

While not necessarily a mainstream recommendation, MIC should be attractive to investors seeking higher income without the “complications” of K-1s, and with only about half the EBITDA exposure to oil and gas markets as many MLPs.  For income diversification, MIC should be on your research list.

Although I am not expecting a 50+ times cost capital gain, similar to its move from $1.58 to $90 a share, MIC should offer attractive total returns, cemented in its current 8.11% yield.

Thanks for reading.  This article first appeared in the Nov 2017 issue of Guiding Mast Investments,  George Fisher

Shire Pharma vs Tribal Sovereignty. Who Will Win?

Shire is a value-priced specialty pharma with several catalysts ahead, one of which is taking on the Indian tribal sovereignty issue. 

Shire Pharma (SHPG) is a diversified, Ireland-based specialty drug firm. Shire has grown primarily through mergers and acquisitions, including the Transkaryotic Therapies acquisition in 2005, establishing its genetic disease business and the merger with New River in 2007 including full rights to neuroscience drug Vyvanse. Shire completed the acquisition of ViroPharma (genetic diseases) in 2014, NPS Pharma (internal medicine) in 2015, and Baxalta (hematology, immunology, and oncology) and Dyax (genetic diseases) in 2016. 

The current PEG ratio for Shire is just 0.77, a level well below the industry average of 1.4.

Of interest to shareholders is the recent lawsuit SHPG filed against Allergan (AGN).  Shire's lawsuit centers on the dry-eye drug Restasis, Allergan's second-biggest selling drug, after Botox, with $1.4 billion in U.S. sales last year.  SHPG alleges Allergen is colluding with Medicare Part D insurers to keep out its more effective, and similar cost, dry-eye drug Xiidra.  Xiidra received FDA approvals last year and the firm has filed for similar approvals in the EU.

Unknown to many, untreated dry eye disease can lead to vision loss, especially with patients with glaucoma.

The complaint, filed in federal court in Trenton, N.J., says Shire offered steep discounts in bids to secure insurance coverage of the company's dry-eye drug Xiidra but the Part D plan providers refused, due to Allergan's "bundled discounts, exclusive dealing" and other tactics.

Approximately 13% of Part D patients have access to Xiidra on their drug formularies, compared with about 88% of commercially insured patients, according to the filings.  It is this vast restriction of the neediest – seniors with vision issues - that is the basis of Shire’s complaint.   In addition, Shire is not the only firm fighting these type of Medicare drug availability issues.

From Dow Jones News:  The lawsuit is the second in the past few weeks to take aim at the closely guarded contracts between drug makers and health insurers and pharmacy-benefit managers that play an important but hidden role determining which drugs patients can get and will sell well. Last month, Pfizer (PFE) Inc. filed a similar suit alleging Johnson & Johnson (JNJ) used "exclusionary contracts" to shield its arthritis drug Remicade from Pfizer's biosimilar.

 The lawsuits reflect just how influential the contracts between drug companies and drug-benefit managers have become in the commercial success of prescription medicines at a time when health plans are trying to control costs.  In the name of limiting spending, drug-benefit managers have been securing steep discounts with one drug company in exchange for restricting access to another company's product. The recent lawsuits are exploring the legality of these increasingly common contracts.

In early September, Allergan sold its Restasis patents to an Indian tribe in a legal maneuver designed to avoid challenges filed at the U.S. Patent and Trademark Office. The Shire lawsuit follows Allergan's announcement on Sept. 8 that it transferred its Restasis patents to the Saint Regis Mohawk Tribe in upstate New York, whose sovereign status could limit legal challenges. The Tribe subsequently agreed to license the patents back to Allergan. 

Much like the tribal casino business is sheltered within the tribal sovereign status, the new avenue taken by Allergan may be the tip of the iceberg, if let stand, with other drugs companies seeking patent extensions or shelter from patent infringement lawsuits by contracting with Tribal nations to exploit their sovereign status. 

Last week, four U.S. senators called for a probe of whether the unusual move was anti-competitive and intended to keep drug prices high.

The lawsuit should be of interest to SHPG shareholders and most all pharma investors. Combined, the SHPG and PFE suits seeking to negate the Indian sovereignty issues could outline the new face of drug patent protection.   

SHPG is recommended for additions to health care portfolios.  While not as well-known as some of its larger peers, Shire could offer better potential than many in its industry.   The current SHPG price of $155 allows for plenty of gains to Morningstar’s target price of $218.   Evercore ISI Group rates the stock as Outperform with a $196 target and Cantor Fitzgerald rates as Overweight with a $222 target. These targets would equate to capital gains potential between 25% and 43% - and worthy of investor’s time for their research

All pharma investors should keep an eye out for how this one plays out (pun intended). 

This article first appeared in the Oct 2017 issue of Guiding Mast Investments.  Thanks for reading,  George Fisher
 

Kennametal Continues Its Recovery

Kennametal (KMT) is an industrial cyclical company recouping from a disastrous 2015 and extensive restructuring.  With a turn-around well underway, the company is eager to regain peak earnings of $3.77 in FY 2012, but it will take several years to recapture these levels.

In a nutshell, KMT provides high-tech industrial consumables to manufacturers, oil & gas drilling, and underground mining.  Founded outside of Pittsburgh in 1938, KMT specializes in items such as drill bits and tools for metal working. Their main product lines include cemented tungsten carbide products where wear and corrosion resistance is paramount. 

In the Industrial Division, KMT focuses on customers in the transportation, general engineering, aerospace and defense market sectors, as well as the machine tool industry.  In the Infrastructure Division, KMT focuses on customers in the energy and earthworks market sectors whose primary industries are oil and gas, power generation and chemicals; underground, surface and hard-rock mining; and highway construction and road maintenance.

While offering consumables provides an ongoing and consistent demand when business is expanding, the opposite is also true.  Consumables then become a double edge sword – higher industrial output increases demand on items which are consumed in the manufacturing process, but slower growth subsequently cuts into demand.  While the overall Industrial segment has been steadily expanding, oil and gas drilling coupled with underground mining have collapsed. The decline in mining and drilling reduced sales and overall profitability. Revenues fell from $2.8 billion in June FY 2014 to $2.0 billion in June FY 2017, reflecting this weakness. 

To overcome this precipitous drop, management undertook a restructuring of its business, closing facilities and cutting employment to reflect the reality of very soft demand.  After writing off $8.50 per share in restructuring costs in FY June 2015 and FY June 2016, KMT looks to have the worst behind it.   

From this very low earnings base, EPS are expected to climb to $2.21 for FY 2018, $2.65 for FY 2019, and $2.92 for FY 2020. 

KMT has a strong balance sheet with limited debt maturities outside of $400 million in 2019 and $300 million in 2021. In times of demand weakness, strong balance sheets are important, and KMT has excelled in managing its debt.     

Kennametal is not alone in experiencing multi-year softness in its business. The company’s revenues have fared about in line with its peers.  While not very comforting to investors over the past 3 years with share prices falling from almost $50 in 2014 to $15 in early 2016, shares have rebound to its current $35, and is valued about mid-range in its 52-week high/low.  

Kennametal is a niche mid-cap industrial firm offering better prospects ahead.  The current market weakness for both KMT’s shares and its products is easing, and long-term investors should be amply rewarded going forward.  As both the energy drilling and manufacturing cycles are usually long in duration, the stabilization and improvement of end-user markets will provide a springboard for KMT to continue rewarding shareholders. 

Thanks for reading.  This article first appeared in the Sept 2017 issue of Guiding Mast Investments

Interpublic Group's Rough Quarter Offers Opportunity for Investors

Interpublic Group (IPG) had a rough 2nd quarter, and investors have had an even rougher time since earnings announcements on July 21.  However, the drop from almost $26 (a 15-yr high) to $21.70 offers a buying opportunity for investors with a longer-term horizon.

IPG is the 4th largest advertising agency in the Big 5 which includes NY-based IPG, London-based WPP, Paris-based Publicis, NY-based Omnicom (OCM), and Tokyo-based Dentsu.  In 2016, 60% of IPG’s revenues were derived from the U.S., 12% from Asia-Pacific, 18% from Europe and the UK, 5% from Latin America, and 5% from others. IPG's top 10 clients accounted for about 20% of revenues and its largest single client accounted for 4%.

The company consists of three major agency networks: McCann Worldgroup, Lowe and Partners, and FCB (Foote, Cone, Belding). Its media agencies are bundled under the IPG Mediabrands entity. It also owns specialty agencies, including public relations, sports marketing, and talent representation.  Founded in 1930s as McCann Erickson, IPG has offered investors a roller-coaster ride of stock value.   

In 1987, share prices were $4 (adjust for four stock splits), rose to $58 in 1999, only to fall back to the $4 range by the depths of the market selloff in Feb 2009. Not helping matters, IPG was embroiled in accounting problems from 2002 to 2007.  Overall, if investors are a bit gun shy of IPG’s history, it would be quite understandable.   

However, while the short-term seems challenging, longer-term opportunities should amply reward current shareholders. 

2nd quarter results came in light of expectations.  Consensus earnings estimates were $0.34 a share and the company announced $0.27, 20% below street outlook. Revenues were also lighter than expected at $1.88 billion vs anticipated $1.96 billion, and represented a 1.7% year-over-year sales decline. In addition, management failed to generate year-over-year margin expansion, the first time since 2013.  On the conference call, management projected a turnaround in the second half, as it maintained its organic growth and operating margin expansion guidance for the full year.   

The US is experiencing a slowdown in overall advertising and marketing spending that has affected IPG’s peers as well.  The weakest business sectors for IPG in the first half were financial services, telecom, and technology.  Declines in Europe and Asia-Pacific markets resulted in no quarterly organic growth for the entire international segment.

Management believes the political climate of uncertainty in the US and Europe is adversely affecting the marketing psyche of companies, and expects more clarity, coupled with stronger demand for marketing services, as the year progresses.

Operating margins dipped from 11.0% in 2nd qtr. 2016 to 10.3% during the most recent quarter.  While management believes the last half of 2017 will produce margin improvements, investors should expect a continuation of weak margins, mainly driven by weak revenue growth amid stiff competition. 

IPG shares now offer a 3.3% yield after raising the dividend 20% in Feb 2017.  Management has maintained a 25% to 50% payout ratio over the past 6 years. 

Over the longer term, IPG has a fee and commission structure that is both relatively strong and sustainable.  While it operates in a very competitive environment, the ability to excel in creative talent, to successfully execute an increasingly complex marketing strategy, and the firm’s substantial market share drives IPG’s customer loyalty and new client wins.

As business improves, margin expansion should get back on track, and at least equal Omnicom’s 12.5%.  Management has been growing its business via smaller, bolt-on agency acquisitions, adding to margin improvement over time.  IPG is trading at 2-yr lows relative to its peer, Omnicom.

Of interest to investors, Return on Invested Capital ROIC has been steadily expanding since hitting a low in 2009.  After bottoming in 2009 at 5.0%, ROIC has risen to a 2016 year-end level of 15.0%. 

Earnings per share consensus is for $1.43 this year vs $1.34 in 2016.  Business and earnings are expected to pick up over the next three years, with $1.60 per share expected in 2018, $1.77 in 2019 and $1.96 in 2020. 

Partially driving higher EPS will be an average $300 million annual share buyback, or about 3.0% of outstanding float a year (based on current market cap).  Share count peaked in 2010 at 550 million shares, and has fallen to under 400 million currently.  Supporting the share reduction has been annual free cash flow generation of between $400 and $700 million.    

While the advertising sub-sector of the Consumer Discretionary sector has underperformed the overall market, buying these firms during temporary additional weakness should increase potential gains. IPG’s current decline should be temporary, and if so, over the longer term will provide more than adequate total returns.  Investors looking to expand exposure to this sector should review IPG.     

Thanks for reading.  This article first appeared in the Aug 2017 issue of Guiding Mast Investments.  George Fisher

Walgreen's: Moving ahead

Walgreen’s: Moving Ahead:  Walgreen’s (WBA) and RiteAid deal concludes, finally.   After several unsuccessful attempts at getting government approval for its acquisition of RiteAid, WBA has adjusted its appetite for more stores and has agreed to purchase 2,187 locations around half of RiteAid total sites.   While smaller than initially desired, the $5.75 bill purchase should quickly get FTC approval.  

Since its beginning in 1901, WBA has been one of the most effective retail operators and has emerged a major player within the pharmaceutical supply chain. The firm processed approximately 19% of total U.S. prescriptions during its fiscal 2016, which makes it one of the largest retail pharmacies. The firm filled 929 million 30-day equivalents prescriptions last year.  With the merger of European-based Alliance Boots, WBA has a unique global retail pharmacy footprint.  

About 2/3 of revenues are derived from the distribution of pharmaceuticals, and puts WBA squarely in the crosshairs of healthcare reform and costing.  WBA’s profitability will be driven from synergies of the acquisition of additional stores and pushing more sales from the “front end” or non-pharmaceutical items.   

As most investors can appreciate, the competition for drug sales continues to intensify.  With fewer third party payers, which are the majority of WBA’s clients, distribution profits have been squeezed as payers negotiating positions improve with volume strength.  WBA has been countering margin pressures by growing both in size and importance in the distribution channel, hence the addition of almost 2,200 more stores. 

The merger with Boots has altered Walgreen's front-end retail marketing approach to emphasize higher margin cosmetic’s and limited grocery items.   However, if the most recent quarter is any indication with total same-store-sales SSS growing by 2.4%, the -0.8% decline in front-end continues to be an issue.

Historically, WBA has been a retail growth powerhouse with same-store-sales SSS in the low double digits, driving high Return on Invested Capital.  However, as SSS declined, so did ROIC.  According to fastgraph.com, in 1996, WBA generated ROIC of 20%, in 2006 18%, and in 2016 8.5%.  As a comparison, Walmart generated ROIC of 12%, 13%, and 11%, and Target generated ROIC of 7%, 11%, and 12%, respectively.  

Over the past year WBA has been an obvious under-performer vs S&P 500.  WBA is down about 5% while SPY is up by a bit more than 15%.  

With the overhang of the RiteAid drama now in the rear-view mirror, management can focus on improving performance.  

The bullish case for WBA is as compelling as the bear and neutral case.  

75% of the US population resides within the geographic reach of its 8,100 stores. This coverage increases its desirability to drug providers and provides scale in pricing negotiations.  

Indisputably, pharmaceutical sales will continue to grow, both in the US and Europe.  WBA is unique in the combination of both these markets, giving investors both the benefits and pitfalls of a multinational health care company.

WBA has generated strong operating cash flow.  In FY (Aug) 2016, WBA generated $7.8 billion in operating cash flow and $8.1 billion over the previous 12 months.  OCF has almost doubled from an average of $4.4 billion from 2007 to 2015and has created a current cash balance of $11.8 billion, before the RiteAid acquisition.  OCF growth is expected to continue its growth with the addition of more retail locations.       

Cost containment and cost reductions continues to be a key focus of management. since 2010, operating expenses as a percentage of sales has declined from a high of 23% to 18%, offsetting drug distribution margin pressures. 

In addition to higher operating cash flow and lower operating expenses, WBA has been aggressive in its cash and working capital management.  In 2013, the average cash conversion days, or how fast a company can convert cash on hand into inventory and accounts payable, through sales and accounts receivable, and then back into cash, was 32 days. As of last quarter, conversion days had dropped by almost 2/3s to 13.5 days, representing a substantial improvement in working capital management. 

In March 2013, WBA and wholesaler AmerisourceBergen Corp (ABC) announced a 10-year agreement (subsequently extended to 2026) to source all drugs through a newly formed strategic partnership which would enable sharing of synergies by layering ABC's generic volume into WBA. Previously, WAG sourced branded pharmaceuticals through Cardinal Health Inc., specialty pharmaceuticals through ABC and generics directly from manufacturers. WBA currently owns approximately 26% of ABC.  This relationship helps build profitability for the longer term.  

WBA’s valuations are in line with its major competitor, CVS Heath.  Investors should expect the Beta to come down as the trials and tribulations of the RiteAid acquisition fall by the wayside.  

While not all is rosy at WBA, most analysts have a favorable opinion of the future for Walgreens.  The average price target is in the $95 range, for a potential gain of 21%.  Driving share growth will be earnings growth from the current $5.00 estimates for this year to $6.00 in 2019.  

This article first appeared in the July 2017 issue of Guiding Mast Investments.  Thank you for reading, George Fisher
 

HollyFrontier: Buy for income; Stay for the capital gains

HollyFrontier’s current weakness offers long-term investors a prime buying opportunity.  Mid-cap value stock HollyFrontier (HFC) is one of the largest independent petroleum refiners in the U.S., with operations focused in the Mid-Continent, Southwest and Rocky Mountain regions.  

On May 3rd, HollyFrontier reported a first quarter net loss of $(45.5) million, or $(0.26) per diluted share. The Company also declared a quarterly dividend of $0.33 ($1.32 annually) per share to shareholders. At the end of the qtr., book value stood at $26.00.

First quarter results were negatively impacted by planned and unexpected refinery outages for repairs and routine maintenance.  There is no major downtime planned until Nov, and these issues could be considered as “one-time”. For the balance of the year, quarterly earnings per share are expected to be $0.77, $0.62, and $0.22. EPS for 2017 is expected at $1.47 to $1.52 and for 2018 between $2.26 and $2.77.  

HFC rallied after the election from around $23 to a high of almost $34, but fell back in May after the earnings disappointment to $25.   

Driving investor interest was the belief the current administration would reduce the regulatory cost of renewable identification numbers, or RINs.  RINs are a bio-fuel tracking mechanism that is like “carbon credits” where bio-fuel companies generate RINs that can be sold to refiners like HFC to offset production of fuels like E85. RINs are a positive for ethanol makers and an expense for refiners. HFC currently spends over $100 million a year to purchase RINs.  The thought process is that presidential advisor Carl Icahn, a large investor in refining firms, would be instrumental in reducing the burden and expense of the RIN program.  

However, that has not yet happened.  From HFC 1st qtr. 2017 10-Q:  The (RIN) regulations, in part, require refiners to add annually increasing amounts of “renewable fuels” to their petroleum products or purchase credits, known as renewable identification numbers (“RINs”), in lieu of such blending. Compliance significantly increases our cost of products sold, with RINs costs totaling $66.0 million for the three months ended March 31, 2017. Year-over-year increased costs of ethanol blended into our petroleum products, which exceeded the cost of crude oil, also contributed to lower refining margins for the quarter.  

RIN payments are somewhat volatile and during the first quarter, the RIN program reduced profits per share by $0.38.  Annualized, a 50% reduction in RIN expense could add between $0.30 and $0.68 per share to profitability.  At a 10x valuation, this increase could add $3 to $7 a share to HFC valuation.    

HFC maintains one of the most complex refinery operations.  HFC’s complexity ratings is 12.1, on a scale of 1.0 to 14.0, with a US average refinery complexity of 9.0. For investors, this means that HFC operates one of the most complex and potentially profitable chains of refinery assets in the US. The higher complexity factor allows HFC to refine lower grades of crude into gasoline and diesel, potentially expanding comparable margins.

This advantage shows up as a substantially higher ROIC than its peers. In 2016, HFC exceled in generating returns on invested capital. At a ROIC of 17%, HFC bested its peer 5-yr average of 13% by 30%, and was second only to Western Refinery’s 19%. HFC has generated first class operating profits per barrel and its 5-yr average profit per barrel is best of its peers. In 4 of the last 5 years, HFC has been either #1 or #2 in industry profitability.

In Feb, HFC completed the acquisition of the Canadian lubricant business from Suncor (SU). Wall Street is expecting the acquisition will stabilize commodity-driven refinery spreads and overall operating profitability.  

HFC owns 22.4 million limited partner units of its midstream MLP spin-off, Holly Energy Partners (HEP), representing a 39% stake, and also holds a 2% general partner interest.  At current valuations, HEP shares owned are worth $4.75 per HFC share and contributes $0.30 per share in distributable income for HFC stakeholders. 


Catalysts for higher share prices are: 
1) improving refining margins, partially created by a higher spread WTI to Brent; 
2) reduction in the RIN program; 
3) reduction in federal income tax rate;
4) increased profitability from the lubricant business expansion; 
5) increased contributions from Holly Energy Partners.

At the current price, HFC offers a 5.7% dividend yield, providing strong support to total stock returns.  While patience may be needed for HFC to realize its full potential, buy for its current income and stay for the capital gain potential.  

This article first appeared in the June 2017 issue of Guiding Mast Investments. Thanks for reading, George Fisher
 

Updates: Glaukos (GKOS), Ferrari (RACE). Syericycle: Interesting combo of medical waste disposal and information destruction

Updates on recommendations Glaukos (GKOS) +42% and Ferrari (RACE) +62%:   Based on a 42% capital gain in 4 months Jan 1017 to April 2017 for GKOS and the high-risk nature of the single-product ophthalmic medical firm, I took profits and moved on. My concern is the high valuations with little in the form of cash earnings on the horizon.  In addition, there will be plenty of competitive products from both hard devises like the iStent and less invasive eye drops.   
       

Ferrari has done a bit better with a 62% gain in 7 months and is also trading at elevated valuations compared with other ultra-luxury brands.  Profits were taken as well and the positon was reduced by half.   If share valuations return to those experienced over 6 months ago, I would again be a buyer of RACE.   If not, I am happy with retaining a half position and the cash profits.     

Stericycle (SRCL) offers an interesting combination of medical waste disposal and “information destruction” services.  SRCL has historically been focused on surgical and medical waste disposal of items such as needles, sharps, gloves and gowns, mainly generated at large hospitals with active surgical centers.  As a service provider to cost-constrained facilities, SRCL grew by acquisition and consolidation in their market.

There used to be 2,000 medical incinerators in the US.  Due to more stringent regulations and a growing preference to sterilize and reuse (autoclave process) than disposal, the number of medical waste disposal incinerators has shrunk to under 50.  There are only 15 sites that accept outside generated waste, and SRCL operates 10 of these facilities. In addition, SRCL operates 200 transfer stations to efficiently move waste through its disposal network.    

The company maintains relationships with over 500,000 customers with an annual retention rate exceeding 92%.  The company believes it has a 10% global, and 30% of US, market shares in the fragmented industry of medical waste management.  

In 2015, SRCL moved past its medical focus and into document shredding and disposal, interesting known as “information destruction”.  Management bought market leader Shred-it, adding mobile units, an established customer base and routes, and shredding equipment.      

The addition of document management adds to the plate of services offered to existing clients.  Management believes shredding adds a minimum revenue potential of 5% and 6% per hospital client and 7% to 10% for physicians’ offices.   

US Domestic Regulated Waste and Compliance Services generated $2.4 billion in 2016 revenue and constituted 66% of total receipts.  Communication Services was $300 million in revenue, 8% of the total, and International was $900 million or 26%.

Under Communications Services, SRCL offers comprehensive solutions to patient communication issues for hospitals and doctor offices.  These include, from their website: 
•    Live customer service during the day or after business hours to provide superior service, capture additional revenue and enhance customer/patient satisfaction.
•    Book appointments online in a self-serve manner or through trained agents over the phone at time that is most convenient for customers or patients. 
•    Reduce no-show rates and missed appointments with appointment reminder notifications via call, email or text.
As costs are being squeezed across the spectrum of medical expenses, SRCL strength is its relative size and diversity of product offerings.  For example, in 2016, management generated $411 million in free cash flow.   Debt is being reduced by 8% to 9% annually, and should be below $2.6 billion by the end of this year.  

However, investors have been burned recently based on stumbles with integrating Shred-It.  Share priced peaked in 2015 in the $140s, and have fallen about 50% since. 

Management is calling for flat earnings comparison 2016 to 2017.  According to the latest investor presentation, 2016 EPS of $4.75 should be adjusted as follows:
Price Concessions          -$0.25 to -$0.30
Corporate Expenses         -$0.17 to -$0.21
Revenue Growth        +$0.17 to $0.21
Merger Synergies        +$0.13 to $0.15
Share Repurchase         +$0.05 to $0.07

Net result is 2017 EPS in the $4.60 to $4.75 range.  Of concern is the high relative price concessions already identified as a hurdle.  

Investors looking for exposure to the medical sector should review Stericycle.  Their niche businesses and extensive cross selling opportunities should allow management to get back on the growth track after stumbles caused by customer consolidation, claims of inappropriate price increases, and auditor concerns with financial controls.  These issues appear to be already priced into stock valuations, and a return to its historic growth projections would reward long-term investors.     

Consensus EPS growth is expected to be in the 8% to 10% range and SRCL does not currently pay a dividend. Price targets vary from $95 to $100 range, offering a 9% to 10% total annual return over the next 2 years.   

This article first appeared in the May 2017 issue of Guiding Mast Investments.  Thanks for reading, George Fisher
 

Silver Run Acquisition II: Replay of SRA1's 92% 1-yr return?

Silver Run Acquisition II (SRUNU):  A replay of SRA1’s 92% 1-yr return? A year ago, we offered a new IPO company as an Off the Radar Screen choice – Silver Run Acquisition Corp SRA1.  Due to increase risks, we don’t usually review IPOs or newly formed companies, especially in the high-risk area of oil and gas exploration.  There are plenty of small-cap carcasses discarded along the side of the energy superhighway. 

However, SRA1 is different.

The investment strategy is to buy into a “special purpose acquisition corporation” SPAC, which is also known as a “blank check” corporation, and is formed with the specific purpose of building a new company with fresh capital to purchase oil and gas assets.    In this type of company, investors are relying on the partners’ management abilities to locate, purchase, and execute a business plan.   In the case of SRA1, the attraction is Mark Papa, founder and retired CEO of EOG Resources (EOG), one of the industry’s most revered managers.   Papa came out of retirement for the opportunity to develop and manage SRA1.  The original $400 million blank check nature of the structure, combined with issuing addition shares over the past year, has allowed Papa to build an $3.6 billion market cap oil and gas E&P company with no debt.     

Backed by Riverstone Holdings, SRA1 has morphed into Centennial Development Corp (CDEV) and share prices have risen from a post-IPO price of below $9.48 (including excised warrants) to $18 today.  Investors who bought the SRA1 SPAC shares received 1 common share and 1/3 of a warrant. Recently, the warrants were converted into additional shares. CDEV is currently focused on the opportunities in the Permian Basin, one of the hot drilling areas in the US.  Of the 809 drilling rigs currently operating across the US, almost 40% are working in the Permian Basin. Analysts at Wunderlin recently upped its price target on CDEV to $28.     

Now along comes Silver Run Acquisition II (SRUNU) another Riverstone Holding SPAC.  The concept is to duplicate the success of CDEV.  Similar to Papa, James Hackett, former CEO of Anadarko Petroleum (APC), is the attraction of SRUNU. 

During his CEO tenure at APC from 2003 to 2012, Hackett proved to be a good steward of shareholder capital, taking on a minimum of debt and equity issuance while focusing on delivering above-average returns on invested capital. Hackett’s management style included an insistence on maintaining a strong balance sheet. which has helped APC weather the current low-price environment.   

Silver Run Acquisition II recently had its IPO and sold to investors 100 million shares of stock and 33 million warrants, including overallotment, worth $1.0 billion.   The IPO proceeds are being held in escrow until the company starts making acquisition transactions.   

Riverstone owns 20% of SRUN's current shares, giving them an incentive to make sure subsequent transactions are in the best interest of all shareholders. In addition, Riverstone has given a forward commitment to purchase $400 million in common shares and warrants (40 million shares plus 13.3 million warrants) at $10 per share at the time of the initial purchase transaction. Combined, Riverstone could own upwards of 37% of SRUN.   

The SRUNU “units” consists of one share of common stock and 1/3 of a warrant to buy additional shares at $11.50.

While CDEV's CEO Mark Papa had broad experience in onshore oil and gas, it should be noted that Mr. Hackett's expertise also includes companies with significant offshore assets, including Anadarko, Devon, Ocean and Seagull. That is not to say that the offshore arena would be an area of focus, but it is one possibility.   

While the use of SPAC structures are becoming more popular, the risks involved have not diminished.  As unproven entities, it is extremely important investors feel comfortable with management’s past abilities as this is all they have to evaluate, coupled with the expertise of Riverstone.  On this front, I support both Hackett and more importantly Riverstone Holdings.  

Speculative investors may want to review SRUNU as the IPO and Riverstone commitment has generated over $1.4 billion in capital for Mr Hackett to spend – one sizeable blank check and definitely sufficent capital to acquire assets that are being offered on the cheap by financially distressed energy firms.

The key to both SRUNU and CDEV is their ability to find undervalued oil and gas assets. In these days of stress and over-leverage in the energy field, private equity firms are offering stiff competition at times.  Yet, both SPAC companies have the envious position of carrying no debt in an industry overflowing with bad loans. 

Having $1.4 billion in cash and no debt certainly improves SRUNU’s negotiating position.  In today’s energy segment, there should be plenty of profitable opportunities to pick from among the dying carcasses lying along the side of the energy superhighway.    

However, speculative and unproven it is and investor need to be comfortable with this level of risk. 

As an add-on to my position in CDEV, I also bought into SRUNU.   

This article first appeared in the April 2017 Issue of Guiding Mast Investments.  Thanks for reading.  George Fisher

Who is the Boss? It's founder-run companies with a 310% history of out-performance.

Who is the Boss?  It’s founder-run companies with a 310% out-performance history.    ETFs are not a new investment vehicle and have been around for over 20 years.  Developed by Morgan Stanley to counter index mutual funds, ETFs have their roots in MS’s WEBS, or World Equity Benchmark Shares, which represented the components of various international stock exchange indexes. For example, the Malaysian WEBS included stocks that make up the Kuala Lumpur Composite Index.  In their heyday, WEBS were offered for market indexes of 16 mainly developed countries including Australia, Canada, Hong Kong, Japan, Malaysia, Mexico, Singapore. 

I use ETFs as a means of garnishing exposure to industries or sectors which would be difficult to replicate by investing in a few specific stocks.  I look for ETFs with a twist or a focus that sets them apart from typical market-oriented products.  Equal-weighted S&P 500 (RSP) is an example of the type of ETF I gravitate to.  

Another such ETF is the new Global X Founder-Run Companies ETF (BOSS).  BOSS is a bet that company founders will be better managers than subsequent generations of executives, resulting in stock outperformance.  The ETF, with an inception date of 2/13/17, invests mainly in mid- and large-cap firms where the founders are still in charge.  While the portfolio is expected to be equally weighted and rebalanced annually, sector exposure leans towards tech and healthcare.  

The strategy behind BOSS is simple: firms run by founding fathers (and mothers) outperform over time.   In a report by Chris Zook, Bain Capital  shows that since 1990, founder-run companies outperformed the S&P 500 index by 310%.  The most outperformance has been since the crash of 2008-2009.    

The reasoning behind this is pretty straightforward.  From the Bain report:  In his blog, Ben Horowitz lists three reasons his VC firm prefers founder CEOs: founders have the moral authority to make the hard choices, they know the detail of the business and have better instincts, and they have a long-term perspective on investments and building a company that lasts.

Zook lists three basic business model and management style differences that clearly separate founder-run companies from firms managed by post-founder teams. 

The first is the unique, spiky feature, or capability that gives a business special purpose. We call it business insurgency. My co-author James Allen refers to this as waging war on industry norms on behalf of underserved customers, as Netflix did for video rentals, or to create a new market entirely, as Google has done, following its mission to organize all of the world’s information. 

The second element of the founder’s mentality is a front-line obsession — as the founder had. It shows up in a love of the details and a culture that makes heroes of those at the front line of the business and gives them power.

The third element is an owner’s mindset, the fuel that propelled the rise of private equity, whose essence is dialing up speed to act and taking personal responsibility for risk and for cost.

In addition, founders tend to have significant personal wealth tied to the companies they lead, and thus often focus on long-term value creation through innovation and entrepreneurial-ism.  Global X adds: For example, the average annual compensation for founder/CEOs is 32% less than that of the average S&P 500 CEO, as founders understand that maximizing their salary could come at the expense of deploying cash to fund long-term growth opportunities, and thus hurt their equity value over the long term. In addition, these CEOs are careful to not take on excessive debt, as bankruptcy would wipe out the value of their equity stake. As a result, founder-run companies exhibit 52% lower debt-to-equity ratios than the S&P 500 as a whole.  

The list of the top 15 holdings out of a current total of 96 is an interesting list of stocks, many of which are probably unknown to most investors:

While the 0.65% ETF fee is higher than many would like, the diversification this ETF offers is unique.  As a traditional growth-focused portfolio, many of the fundamental aspects could seem expensive, especially in an overvalued market.  For example, the average PE of the BOSS’ portfolio is 32, average price to book value is 2.97, and the average ROE is 9.5%.   

I have taken a starter position in BOSS and expect to add to it over time.  I like the concept and strategy, and it fits my overall ETF selection framework.

More information can be found in the Bain Report titled “Founder-led companies outperform” and at the Global X ETF website, both links are below.

https://hbr.org/2016/03/founder-led-companies-outperform-the-rest-heres-why

https://www.globalxfunds.com/introducing-the-founder-run-companies-etf/

This is one ETF worthy of your time for due diligence. 

This article first appeared in the March 2017 issue of Guiding Mast Investments Newsletter.  Thanks for reading.  George Fisher

MLPs: Don't Fret Rising Interest Rates

MLPs for income.  MLPs should be in your portfolio for income.  In a low rate environment, investors have been hamstrung for the past several years looking for income. In their 1st qtr. Investment Recap, JP Morgan offers the following table of average yield by asset class.  

There are tax implications to owning MLPs, such as the need to file K-1s and the debate concerning investing with tax-deferred accounts.  It is important that investors review these issues with their tax preparer.  For DIY tax payers, tax filing software includes easy to complete forms for MLP income.     

Many investors are concerned about buying stocks in the face of rising interest rates. JP Morgan also addressed this issue with a chart of the 2-yr rolling correlations between weekly stock returns and interest rate movements going back to 1963.  Along the bottom is the yield on 10-yr Treasuries and the left side number is the correlation coefficient, with the horizontal line in the middle at 0.  Above the line indicates a positive correlation, i.e. they move together.  Below the line is a negative correlation, i.e. stocks decline and rates increase.

When 10-yr Treasury yields are below 5.0% (red line), rising rates have historically been associated with rising stock prices.  The break point is at the 5.0% yield level where stock returns turn negative as rates continue to increase.  

Many fixed income forecasters peg 10-yr Treasury yield in the 3.0% to 3.5% range at year end.  While this is creeping up from the current 2.49% yield, it is still below the 5% threshold suggested by JPM.  

With an anticipated decline in stock price returns, income will become a higher portion of total investment returns, hence a focus on dividend and distribution yield.  

Midstream MLPs have been making a comeback after being decimated with the decline in oil and gas prices since 2014.  For many firms, the darkest days should be behind them as oil settles into a $50 to $60 range over the next few years.  

Investors who are seeking long-term income should review the following four MLPs:
o    Spectra Energy Partners – SEP – 5.8% yield
o    Enterprise Products Partners – EPD – 5.7% yield
o    Dorchester Minerals – DMLP – 5.4% yield
o    Dominion Midstream – DM – 3.25% yield

More speculative firms worthy of further research include:
o    Summit Midstream – SMLP – 8.8% yield
o    Enable Midstream – ENBL – 7.7% yield
o    Phillips 66 Partners – PSXP – 3.7% yield

As the energy midstream markets continue to improve, investors in these MLPs will see distribution increases, improving their yield on cost.  For example, EPD continues to raise its quarterly distribution.   Since the partnership’s IPO in 1998, EPD’s latest hike represents the 59th distribution increase and the 50th consecutive quarterly increase.  As more projects come online, Dominion Midstream management has set a goal of raising its distribution by 20% a year over the next few years.  

Thanks for reading.  This article first appeared in the Feb 2017 issue of Guiding Mast Investments.  George Fisher
 

Glaukos Medical: Small-Cap Firm with Big Opportunities

Glaukos Medical (GKOS) is an interesting small ophthalmic medical technology company.  GKOS, with 2016 revenues of around $110 million, has devised a “stent” that is surgically implanted in the eye to allow the organ to consistantly drain, reducing eye pressure.

According to the company, there are over 4.5 million people in the US with glaucoma, and 83 million inflicted worldwide.  The vast majority have open-angle glaucoma, which manifests itself through elevated intraocular pressure (IOP), aka high eye pressure.  GKOS believes the current global glaucoma treatment market is around $5 billion, and could grow to $7 billion in 2021.  

Left untreated, glaucoma can cause loss of vision, and is the leading cause for blindness across the globe.  Conventional treatments include eye drops multiple times a day, laser surgery, and invasive surgery.  However, each treatment has its severe drawbacks.  The drops are uncomfortable and for many patients causes consistent eye irritation; laser treatment results typically last only 1 to 5 years; and invasive surgery is highly complicated with lower success ratios.   Typically, eye drops are prescribed, but 40% to 60% of patients stop taking them.

I can appreciate the problems with the drops as I have been taking them for several months.  

There is a new area of treatment called micro-invasive glaucoma surgery, or MIGS.  Treatment typically involves implanting a device in the eye to relieve eye pressure, and is often used in connection with cataract surgery.   

Usually the treatment goal is to reduce IOP to the 15 range, with a reading of 20+ being the level to begin treatment.  In 2012, the FDA approved the GKOS stent, called iStent, after clinical trials showed a mean reduction in IOP from 23.0 to 14.9 after 3 years and to 16.3 after 5 years.  

iStent is the first and only FDA-approved MIGS implantable micro-surgical devise to help regulate eye pressure, but there are others in the works.  Competitors are working on similar devices (Alcon’s Cypass and Ivantis’ Hydrus drain tube pictured above next to a penny for comparison), but they are substantially larger in design and appear to be more cumbersome.  At 1 mm, iStent is quite a bit smaller than the 6.5mm Cypass or 8.0mm for Hydrus.  The iStent is smaller than the “L” in the word “Liberty” on the front-side of a Lincoln penny.  Pull one out of your pocket for comparison and you may be amazed at its small size.  iStent is also the smallest surgical device ever approved by the FDA.  

While there will eventually be competition, it seems the iStent product benefits and “first out of the gate” positioning will favor GKOS for some time.  

iStent has been approved for 100% reimbursement coverage by Medicare and most national private insurance companies approve of its use. 

There are currently 2,200 surgeons in the US approved to use iStent, out of a total of 5,500 surgeons who perform the majority of cataract surgeries. GKOS is expanding its surgeon base by around 60 per month, or about 30% annually.   GKOS is currently seeking 2 new FDA approvals for spin-off and improved designs of the iStent.  

Share prices collapsed in Jan 2015 from $25 to $15, based on a temporary slowdown of growth.  However, in May 2016, investors started to regain confidence in the GKOS story, and share prices climbed to over $30 by Aug, and the stock has traded between $30 and $40 since.  The current price is $34.  

William Blair, Wells Fargo, Piper Jaffery, Roth Capital, GMI, and Cantor Fitzgerald have GKOS rated as a buy or outperform with three analysts rating the stock as neutral.  The average price target is $41.    

Anticipated earnings per share are $0.12 in 2016, $0.22 in 2017, and $0.54 in 2018.  Revenues are anticipated to grow to $110 million, $142 million and $172 million, respectfully.  The firm lost
-$2.12 in 2015.  

Technically, the stock appears to be about its support range of $32, and if it falls below that level, it could hit $28. 

While the company has potential to continue growing in the 40% range, and is on the cutting edge of ophthalmic medical technology, it is difficult to peg a valuation on shares.  I like the exposure to a growing glaucoma medical treatment, but GKOS is not for the faint of heart as it is a very speculative buy.   Interesting but speculative.  

 

This article first appeared in the Jan 2017 issue of Guiding Mast Investments.  Thanks you for reading.  George Fisher

Algonquin Power: Growing US Utility Based in Canada

Algonquin Power (AQN) is a Canadian-based diversified utility with growing holdings in the US.  AQN operates windmill farms in Canada, water utilities in the west, and electrical and gas utilities in the east.  With the recent $3.2 billion acquisition of Empire District, AQN has materially expanded its utility operations in the US. AQN’s Liberty Utilities subsidiary now serves over 782,000 customers within a regulated US utility profile.  AQN also operates regulated and non-regulated power generating facilities on both sides of the border with a total capacity of over 2,500 MW.

AQN has been building its US business for many years.  In 2009, AQN partnered with Nova Scotia based Emera (EMRAF) to purchase electrical transmission lines around Lake Tahoe, and has been acquiring smaller US utility asset ever since.   

Liberty Utilities has operations in Arizona, Arkansas, California, Georgia, Illinois, Iowa, Kansas, Massachusetts, Missouri, Montana, New Hampshire, Oklahoma, and Texas. 

AQN was recently listed on the NYSE and should begin to appear on income investor’s radar screen.  Unlike many foreign utilities with US assets, AQN’s dividend is paid in US Dollars.   There is sufficient operating cash flow from US operations to cover the cash dividend outlay to US investors.  

While the value of shareholdings carry currency risk, the distribution payout does not, and this advantage should be attractive to income seekers.   AQN currently offers a 4.9% yield.

For the past 7 years, AQN has partnered with Emera on many US projects, with Emera acting as an active buyer of newly issued shares to finance various US expansions.   Emera, known for being shareholder friendly, has several directors on AQN’s board.  It seemed like an eventual good match, with Emera having a 62 million share head start.  However, Emera decided to purchase Florida-based TECO utility and sold its position in AQN to finance this expansion.  Since buying in 2010, I have been “hoping” for a merger as AQN could help EMRAF’s Canadian-government mandated renewable energy generating profile. 

The company expects to invest C$9.7 billion between 2017 and 2021.  Returns on this capital budget should allow earnings to grow at an 8% or higher rate, with matching dividend growth.

Investors should expect AQN to continue to expand by acquiring smaller utilities assets across the US. Its diversified footprint reduces overall utility risk, and coupled with its US dollar payout, should be considered as a core small-cap utility holding.  

Thank you for reading.  This article first appeared in the Jan issue of Guiding Mast Investments.  


 

Hill Rom: Underfollowed medical equipment firm

Hill Rom Holdings (HRC) is a mid-cap medical equipment company overlooked by many investors.  Their product portfolio is extensive and growing with a concentration in patient mobility. The company also sells services for their products such as hospital room and facility design, training, and clinical solutions as well as providing rental and leasing of their equipment. The company has recently completed several acquisitions, including point of care diagnostics and testing equipment manufacturer Welch Allyn in 2015, German operating room equipment manufacturer Trumpf Medical in 2014 and disposable surgical blades and scalpels manufacturer Aspen Surgical in 2012.  Management plans on more acquisitions over the next few years. 

Of interest is the firm’s focus on acquiring mainly privately-held firms with strong niche markets that expand HRC’s product offering to their existing customers.  Only 40% of 2016 revenue was generated from hospital’s capital expenditure spending, such as beds and operating room equipment.  60% of revenues was from services, leases, and medical disposables. A strong non-capital expenditure dependent focus allows HRC to better maneuver some of the market fluctuations seen by its equipment peers.    

Years ago, HRC’s main products were hospital beds and funeral caskets, but in 2008 spun off the casket business and has been expanding its medical equipment business, mainly through acquisitions. For example, in 2015, HRC purchased privately-held Welch Allyn, a manufacturer of home- and doctor/hospital- based blood pressure testing equipment.   HRC reports with a Sept fiscal year end.  Total FY2016 revenues were $2.7 billion

The company focuses on patient care solutions in several core areas:

·    Advancing Mobility focuses provides patient care systems including a variety of bed systems, such as Medical Surgical (MedSurg) beds, Intensive Care Unit (ICU) beds, and Bariatric patient beds, as well as mobility solutions such as lifts and other devices used to safely move patients.

·    Wound Care and Prevention offers non-invasive therapeutic products and surfaces designed for the prevention and treatment of a variety of acute and chronic medical conditions, including pulmonary, wound, and bariatric conditions.

· Medical Equipment Management and Contract Services leases to health care providers a wide variety of moveable medical equipment, such as ventilators, defibrillators, intravenous pumps and patient monitoring equipment.

· Surgical Safety and Efficiency offers surgical tables, lights, and pendants utilized within the operating room setting. It also offers a range of positioning devices for use in shoulder, hip, spinal and lithotomy surgeries as well as platform-neutral positioning accessories for nearly every model of operating room table. In addition, it offers operating room surgical safety and accessory products such as scalpel and blade, light handle systems, skin markers and other disposable products. The products offered within this category are primarily recurring, consumable revenue streams.

·    Respiratory Health offers therapeutic products that provide bronchial hygiene (airway clearance) for acute and home care patients.

Hill Rom reports in three groups: Patient Support Systems, Surgical Solutions, and Front Line Care.  

Patient Support Systems FY2016 revenues were $1.4 billion, up 2% over previous FY 2015.  The company is forecasting low-single digit revenue growth for FY2017. 

Surgical Solutions FY 2016 revenues were $408 million, down 1% from FY2015. The company is forecasting mid-single digit revenue growth for FY2017.   

Front Line Care FY2016 revenues were $810 million, up 6% from FY2015. The company is forecasting mid-single digit revenue growth for FY2017. 

While revenues were relatively flat for 2016, margins are expanding as the firm realizes cost synergies from its Welch Allyn acquisition. In addition, the company is on an overall cost savings plan to boost profit margins.  

It is management’s goal to expand earnings per share by approximately 14% to 18% while growing revenues by 3% to 5%.  Although it is tall order, the street seems to believe management can deliver on these targets.

Of the six analysts following HRC, three have the stock recommended as a Strong Buy, two as a Buy and one as a Hold.  The average price target is $67, or 26% above HRC’s current price.  To achieve this price target, earnings will need to grow to over $3.94 per share and the PE ratio will need to expand from its current 15 PE to 17 PE.  This falls in line with EPS estimates of $3.78 in FY2017 and $4.19 in FY2018.  

Zack’s commentary on its Hold recommendation:  Hill-Rom ended fiscal 2016 on a promising note with its fourth quarter numbers squarely beating the Zack’s Consensus Estimate. The company’s outcome on a yea rover-year basis was also impressive. The company’s year-over-year outcome was impressive along with record level of gross margin. We are upbeat about the company to remain on a solid growth trajectory over the near term based on its strong 2017 guidance. Based on several positive catalysts, we expect the company to expand geographically in the coming quarters. Notably, in the last reported quarter, Hill-Rom posted strong growth in both Asia-Pacific and the U.S.

However, Hill-Rom’s persistent poor performance in the International front, especially in the Middle East and Latin America keeps us concerned. Unfortunately, no near-term improvement can be expected in the existing capital crunch condition that eventually led to economic and political downturns in these economies.

Hill Rom does not lack competitive pressures.    HRC competes with a variety of small and large companies such as Stryker Corporation, Universal Hospital Services, Philips, Covidien, GE Healthcare, Skytron and DeRoyal.

Investors seeking a smaller healthcare company would be well served to review Hill Rom. The company stock has almost doubled since Jan 2013.  While not as flashy as biotech or as massive as Johnson & Johnson, HRC is well positioned for a continuation of its expansion through acquisitions. 

 

Thanks for reading.  This article was first published in the Dec 2016 issue of Guiding Mast Investments.  George Fisher

Eight high-yield stocks with capital gains potential

Morningstar offers a premium stock screening tool which allows users to filter specific results.  I recently ran a screener looking for higher yielding stocks that are well liked for current undervaluation and offered above average historic dividend growth.  The screen criteria:

·         US Domestic Company

·         Morningstar Rating of 4 or 5 Stars (their highest)

·         Current Yield Over 4.0%

·         5-yr Dividend Growth over 7%

 

It is not surprising 7 out of the 8 stocks are either energy or financial asset managers.  These are the two most beaten down segments of their respective out-of-favor industrial sectors.  Five out of the eight are master limited partnerships.

An undervalued stock offering greater than a 4% current yield with a history of raising annual distributions by almost 3 times the inflation rate should be of interest to investors on many fronts.  These eight stocks should be on your research list or in your portfolio. 

Keep these names on your radar screen with their respective discounts to Fair Valuation:

 

Stock                                                    Discount

HollyFrontier Corp (HFC)                    46%

Magellan Midstream LP (MMP)             13%

Spectra Energy LP (SEP)                      17%

Sunoco Logistics LP (SXL)                    16%

KKR & Co LP (KKR)                               24%

Blackstone Group LP (BX)                    36%

Waddell & Reed Financial (WDR)         26%

The Mosaic Co. (MOS)                           26%

 

Thanks for reading.  This article first appeared in the Nov issue of Guiding Mast Investments.  George Fisher

Putnam Investment's parent, Power Corp of Canada is undervalued and overlooked

Founded by the Demarais family, Power Corp of Canada (PWCDF, PWF.TO) is a powerhouse Canadian financial company unfamiliar to most investors.  However, it offers stable exposure to Canadian and European markets.  Power Corporation of Canada is a diversified international management and Canadian holding company. Through its subsidiary, Power Financial Corporation, it has interests in companies in the financial services sector in Canada, the United States and Europe. Through its subsidiary, Square Victoria Communications Group, it holds interest in companies from the communications and media sector. Power Corporation also holds and actively manages a portfolio of investments in the United States, Europe and Asia. The company manages assets of $1.22 trillion.

Power Corp’s largest investment is a 68% owner of Power Financial.   PWCDF also owns a communications and media firm along with various other investments.   The investments include private equity positions in companies in Europe, the US, China and the Pacific Rim. 

The company reaches 12 million Canadians and serves about 1 in every 3 Canadian households, a statistic that makes Power Corp the envy of most US financial firms. 

Power Financial, its largest holding, is a financial services company involved in insurance, money management, and European equity investments.  Power Financial offers some well-known financial services brands, such as Canada Life, Great-West Life, Irish Life, London Life and Putnam Investments.   ICM Financial offers wealth management services along with commercial employee benefit packages.  Power Financial, through its interest in Pargesa (PRGAF, PARG.SW), owns about 12.5% of Groupe Bruxelles Lambert (GBLBF, GBLB.BR.), itself a holding company with concentrated equity investments in major European companies.    For example, GBLBF owns a 3.6% interest in the French oil giant Total (TOT) and represents about 20% of GBL’s book value. 

Power Corp pays a $1.04 annual dividend for a current 4.8% yield.  Unlike many of its US counterparts, Power Corp improved its long-term value during the financial crisis of 2007 to 2009 by earning their dividends and maintaining their payouts.  However, like much of the financial sector, Power company stocks slid by about 50%. PDWCF raised their dividend by 7% earlier in the year.

As interest rates turn up in the US and Canada, insurance companies are expected to be positive benefactors of higher interest rate spreads.   As the US Dollar weakens against the Canadian Loonie, PWCDF investors will benefit as well though higher share prices and dividends. However, as a thinly traded ADR, limit orders should be utilized for all buys and sells.

Investors seeking greater exposure to foreign financial firms should review Power Corp.

 

Thanks for reading and this article first appeared in the Oct issue of Guiding Mast Investments.  George Fisher

HollyFrontier (HFC) is out of favor, but valued priced.

HollyFrontier (HFC) is an out of favor oil refiner whose stocks has collapsed by 50%.  However, according to Morningstar, there should be a lot to like for patient and contrarian investors.  In addition, the current yield of 5.2% allows investors to generate above average income while waiting for oil markets to improve. 

HFC is among the largest independent refiners with operations in the Midwest, Southwest and Rocky Mountain regions.  HFC operates five large refineries producing gasoline, jet fuel, asphalt, heavy oil and lubricant products.  53% of recent production is gasoline.  HFC has current capacity of 457,000 barrels of processing per day, and is planning on expanding its capacity to over 500,000 barrels.  Similar to its peers, HFC has been dropping down terminal and pipeline assets to a MLP, Holly Energy Partners (HEP).  HFC is the General Partner and owns 39% of HEP outstanding shares. 

While the refining segment has been weak in operating profits from a substantial drop in crude prices, a shrinking of crack spreads, and a buildup of gasoline and finished products, HFC has historically out earned many of its peers.  Comparing a list of operating profit per barrel of crude refined for its peers from 2011 to 2015, as offered on their investors presentation, HFC has generated first class operating profits per barrel.  Its 5-yr average profit per barrel is best of its peers.  In 4 of the last 5 years, HFC has been either #1 or #2 in profitability.   

At 17%, HFC also excels in generating returns on invested capital.  HFC bests its peer 5-yr average of 13% by 30%, and is second only to Western Refinery’s 19%.  Even in today’s tough operating environment, HollyFrontier continues to generate operating results that exceeds its peers.

One important advantage for HFC is the complex nature of its refinery assets allows the firm to utilize lower cost heavy sync crude from the oil sands.  HFC’s complexity ratings is 12.1, on a scale of 1.0 to 14.0, with a US average refinery complexity of 9.0.  For investors, this means that HFC operates one of the most complex and potentially profitable chains of refinery assets in the US.  The higher complexity factor allows HFC to refine lower grades of crude into gasoline and diesel, potentially expanding comparable margins.   When the oil market returns to more normal pricing, HFC’s profitability should improve.

Morningstar rates HFC as 5 Star with a price target $47, and believes HFC is trading at a 45% discount to its fair value.  M* is looking for West Texas crude to average $50 in 2017, $65 in 2018, and $60 in 2019.  This pricing level for WTI will support higher profits for HFC.  While many Gulf Coast refiners rely on water-borne oil for supply whose pricing reflects the Brent price collar, the mid-continent locations of HFC refineries allow the firm to utilize WTI priced crude.  The spread between Brent and WTI (with WTI lower) can be as much as $5, giving HollyFrontier a distinct cost advantage in a low margin, commodity business. HFC’s ability to utilize both sync crude and WTI will continue to allow the company to operate with one of the higher profits per barrel of throughput.   

HFC announced its second quarter earnings at a loss of -$2.33 per share after non-cash charges for impairment of goodwill and asset write-downs.  Before the $650 million of charges, HFC earned $0.28 a share for the qtr.  For 2015, HFC earned $3.90 a share and is expected to earn between -$0.68 and $1.07 (after and before charges) in 2016, $2.19 in 2017, and $3.08 in 2018.  The upcoming 3rd quarter historically has been the best of the year, followed by the 4th which is the worst of the year.   

The dividend of $1.34 offers a yield of 5.3% and is qualified.  Investors should note the dividend was cut by 60% in early 2015 due to the weak commodity environment.  The dividend is supported by operating cash flow in excess of $720 million over the previous 12 months and $533 million in cash on the balance sheet. 

HollyFrontier has a current book value of $27.80 and trades at a 6% discount to BV.  The 5-yr average price to book value is a 30% premium, which would represent a share price in the high $30s.

Investors looking to stretch for higher yield and willing to accept a higher risk over the short term may consider HFC.  While rated only B (Below Average) for 10-yr consistency in earnings and dividend growth, the prospects of a turnaround in profitability leading to higher share prices combined with a comfortable current yield should offset a lack of dividend growth. 

 

Thanks for reading and this article was first published in the Sept issue of Guiding Mast Investments.  George Fisher

Interested in buying a new Ferrari for "free" every year? It's actually quite simple.

Interested in buying a new Ferrari for “free” every year? It’s actually quite simple.  Just buy 400,000 shares of Ferreri NV stock (RACE) and receive a $0.51 per share annual dividend.  This will total about $16,000 more than the entry level Ferreri at $188,000.  (However, the stock will cost you $18 million to begin).

Last fall, Italian auto maker Fiat/Chrysler spun off its ultra-high end luxury and race car division.  Now publically traded, RACE is rated 4 Star by Morningstar and generated an interest for further research. 

Of instant notice is Ferreri’s profitability.  RACE generates high ROIC in the upper teens and low twenties, and gross margins of over 50%.  As with many luxury goods manufacturers, one feeds the other, with the image of exclusivity driving both.  There is almost no other automotive brand that competes with Ferrari as the retail brand plays heavily on its Formula One success.  As the global economy continues to expand, the pool of high-net-worth potential customers is expected to grow. 

Morningstar’s comments: We calculate that Ferrari's median EBITDA margin during the past 10 years is 25.8%. The only other automotive company that had matching profitability in the same time frame was Porsche at 26.3%. The next closest, BMW, was roughly 10 percentage points lower at a 16.2% EBITDA margin.

On the downside, the cost to stay ahead of the Formula One pack is expensive and a few years of poor racing successes could weigh on RACE brand exclusivity and hence its profitability.  

Over the past 10 years, M* calculates revenues grew by 9% annually while volume increased by 4% annually.  This demonstrates the pricing power enjoyed by Ferrari.  With similar growth, volumes are expected to top 9,000 units in 4 years. 

UBS covers Race and recently issued a description of the company as reported on benzinga.com:  UBS's Michael Binetti commented on Ferrari's positive outlook, previewing earnings. After positive analysis, Binetti reiterated the automotive company's Buy rating and $50.00 price target. Binetti believed Ferrari's future earnings reports would act as a "thesis stress test" for Ferari. "RACE's car shipments declined by less than 5 percent vs luxury auto peers' shipments down over 30 percent in the same period… and the model is about to be tested [again]," said the UBS analyst.

The analyst was seeing "sluggish spending" in global luxury categories; however, Binetti's recent conversations with Ferrari management instilled confidence in the company's ability to continue its "strong" new car innovation initiatives and positive margin drivers' growth.

"RACE deserves to trade in line with global luxury peers due to high visibility into revs & cash flows as most products are pre-sold to wealthy consumers via long waitlists," stated Binetti.

As a European firm using RACE as its US ADR trading vehicle, Ferrari reports in Euros and investors need to factor in currency exchange risks.  M* calculates that for every $0.05 increase or decrease in the Euro:US$ exchange rate will impact RACE Fair Valuation by $2.30. The current Fair Valuation is $52 based on a 1.14:1 ratio.  If the euro strengthens to 1.30:1, Fair Valuation could jump to almost $60.

RACE is trading at $45 and a current M* valuation discount of 13%.  Nibbling here with an eye towards adding more around $41 would be advisable.  You may be able to afford to buy a few more shares of RACE than the cars it produces.   

 

This article first appeared in the Aug issue of Guiding Mast Investments.  Thanks for your time and interest.  George Fisher

BGC Partners: Potentially 45% Undervalued Plus 7.2% Qualified Dividend

BGC Partners (BGCP) is a unique financial firm with a diversified revenue stream.  BGCP is a financial brokerage firm in third-party markets; a commercial real estate broker for sales, lease, and operational property management; has substantial cash along with investments in exchange-operator Nasdaq (NDAQ). 

BGCP Financial Services offers brokerage facilities to institutions and banks.  These include trade execution, clearing, and broker-dealer services.  As major banks continue to withdraw from proprietary trading and as financial product structures become more complex, BGCP’s services will be more valuable. 

Real Estate Services include commercial real estate sales services, leasing and property management, along with consulting and advisory services.  BGCP’s major brand is Grubb Knight Frank, Newmark, Cornish & Carey.

Revenues for the 2nd qtr 2016 totaled $652 million.  Sales were generated 60% in North America, 32% in Europe, Middle East and 8% in Asia, and were generated by the following areas:

 Financial Services:

Interest Rates, Credit, F/X services 42%. 

Energy, Equities, Commodities trading 18%

Real Estate:

Leasing, property management 26%

Capital markets 13%

BGCP owns about $850 million in Nasdaq stock, payable over the next 15 years. A few years ago, BGCP sold an electronic trading platform for cash and stock to Nasdaq with a multiple year payout.  BGCP is expected to receive approximately $50 million a year in Nasdaq stock.  This asset is not on BGCP’s current balance sheet

In addition, the company has cash on hand of about $450 million and an equal amount of non-Nasdaq investments.   Total debt as of the most recent quarter is $1.1 billion, and is comfortably covered by current cash and investments of $900 million.     

BGCP is co-managed by financial powerhouse Cantor Fitzgerald, with some top executives overlapping responsibilities.  For example, Howard Lutnick is CEO of both firms.  Investors need to appreciate that BGCP stock is used as a compensation tool for management, and is one reason the dividend is quite high. 

BGCP pays an annualized dividend of $0.64 for a 7.22% qualified dividend yield.  Many stocks with this level of income are more complex MLPs or could be non-qualified dividend payers such as REITs or some preferreds.  BGCP’s next ex-dividend date is just around the corner on Aug 16.   

BGCP may offer a clear upside based on valuation.  Updating last fall’s valuation matrix offered by Nat Stewart, Opus Cap Management, BGCP could be worth as follows:

A)     Financial Services: Voice/Hybrid financial services and Electronic trading generated $300 million in annualized 2nd qtr pre-tax earnings x 15 times = $9.04 per share.   

B)     Real Estate Services:  $100 million pre-tax earnings x 11 times = $2.50 per share.

C)      $850 million of future Nasdaq stock = $1.92 per share.

D)     Corporate net debt ($900 million liquidity minus $1,100 million total debt) = -(0.50) per share.  

The sum of these parts equates to $12.98 a share, or about $4.11 above the current price of $8.87.

Adding this 45% potential undervaluation to a 7.22% current yield should gain the attention of most small cap and income investors.     

I have been buying BGCP for a combination of income and capital gains potential.  I feel comfortable with both from a long-term perspective.

 

This article first appeared in the Aug issue of Guiding Mast Investments.  Thanks for your time and interest.  George Fisher

Spectra Energy Partners (SEP) : Low Risk Natural Gas Pipeline MLP

I have owned SEP for several years, making my first purchase in mid-2012 with share prices at $31 and a quarterly dividend of $0.48 ($1.92 annually).  Shares now trade at $46 and the quarterly dividend is $0.64 ($2.56 annually).  This represents an increase in income of 35% and capital appreciation of 48% over the past 4 years. 

Spectra Energy Partners is one of the largest pipeline MLPs with assets including more than 15,000 miles of transmission and gathering pipelines, approximately 170 billion cubic feet of natural gas storage, and approximately 4.8 million barrels of crude oil storage.  SEP is a MLP spin-off of Spectra Energy (SE), a natural gas utility.  SE is the General Partner and the parent with about $6 billion in projects under construction that will eventually drop down to SEP, fueling SEP’s continued growth.  SE has identified an additional $20 billion in projects that could move forward by the end of the decade.  With a market cap of $13 billion, SEP is the 9th largest US pipeline company, and has strong exposure to the growing footprint in the Marcellus shale, the US’s most prolific gas play.   

SEP’s network of interconnecting gas pipelines connects several major gas fields with substantial user markets.  The core of SEP's gas pipeline system is Texas Eastern Transmission, a massive pipeline that can move 10% of U.S. gas consumption and which runs from the Gulf Coast to New York, directly through the heart of the Marcellus. SEP also owns Algonquin Gas and the Maritimes and Northeast Pipeline, providing gas to New England along with 50% of Gulfstream, one of the major gas pipes into Florida.  The key and unique feature to this pipeline system is that all of Spectra's gas pipelines are interconnected.  Utilization on the pipes is high and all pipelines generate fixed-fee cash flow from long-term contracts, making SEP one of the most stable cash generators in the MLP sector.   

SEP is one of the few MLPs that acts as a pure tollbooth operator--it has no commodity price exposure, and about 95% of its income stems from long-term capacity contracts. The average term of its contracts remaining is between 9 and 10 years.   In the current low gas price environment, many MLPs are struggling with their commodity exposure. 

Over the past 5 years, SEP has greatly outperformed its peers as calculated by the total return of the Alerian MLP Index.  A $100 invested in SEP on Jan 1 2011 would have been worth $188 as of last Dec vs $107 for the Alerian MLP Index and $180 for the S&P 500.  

However, as with most MLPs, SEP pays a pretty penny to SE for General Partner services.  Typically compensated by Incentive Distribution Rights, or IDRs, SEP pays its general partner fees based on cash available for distribution, with incentive thresholds along the way.  SEP currently pays a fee equal to a maximum of 50% of distributable income over $0.45 per share per quarter.  This will total about $300 million in 2016 and is expected to rise to $475 million in 2018, and represents General Partner payments increasing from $1.00 per SEP share in 2016 to $1.58 in two years. 

While typical in the industry, it is important for investors to appreciate the payments going to the General Partner.  Owning both the MLP and the General Partner is an approach I utilize to take advantage of lucrative IDRs.     

Income investors seeking a reasonable 5.5% yield with the tax advantages of a MLP should review SEP if it is not already in the portfolio.  The quality of its assets, the growth platform as laid out by management, and the lack of commodity exposure should make Spectra Energy Partners a quality, long-term investment selection.  

 

This article first appeared in the July issue of Guiding Mast Investments.  Thanks you for reading.  George Fisher

 

Johnson Controls: From Hoover Ball Bearing to Tyco's Rolodex of 3 Million Clients

Johnson Controls (JCI) is a mid-cap industrial firm offering steady growth at a fair market valuation.  Founded in 1883, JCI has a long history of earnings and dividend growth, fueled by a combination of acquisitions and organic growth. 

WS Johnson, founder of JCI, is the father of multi-zone heating systems, inventing the multi-zone pneumatic control system.  Called an electric tele-thermoscope, this system of multiple thermostats and heating/cooling zones is still a major component of JCI today. 

JCI has expanded into a major worldwide player in the building and construction energy efficiency business, and the company continues to morph its business.

I first learned of JCI in 1985 when the company purchased a firm of which we owned stock. My bride’s grandfather had been on the Board of Directors of the Hoover Ball Bearing Company, which itself had morphed from manufacturing steel tanks and ball bearings in 1949 to automotive seats and interiors.  At that time, JCI was a manufacturer of automotive batteries, looking to expand its auto OEM business.  We owned some shares in Hoover and participated in the acquisition by JCI.  I have owned JCI on and off since 1985, depending on college education tuition payment requirements.   As all my kids have graduated and it’s not yet time for grandkids to suck me dry, I’m a current shareholder. 

JCI continues to transform its business and has announced major restructuring over the past 12 months.  JCI announced it was spinning off its auto interiors business while retaining its auto battery business, now called the “Power Segment”.

The interiors business accounted of 54% of 2015 revenues, making the split a substantial change in business profile.   JCI recently sold some non-core auto assets and established a joint venture with Hitachi for others.  JCI is pursuing a spin-off of its Automotive Experience business. Following the separation, which is expected to take effect in Oct 2016, the Automotive Experience business will operate as the independent, publicly traded company named Adient. 

Management also announced it was merging with Tyco Int’l (TYC), a fire/security alarm system company, and plans to move its headquarters from Milwaukee to TYC’s home country of Ireland.  TYCO offers home and commercial security and fire protection systems, and purchased the Brinks Security firm in 2011. Under the terms of the agreement, JCI shareholders are expected to own about 56 percent of business equity, and Tyco shareholders will own about 44 percent. The company will have annual revenues of $32 billion.

Tyco brings an active rolodex of over 3 million customers.  Johnson Controls has a network of 15,000 heating and air conditioning service providers.  The ability to cross-market security and fire protection programs with building energy efficiency platforms for heating and cooling is an intriguing opportunity.  It is this cross-marketing that is driving the merger and refocus of JCI. 

While auto OEM accounts for 25% of battery sales, the spin-off of Adient will greatly shift JCI’s customer risk away from concentric automotive trends to more ongoing building maintenance and construction.  JCI should no longer be lumped together with low-growth automotive suppliers. 

Being categorized as an auto supplier has hurt share values.  According to Credit Suisse, the “new” JCI, with Tyco merged and Adient spun off, will improve valuations.  The Building Efficiency, Power, and Tyco segments EBITDA could create share prices at 10.5 to 11.0 times while the auto Adient business could be valued as low as 4.5 times EBITDA. 

According to Credit Suisse, JCI is currently worth about $50 a share, while it is trading at a price below $45.  Several other analysts also have price targets in the $50 to $55 range, make the current share price undervalued by between 13% and 22%. 

According to fastgraph.com, JCI has generate an 11.3% 20-yr average annual returns vs 6.9% for the S&P.  However, over the previous 3 and 5 year time frames, JCI has underperformed and the automotive supplies sector has not been an erupting volcano of opportunity.  With the spin-off of Adient and the merger with Tyco, better days should lie ahead for shareholders. 

The restructuring and refocus of JCI comes with a higher execution risk.  It is this risk that is creating uncertainty and a lower current valuation.  The ongoing yield of 2.3% is not very exciting, but is more than offset by a 14% 5-yr dividend growth rate.

Investors looking for growth and income should take the time to review Johnson Controls. As the cloud of uncertainty lifts with increasing earnings growth and a successful cross-marketing campaign, JCI’s PE multiples should expand from its current 11 to a more reasonable 13 to 15. 

This article first appeared in the July issue of Guiding Mast Investments.  Thank you for your time and interest, George Fisher