Canadian-based Power Corp: Compelling value and Benefactor of a Weaker Dollar

Power Corporation combines undervalued NAV with benefits of foreign dividends in times of a weakening US Dollar.   

Power Corporation (PWCDF) is a Canadian financial holding company trading at a discount to the sum of its parts.  In addition, if the US Dollar were to weaken against the Canadian Dollar, income investors will be rewarded through a higher yield.  

However, the structure is a bit complicated.  Power Corp major assets include:
-    65.7% interest in Power Financial Corp, 
-    100% ownership of Square Victoria Communications,
-    100% ownership of Power Energy Corp,
-    100% ownership of the Sagard Funds.

Power Financial is a major Canadian financial services firm focused on insurance and investments.  Power Financial owns interests in several well-known life insurance and wealth management firms, these include:

1) 62.7% stake of Great West Lifeco. Great West Lifeco owns the following insurance companies:  The Great West Life Assurance Company, London Life Insurance Company, The Canada Life Assurance Company, Irish Life Group Limited, and wealth advisors Putnam Investments.  Combined, Great West has $1 trillion in assets.  

2) 58.8% stake of IGM Financial.  IGM in turn owns Canadian-based wealth managers Investors Group, Mackenzie Financial Corporation, and Investment Planning Counsel.

3) 27.5% indirect ownership of Brussels-based holding Company Groupe Bruxelles Lambert.

Power Financial’s interest in Great West Lifeco is worth C$21.07 billion (USD$15.05), and IGM C$5.07 billion (USD$3.63 billion).  With Groupe Bruxelles Lambert’s US$12.9 billion market cap, a 27.5% interest would be valued at C$3.5 billion (USD$2.4 billion).  Combined, Power Financial could be worth around C$29.66 billion (USD$21.60 billion).  

Power Corp’s interest in Power Financial could be worth about C$18.53 billion (USD$13.24 billion).  

In addition, Power Corp owns investments in Canadian roof-top solar, manufacturing, a French-Canadian newspaper which is a top Canadian site for news and information, along with online employment and advertising agencies.  Power Corp also owns Sagard Funds, a diversified European private equity fund manager, with investments in the US and China.  

As of June, Power Corp had C$812 million in cash and C$652 million in debt.  In addition, Power Corp other investments in Saga Funds, Power Energy and Square Victoria Communications is on the books as having a value of $2.1 billion (USD$1.6 billion).  In total, Power Corp should have an NAV of $20.7 billion (USD$14.9 billion)

However, PWCDF has a market cap of C$13.27 billion (USD$9.45 billion). Current valuations puts a 35%+ discount to a sum of the parts estimates.  Power Corp pays a quarterly dividend of C$0.31, or C$1.24 a year.  At the current exchange rate, this would be equal to USD$0.96 per share annually.  With PWCDF trading on the OTC markets at $20.60, the dividend would create a 4.6% yield and represents a comfortable 30% payout ratio.

Power Corp traded at a 9.1 PE vs a 5-yr average of 10.8, for a 15% undervaluation from its 5-yr average.   S&P and Dominion Bond Credit Ratings both rate Power Corp as “A” with a stable outlook.

The US share price collapsed with the strength of the US Dollar and represents an almost 30% difference in valuation solely from the foreign exchange exposure.  The Canadian Dollar has historically traded about parity to the US Dollar, but as with all major currencies, has declined to about $0.71 on the $1.

If the USD weaken in 2016, the US share price and dividend income would respond accordingly, increasing the potential gains for investors.  Even without a currency adjustment, Power Corp’s consensus price target is around C$35 for a 25% potential gain.

Investors looking for income and willing to take on a bit of foreign exchange risk should look at Power Financial.  The rewards could be quite pleasant over the next few years as the US Dollar weakens and Power Corp continues to grow, gaining higher investor attention.

This article first appeared in the Jan 2016 issue of Guiding Mast Investments.  

Thank you for reading,  George Fisher

It's Time to Focus on Taxes

Year-end is fast approaching and the time for tax planning is slipping away.  Forbes and Morningstar published articles as a reminder of familiar actions investors may take to reduce their tax burden.

1. Contribute to a tax-advantaged savings plan.

Contributing to a 401(k) or an IRA may be the smartest tax move that most taxpayers can make. Not only does it reduce your taxable income for the current tax year and allow your potential earnings to grow on a tax-deferred basis, it also helps get you closer to achieving your retirement savings goal.

Contributions to your 401(k), 403(b), or similar workplace retirement plan must be made by December 31, 2015, to impact your 2015 taxes, so you need to act quickly to increase your deferral. The 2015 401(k) contribution limit is $17,500 ($23,000 for people age 50 or older). With a non-workplace IRA, you have until April 15, 2016, to make a 2015 tax-deductible contribution of up to $5,500 ($6,500 if you’re age 50 or older).

Other possibilities for tax-advantaged plan contributions are a Simplified Employee Pension plan (SEP), for self-employed individuals, or a Health Savings Account (HSA). Contributions to either of these plans can be made up until April 15 and still apply to 2015.

2. Adjust your withholding.

Ideally, the amount of money withheld from your paycheck or sent to the IRS in quarterly payments should come very close to your actual tax liability. Withhold too little and you could have a big tax bill when you file your return. Withhold too much and you’re giving the IRS what amounts to a tax-free loan of money that you could be using to pay down debt or save for retirement (and, potentially, reduce your taxes). There’s still time to adjust your withholding for 2015 by making changes to the W-4 you have on file with your employer, or, if you make quarterly payments, by increasing or decreasing your payments between now and when the last 2015 payment is due in January. Keep in mind that the longer you wait, the fewer pay periods you’ll have to reach your target.

3. “Harvest” your investment losses.

If you have capital gains outside of your retirement accounts, you may be able to lower your tax liability through tax-loss harvesting. That simply means selling losing investments that no longer fit your investing strategy and using the loss as a write-off against some or all of your gains. If you employ a tax loss harvesting strategy, you must be aware of the wash-sale rule that disallows the write-off if you purchase substantially the same investment 30 days before or after the loss sale.

Note: The time has passed for the “double down” strategy of tax loss harvesting.  In Nov, investors could have bought shares of their losers, waited 31 days and then sold their original shares to maintain their position and capture their paper loss. Now, if investors want to harvest their loss for 2015, they either need to exit the position for 31 days or switch to a similar but not the same investment.

4. Contribute to charity.

Contributing to charitable causes before the end of the year is a tried-and-true tax-reduction strategy for taxpayers who itemize deductions. But remember to get a receipt for every contribution you make, not just those over $250. Also, if you want to be more strategic, you could open a donor-advised fund, which offers several advantages for managing your charitable-giving activity. You could, for example, contribute a lump sum to the fund before December 31, take the entire deduction on your 2015 tax return, and then instruct the fund to use the money to make next year’s gifts.

One strategy that offers two tax benefits is donating appreciated securities, such as stocks or bonds, to charity. The tax code allows you to use the current market value of the asset as a deduction without having to pay tax on the capital appreciation, so you get the charitable contribution deduction and avoid capital gains tax.

5. Use your annual gift tax exemption.

An individual can give up to $14,000 a year to as many people as you choose ($28,000 if you and your spouse both make gifts) to help reduce the amount of your estate and help reduce or avoid federal gift and estate taxes. This may include cash, stocks, bonds, and portions of real estate.

However, anything above $14,000 per person per year may be subject to gift taxes, so it’s important to keep track of this information. For more information, speak with your tax adviser and review IRS Publication 559, Survivors, Executors, and Administrators.

If you would like to contribute money toward a child’s education, consider a 529 plan account.

Contributions are generally considered to be removed from your estate. You can also make a payment directly to an educational institution and pay no gift tax.

Note: I prefer to use a Coverdell Educational IRA for the initial $3,000 per child contribution.  The Coverdell offers better control over the investment selection process and does not usually carry as high a fee as many 529 plans. 

6. Accelerate deductions.

In addition to charitable contributions, other types of deductions offer some flexibility. If you make estimated state or local tax payments, for example, you could send in the January payment before the end of this year. And maybe you could do the same with a property tax bill that’s due near the beginning of the next year. Other possibilities include accelerating payments for medical services or purchasing work-related items, such as uniforms, for which you are not reimbursed. Recognize, however, that increasing your tax deductions only makes sense if you have enough of them to exceed the standard deduction of $6,200 for single taxpayers, $12,400 for married couples filing jointly, and $9,100 for heads of household.

BGCP Partners: 46% of Market Cap is in stock of Financial Exchange Comanies

BGCP has sold two segments of its business for $1.2 billion in stock of NASDAQ (NDAQ) and Intercontinental Exchange (ICE).

A few months ago, we wrote a piece on BGC Partners (BGCP) and BGCP has been one of our top rated stocks.  As discussed, BGCP was in an acquisition battle with CME Group (CME), operators of the Chicago Mercantile Exchange, over GFI Group a European-focused middle market broker.  BGCP won with an offer of $750 million.  The crown jewel of GFI’s business is an electronic trading platform known as Trayport.   Trayport’s specialty is trading energy and commodity contracts.

As anticipated, BGCP recently announced the sale of the Trayport platform to Intercontinental Group (ICE), operators of the NYSE.  The sale price is $650 million in ICE stock.  In 2014, GFI’s revenues were split with Trayport trading platform accounting for around $80 million and the balance of GFI generated $640 million.   Based on these numbers, BGCP sold Trayport for 8 times revenues and paid 0.16 times revenue for the remaining GFI business.    

In addition to this sale, BGCP recently sold another trading platform used for trading currency futures to NASDAQ for $750 million, mainly in stock, which is to be paid out over the next 12 years at about 1 million shares annually, or a value of about $50 million a year. 

Combined, these two deals create assets of over $1.2 billion, or about 46% of the market cap of BGCP at $2.6 billion.  BGCP’s revenue are split 60% financial services and 40% real estate services. 

As shown, BGCP is a niche financial services and real estate services company.  While the real estate services are fairly straight forward as a leading commercial property leasing and sales broker, the financial services are a bit more specialized.  A good description of the financial services is provided by the company:

The Financial Services segment provides brokerage services, including fixed income securities, interest rate swaps, foreign exchange, equities, equity derivatives, credit derivatives, commodities, futures, and structured products. This segment also offers trade execution, broker-dealer, clearing, processing, information, and other back-office services to a range of financial and non-financial institutions; and electronic marketplaces comprising government bond markets, interest rate derivatives, spot foreign exchange, foreign derivatives, corporate bonds, and credit derivatives. In addition, it provides screen-based market solutions, which enable its clients to develop a marketplace, trade with their customers, issue debt, trade odd lots, access program trading interfaces, and access its network and intellectual property; software and technology infrastructure for the transactional and technology related elements; and certain technology services. Further, this segment offers financial technology solutions, market data, and analytics related to select financial instruments and markets through BGC Trader and BGC Market Data brands.

BGCP’s client base is diversified and primarily serves banks, broker-dealers, investment banks, trading firms, hedge funds, governments, corporations, property owners, real estate developers, and investment firms, as well as institutional clients.  62% of its business is from the Americas, 30% from Europe, and 8% from Asia.

BGCP was originally spun off from privately-held Cantor Fitzgerald, and Cantor still owns 25% of outstanding shares.  Management owns 31% and the public owns the remaining 44%.  Howard W. Lutnick is the Chairman of both BGC Partners and Cantor Fitzgerald.

Last month, BGCP raised their divided 16% and the stock now yields 5.96%.  BCGP is not a REIT or a MLP, and its dividends are qualified for tax purposes.

Investors should keep in mind the stock is used as a compensation tool for management.  This is the reason for a large yield and lots of stock options.  On the positive side, retail investors are linked at the hip with management’s self-serving goal of higher dividend income and higher share prices.   

BGCP is an underfollowed niche financial firm managed by some of the smartest minds on Wall Street.  Their push into real estate services should do well over the next few years as the fragmented commercial business consolidates and is the company’s growth platform going forward.  The current stock price of under $10 is a bargain based on BGCP’s holding of $4.60 in ICE and NASDQ stock. BGC

The Austrian Oak's Rules for Sucessful Investing

Arnold Schwarzenegger gave an interesting speech recently at the Global Transformation Forum in Kuala Lumpur, Malaysia.  The speech was short, and was an outline of his six rules of success.  Whether you like the Austrian Oak or not, it is difficult to argue with his level of success.  The rules are simple and directly apply to every investor. Take a few minutes to see how you are implementing the Austrian Oak’s guidelines.   

1. Have a vision.

“If you know where you're going everything will fall into place.”

2. Never think small

“It takes the same amount of energy to think big, as it takes to think small. So might as well.”

3. Ignore the nay-sayers

“Take the words 'it's impossible' and 'it can't be done' out of your vocabulary. Everything the nay-sayers say is a liability, will only prove to be an asset to you.”

4. Forget plan B

“As soon as you start telling yourself that you have something to fall back on, this is the most dangerous thing, because it means you're already doubting yourself. Don't take your eye off the ball, don't take your eye of plan A, there is no plan B!”

5. Work your ass off

“You never want to fail because you didn't work hard enough. None of my rules will help you, unless you're willing to work, work, work! You can't climb the ladder of success with your hands in your pocket.”

6. Don't just take, give something back

“We must serve a cause greater than ourselves. All of us need to create change. Don't just work on 'me', work on 'we'”

Success in accomplishing any financial goal begins with an objective and plan how to get there.  If the vision is to have sufficient funds saved and invested upon retirement in 30 years, development of a plan with benchmarks along the way will aid in its attainment.  Markets go up and markets go down, and what seemed very achievable in strong markets may not seem so in market declines. But staying the course with a clear destination in sight will help offset short-term negative investment psyche.

Developing a successful portfolio management and investment plan incorporates most of the above attributes. Determining your specific level of risk and overall investment goals will ensure a better portfolio outcome.  If you are risk adverse, buying a speculative utility stock with a higher dividend, justifying it as an income play, may not suit your overall needs.  Overweighting in a few industrial sectors may not be an inappropriate strategy, unless it is done unintentionally.

Time and efforts spent to expand your knowledge of finance always pays off in the long term.  It is important to know what you know and to know what you don’t know, and then to stay within the comfort zone of what you know.  As your knowledge expands, so does your comfort zone of investment strategies and options.

Thanks to a good friend, Mr. Bugs Tan, a renowned industrial inventor from Kuala Lumpur, for bringing this short speech to my attention.  Thanks, “Uncle Bugs”. 

This article first appeared in the Nov 2015 issue of Guiding Mast Investments.  Thanks for reading,  George Fisher

A link to the one minute speech: 

https://www.youtube.com/watch?v=tFsUeUJiA9k&feature=youtu.be

What's Up with Stock Charts on Aug 24th?

Most investors look at charts as an important aspect of their initial investment decisions and of their investment monitoring.  On occasion, you look at a chart and scratch your head, thinking, “What is going on here”.  Such could be the case for some ETFs and stocks on Aug 25.

Reviewing the Equal Weight S&P 500 ETF (RSP), the close of the day was $72.30, marking a new 52-week low at the close.  However, the low of the day was recorded at $43.77, and stands as the official intraday price for most 52-week high and low reporting.  Review RSP charts offered above as a line graph and a point and figure graph to demonstrate this occurrence.

What happened is known as a “Flash Crash”.  A flash crash is a very rapid, deep, and volatile drop in prices occurring within an extremely short time period. A flash crash frequently stems from trades executed by computerized and high-frequency trading. 

On that Monday, in an instant, confusion descended and strange glitches were reported. Stocks fell like rocks, only to shoot back up minutes later. Exchanges spit out the wrong prices for widely held funds.  Some brokerage firms reported slow trading for its online customers.  Trading circuit breakers, or forced time-outs, were triggered at a rate 100 times more often than normal. The Washington Post described it as: “Popular stocks and ETFs bounced like rapid yo-yos.” 

       General Electric (GE) dropped 8% in seconds and then recovered just as quickly.

·        Vanguard Consumer Staples ETF (VDC) was briefly down 32 percent.

·        The iShares Select Dividend ETF (DVY) fell a similar amount.

·        In 15 minutes, the SPDR S&P Dividend ETF (SDY) dropped 33 percent, recovering within half an hour.

·        NASDAQ 100 ETF (QQQ) collapsed 17%, and along with others, recouped most of its losses quickly.

Our beloved Equal Weight S&P 500 (RSP) closed on Fri Aug 21 at $76.39.  The ETF opened on Mon Aug 24 at $71.39 for an initial decline of 6.8%.  Over the course of the flash crash, RSP fell to a low of $43.77 for an eye-popping decline of 38.6% from its open and 42.9% from its Friday close.  RSP closed the day at $73.33 for a daily decline of 4.0%.  

However, the stocks that comprised these ETFs did not decline by a representative amount.  For example, while VDC declined 32% during trading house, the underlying stocks within the ETF did not decline greater than 9%. 

While looking at stock charts and reported 52-week high and low ranges, it is important for investors to realize sometimes these low prices were not reflective of the market on that day and were unavailable to most retail investors like you and me - unless you were selling as a pre-programed stop-loss order. 

Stop-loss or good-til-canceled GTC limit sell orders were trigged by the swift action of their intended computerized precision, but also added fuel to the decline. Both of these order types do not guarantee an execution price but rather triggers a trade at or below the designated price. The execution price can be below the designated stop-loss or limit price if trading continues to fall between the activation price and market execution.   This was the case on Aug 24.    

Retail investors probably lost billions as their pre-programed stop loss orders were executed at what was unsustainable and unrealistic low prices.  Someone was on the other side of the trade, and they were the recipients of the billions lost by retail investors. 

Setting stop losses is a popular strategy to reduce risk exposure if either the premise for buying a stock or ETF proves wrong or in the case of a wide spread market pull back.  However, the computerized nature of these orders puts investors at greater risk in the event of a crash as experienced on Aug 24 – regardless of the reason. 

Similar too many other investing actions, the best use of stop loss and GTC orders is: Know What You Are Doing and Caveat Emptor

This article appeared in the Oct 2015 Issue of Guiding Mast Investments.  Thanks for reading, George Fisher

Go North, Young Man, Especially in Taxable Accounts

Interesting income opportunities from a geographically limited Canadian REIT.  Go North, Young Man, especially in taxable accounts.  John Babsone Lane Soule in an 1851 editorial in the Terre Haute Express, offered the phrase: "Go west young man, and grow up with the country."  Investors seeking higher after-tax income may want to look north of the border.  Canadian REITs offer both steady income and have some interesting tax implications that could be favorable to US investors.  

Canadian REIT yields are tax advantaged versus their U.S. counterparts. The Canadian authorities withhold 15 percent on their side of the border, as is the case for all trusts.  However, as with all foreign distributions in non-tax advantage accounts, U.S. investors can recoup a vast majority of these taxes by filing Form 1116 with their U.S. taxes.

Specifically, Canadian REITs are treated as foreign equities for U.S. tax purposes, so their dividends are taxable at a maximum rate of 15 percent like any other qualified stock. In contrast, a U.S. REIT’s dividend is taxed as ordinary income.
There are several Canadian REITs worthy of additional research by US income investors.  One such REIT is Cominar Real Estate Investment Trust (CMLEF, CUF-UN.TO).  Based in Quebec, Cominar owns a wide variety of real estate.  Their holdings include 566 retail, office and industrial/multiuse properties.  Of the 45.9 million sq. ft. owned, 36% is office space, 21% retail space and 43% industrial/multiuse space.  

One risk to CMLEF is its concentration of assets in Ontario.  While it is the third largest Canadian REIT and the largest property owner in the province of Quebec, the lack of diversified geography presents an interesting profile.  Although Quebec is home to more stable government-related offices than other parts of Canada, this tenant usually represents a slower growth profile than resource-based western Canada. Western and Atlantic Canadian assets represent only 10% of CMLEF’s portfolio.      

When converted into US Dollars, Cominar’s dividend are at the mercy of international exchange rates.  For example, the monthly dividend has not changed in Canadian Dollars, but when deposited in our US brokerage accounts, the amount varies.  

For example, the Canadian distribution has been steady $0.1225/share a month since it was raised 2.0% last Aug. However, when converted into US dollars, the monthly distribution has varied from $0.112, or $1.34 annualized, to $0.0.95 or $1.14 annualized.  Using the previous 12 months, distribution income totaled Canadian$1.47 and US Dollar $1.23.   

Cominar yields between 9.2% based on trailing 12 month income and 8.2% based on annualizing the most recent distribution of $.095.  If investors are looking to buy shares on the US markets, the average turnover is a bit light at 2,300 shares a day vs 263,000 shares on the Toronto exchange.  Limit orders should be utilized for US market buys and sells.  

CMLEF recently offered a secondary offering of $155 mil to finance continued expansion of its portfolio.  Share prices have been negatively affected on both the Toronto and US exchanges by this dilution, along with some concerns about stagnate, aka steady, FFO/share of $0.44 in the first quarter.  The Toronto 52 week high/low is $20.11 and $17.34 vs the US share prices of $18.50 and $13.42, respectively.  Market prices are currently sitting on their 52-week lows.

As/If the USD declines against the Canadian Dollar, not only will the US share price of CMLEF improve, but the cash income from the monthly distribution will increase as well – all else being equal.  Keep in mind the opposite is true as well.   

More information can be found on their website:  http://www.cominar.com/ENGLISH/accueil_EN.php

Note and disclosure:  We are not tax advisers and always check tax facts with your accountant and broker for the specific implications to your situation.

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

Hennessy Focus Fund Outperforms

Mutual funds are usually on the bottom of our investment selection list, but Hennessy Focus Fund is the rare exception.

Hennessy Focus Fund (HFCSX) is a mutual fund selection we can support.  It is unusual for a fund to outperform the index over all time periods.  This fund, however, has outperformed the index by an average of 3.0% over the corresponding 1-, 3-, 5-, and 10-year investment periods.  For example, the 10-yr total annual return for HFCSX is 11.05% vs 8.13% for the S&P.  According to Morningstar, since 2005, a $10,000 investment would have grown to $28,500 vs $21,800 for the S&P.    

The fund is considered concentrated with holdings of between 20 and 30 positions.  The top five positions comprise 41% of assets. Consumer Cyclicals are 37% of assets, followed by Financials at 28% and Real Estate at 20%.

The fund is high cost with an annual expense fee of a whopping 1.4%, and a minimum investment of $2500.  Total fees over the previous 10-yr period would have been $2,600.  However, with its after-fee performance as outlined above, its high fee should not be a deterrent. Would you spend $2600 to make gross $9,300 more ($2600 fee + $6700 net outperformance)?     

One interesting aspect of studying outperforming funds is to investigate their new positions. As it is impossible to replicate their success on existing positions, the strategy is to review their recent moves with the expectations of these being within their parameters that created the outperformance.  In this light, the 1st quarter purchases in HFCSX portfolio are as follows:
•    Cell tower operator American Tower (AMT)
•    Asset management firm Brookfield Asset Management (BAM)
•    Specialty finance company Encore Capital Group (ECPG)
•    Specialty material manufacturer Hexcel Corp (HXL)
•    Industrial asset protection firm Mistras Group (MG)
•    Business equipment financing firm Marlin Business Systems (MRLN)
According to Morningstar analysis, Hennessy Focus Fund carries Below Average Risk and Above Average Return, with over 75% of assets in high growth choices across the capitalization spectrum from micro caps to mega cap.  

It should be noted a trend within the markets serviced by AMT.  The latest innovation in cell towers for populated areas calls for more towers but shorter height to gain better cell coverage. 
 
This will cause more sites to be utilized for the same current area coverage, increasing competition for AMT.  Based on this change, the best days for AMT may well have passed.   

Investors looking for greater exposure to these sectors should review HFCSX.  Investors looking for fresh ideas for the growth portion of their portfolios should spend some time researching management’s recent purchases

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

KKR & Co: Value, Income & Growth

There is a lot to like about KKR & Co Ltd (KKR) – value, income, and growth, wrapped in an aggressive management history.    KKR, also known as  KOHLBERG, KRAVIS and ROBERTS, is a private equity  and hedge fund management firm, known for buying and selling companies.

KKR trades at a PE ratio that is half its growth rate, is structured as an LLP offering an 8.0% tax-advantages yield, and should grow earnings at 12% to 14% a year.  KKR manage a portfolio of assets worth $99 billion.  These include private equity ownership of companies and debt to these same companies.

KKR thrives on its brand name and expertise to buy top tier companies, improve margins and revenues, and then sell or spin off the company when appropriate.   In the interim, KKR offers mezzanine and direct financing for companies under their wing, especially after the re-incorporation of their specialty financing are, KKR Financial, in 2014.  An advantage to selling a business to KKR is their access to cheaper and more diversified capital than the majority of their portfolio companies could on their own.  

The underlying business of private equity is expected to continue to grow in size.  Morningstar believes by 2020 alternative asset managers could command 40% of the global asset manager revenue pool versus 33% in 2013. KKR invests its own capital into buyout pools along with investors.  In this way, KKR generates both an equity position in the subsequently owned asset, but charges the pool a management fee.  For example, in a recent pool offering, KKR garnished $1 billion from third-party investors, and matched that with a $250 million contribution sourced from other selling transactions.  

KKR has been very successful in generating money for additional investments, raising over $16 billion in third-party capital in 2012 to 2013. 

In addition, its reputation has helped hire and retain executives in specific field that work diligently to turnaround targeted companies.   One aspect of being taken into the fold is the fees the portfolio companies pay to KKR for consulting services utilized in the design and implementation of a new business strategy. 

In essence, KKR earns management consulting fees, becomes the portfolio company’s lender, and realizes capital gains when the company is sold. 

For example, KKR purchased a safety harness company, Capital Safety in 2012 for $645 million.  Last month, 3M (MMM) agreed to buy Capital Safety for $2.5 billion.  KKR will receive a profit of $1.9 billion for its investment, including a dividend last year.  

Bloomberg’s comments:

 KKR is notching wins as it prepares to market a new private equity fund later this year targeting as much as $12 billion. The New York-based firm has beat analysts’ profit expectations in five of the past seven quarters, benefiting from sales of drugstore chain Alliance Boots GmbH, digital-photo company Fotolio, financial-data provider Ipreo Holdings LLC, South Korean beer maker Oriental Brewery Co., retailer Dollar General Corp. and Biomet Inc., a maker of artificial hips and knees.

In a rising interest rate environment supported by underlying economic expansion, KKR should experience greater spreads in its portfolio financing and fee based businesses.  

Over the longer term, there will be a consolidation of the industry as institutions become more selective in their asset allocations.  Those firms with larger portfolios and stronger brand names will the survivors.  

Long-term investors should consider buying KKR for its current 8.9% distribution yield and the potential for capital gains.

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

Enviva Partners: Unique Biofuel MLP With Juicy Yield

Enviva Partners (EVA) is a new MLP with a juicy 8.2% yield and is the largest global producer of utility-grade wood pellets used in power generation.    

It is not our intention to cover new IPOs.  However, in the past two months there has been interesting niche companies coming to market with a MLP or REIT structure favoring higher distributions.  Last month it was InfraREIT, an electric transmission utility structured as a REIT, and this month it is Enviva Partners (EVA), a wood pellet manufacturer structured as a MLP.

EVA is a new offering by Riverside Fund, a private equity firm, and Hancock Natural Resources Group, a registered investment advisor and a wholly owned subsidiary of Manulife Financial Corporation.  This joint venture was the previous owners of the production facilities.  The JV built four plants and acquired an additional plant.  The JV is also building more plants in anticipation of dropping them down into EVA.

These five plants have current production of 1.7 million metric tons of utility-grade pellets, which is a lower grade of pellets than the “premium” grade used in residential pellet stoves.  There are plan to increase production to 2.0 million tons over the short term. 

EVA has long-term “take or pay” contracts for 100% of its production until 2017 and then 50% of production after 2018.  In other words, the factories are sold out for the next 2 ½ years – and all to the export market.

With over 170 pellet manufactures in the US, why is EVA of interest?   The Europeans are much further ahead of the US in converting their coal-fired power plants to biofuel, with pellets being the preferred biofuel.  Japan and South Korea are also growing utility-grade pellet markets.  Overall, the US supplies 60% of the global wood pellet market, and EVA is the largest. 

In 2014, power generation in Europe consumed 9.2 million metric tons of utility-grade pellets, with the UK representing 50%.  Annual pellet European consumption for power generation is expected to grow by 21% a year, representing a market of 25.8 million metric tons by 2020. 

In the US, natural gas is being used as a coal replacement due to low gas prices – just ask any natural gas E&P investor.  However, with limited domestic supplies of gas and international pricing for LNG gas running 3 to 4 times the price in the US, wood pellets are becoming an important fuel source in Europe, in tandem with a reduction of coal generating capacity.  Wood pellets have the immense advantage of being a base-load fuel source rather than the intermittent nature of solar and wind. 

In addition, EVA owns a pellet export terminal in Chesapeake VA to facilitate the export process.

Pellet plants usually source their raw materials within a 75-mile radius and the five plants are strategically located in the southeast: two in northern North Carolina, two in Mississippi and one in the panhandle of Florida.     

The JV, also acts as the General Partner, Enviva Holding GP and is building three more pellet plants, which should be sold to EVA over the next three years.  The additional production should increase current capacity by 75%. EVA also has the right of first refusal on two more export terminals in Wilmington NC and Pascagoula, MS.

The initial distribution is pegged at $0.41 a quarter, or $1.64 a year.  At a current price of $19.90, the yield is a juicy 8.2%. 

On a pro forma basis, 2014 reported cash available for distribution was $1.46.  Importantly, it does not include production acquired in Jan 2015 that substantially increased capacity.

Based on expanding capacity from the dropdowns and the additional export facilities, EVA is expected to increase EBITDA over the next three years.  This could equate to annual distributions close to the 50% top tier of the General Partner’s Incentive Distribution Rights IDR.  See the article in “Strategic Subject of the Month” section for an explanation of IDRs.  While the General Partner will see substantial per unit fee income, unit holders will be still be adequately rewarded. 

Investors could see their annual distribution increase to $2.47 from the initial target distribution of $1.61 year.

EVA began trading at the end of April, and the quiet period expired at the end of May.  While the underwriters of the IPO have an ingrained self-interest in EVA doing well, the recent consensus is a “buy” with a price target of $25.

According to benzinga.com, Goldman Sachs has a “Buy” recommendation and a $25 target price.  From their report,  

The analysts believe that the stock offers an attractive investment option, given its leverage to rapidly growing wood pellet demand, its low cost asset base, a favorable contract structure, a strong dropdown pipeline and distribution/unit growth, and compelling valuation relative to its closest comparison set.

The company is well positioned to leverage the continuing growth in wood pellet demand. This demand is being driven by major utilizes that are converting their traditional power or heat plants to burning wood pellets in an attempt to meet the EU 2020 renewable energy goals. This is especially true in key European countries, such as the UK, Netherlands, Denmark and Belgium.

The analysts also expect that EVA's sponsors will drop down six additional plants through 2019 given favorable wood pellet fundamentals, while also expecting the company to witness distribution growth at a robust 17 percent CAGR through 2018, driven by a robust dropdown pipeline and cost execution.

CitiGroup, Barclays, Raymond James, and RBC have a “Buy” on the stock.  These are also some of the book-runners of the IPO.

If their target market grows to 25 million tons and EVA’s capacity grows to 3.4 million tons by 2019, their market share of European pellets will decline from the current 18% to 14%, but still represents a substantial share.  

Investors willing to take on a bit higher risk should be amply rewarded over time.  While there is risk concerning fall-off of take or pay contracts past 2017, the growth and strength of the underlying utility-grade pellet market in Europe should alleviate much of those concerns.

For more information, the SEC IPO prospectus is linked below:

http://www.sec.gov/Archives/edgar/data/1592057/000119312515155449/d808391d424b4.htm

This article first appeared in the June issue of Guiding Mast Investments 

Thank you for reading, George Fisher

Berkshire Hathaway - Gettin' Lots of Love, and for Good Reason

Berkshire Hathaway is getting lots of love recently.  As a core long-term holding, if you do not own BRK.B, now could be the time for a starter position.

 We all know of Mr. Buffet and his stock picking acumen.  However, the real value in BRK.B lays in its base business as an insurance company and the investments its makes with its substantial cash flow, also known as the insurance float.

The insurance float is the described as the moneys collected by insurance companies that are not paid out in claims.  For example, when you pay a premium on your auto policy, they cover operating costs of keeping the lights on and of the claims being paid for other policyholders who have accidents. The difference between the two is the insurance “float”.   

 Berkshire Hathaway has amassed a sizable amount of insurance float.  At the end of 2013, BRK has $77 billion on the books, up $7 billion in just the previous 3 years.  In other words, BRK had generated $2.3 billion a year in new investable cash.   Since the early 1970s, BRK has grown its insurance float by 19% compounded a year. 

Most other insurance companies invest their float in fixed income instruments, such as bonds.  BRK, on the other hand, buys companies and operates them for the additional cash flow they can provide.  The media puts the spotlight on BRK’s publically traded stock holdings but the most compelling investment thesis is the privately held companies that are subsidiaries of BRK. 

As of Dec 2013, BRK held $115 billion of listed companies in its insurance portfolio.  This compares with holdings of $166 billion in other assets such as railroads, utilities, energy and financial firms.  BRK has more than 80 units that operate airplanes and power plants, manufacture mobile homes, bricks, and chemicals, and sell products from furniture to chocolate to running shoes. Links to the websites of 60 of these companies can be found below.

http://www.berkshirehathaway.com/subs/sublinks.html

For example, BRK recently closed on the purchase of largest privately held auto dealer in in the country, located in Dallas.  From the press release, “Berkshire Hathaway Automotive is fifth among all U.S. auto dealership groups with over $9 billion in revenue and 81 independently operated dealerships with over 100 franchises in 10 states, including Arizona, California, Florida, Georgia, Illinois, Indiana, Missouri, Nebraska, New Mexico and Texas. Through its affiliated administrator MPP, Berkshire Hathaway Automotive is able to offer its auto retail customers a unique, industry-leading portfolio of proprietary vehicle service and ancillary contracts, which are insured by its two affiliated insurance underwriters, Old United Casualty Co. and Old United Life.”

BRK has accomplished quite a feat by building an economically sensitive portfolio of assets from its growing base of insurance float.   The downside is this strategy adds economic growth risk while other insurance companies have higher interest rate and bond default risk due to their fixed income portfolios.

Nonetheless, BRK has shown the ability to manage its assets for both higher investable cash flow and the purchase of companies at reasonable prices for reasonable growth. This difference will continue to aid in BRK to continue to grow earnings by 7% to 9% a year.     

Of question is wither BRK is getting too large to keep up with its rich history.  Even after spending $26 billion on acquisitions in 2013 and 2014 combined, their cash hoard still grew to $63 billion or $22 billion more than at the end of 2012.  Management has pegged $20 billion as a comfortable cash cushion for its business profile, leaving a potential investable fund of over $43 billion.  For comparison, this excess capital would be enough to buy half of Boeing, United Technologies or 3M – for cash.    

With rising earnings trends in place, BRK is getting more attention from brokerage houses.  Over the past 90 days, earnings estimates have been rising and now stand at $7.61 for 2015 and $8.22 for 2016. 

BRK is one of those stalwart American companies that belongs in every investor's portfolio.  Why?  Because it makes money for its shareholders hand over fist, has done so for the past 50 years, and will continue to do so going into the future.  BRK very infrequently goes on sale and now is a good time either to add to an existing position or to begin a starter position.

This article first appeared in the May issue of Guiding Mast Investment

Thanks for reading,  George Fisher

InfraREIT - Financial Engineering Continues in the Utility Sector

InfraREIT (HIFR) is the first publicly traded high-voltage electric transmission company wrapped in a REIT structure.  Spun off from the Hunt family of companies in January, HIFR is structured more like a MLP than a traditional REIT. 

InfraREIT is a real estate investment trust REIT. The Company owns state-regulated electric transmission and distribution (T&D) assets, such as power lines, substations, transmission towers, distribution poles, transformers and related property and assets, in Texas. The Company leases its T&D assets to Sharyland Utilities, a Texas-based regulated electric utility privately owned by the Hunt family. The Company owns T&D assets throughout Texas, including the Texas Panhandle near Amarillo, natural gas rich Permian Basin, Central Texas, Northeast Texas, and South Texas.  Its T&D assets consist of approximately 50,000-electricity customer delivery points, approximately 620 miles of transmission lines, approximately 10,500 miles of distribution lines, 35 substations and a 300-megawatt (MW) high-voltage direct current interconnection (DC Tie) between Texas and Mexico.  75% of total assets are high-voltage transmission lines.  

Taking a page out of the MLP playbook, HIFR owns the assets, but there is no management team to run the operations.  Similar to a General Partner, IHFR has hired a Hunt-affiliated management company, appropriately called Hunt Management,  for operations and will pay a two tiered management fee.  The first is similar to the IDRs, or Incentive Distribution Rights, usually associated with General Partners and includes a fee of 20% of the shareholder distributions over $1.07 a year.  The second is a fee equals to 1.5% of shareholder equity with a minimum of $13 million and a maximum of $30 million (or $0.22 to $0.50 a share, based on 60 million shares outstanding). 

HIFR will purchase all projects developed by Hunt Development, a construction arm of the Hunt family, which falls within its service territory.  In addition, HIFR has the right of first option to buy several other transmission projects in the planning stages through Texas. 

HIFR currently has a rate base of $1.1 billion and plans on expansion of around $775 million over the next few years.  The current configurations of its assets lie within the boundaries of Texas and falls under the jurisdiction of Texas state utility regulators. Regulators have approved a 9.7% return on equity, Based on 55% debt and 45% equity structure.   As HIFR gains in size, it should be expected management will look to expand into interstate transmission assets as these are regulated by the federal government and offer a higher ROE of upwards of 11.5%.   

Management expects to grow its business by 10% to 15% a year, in line with other transmission firms like ITC Holdings (ITC).  The initial annual dividend is set at $0.90 and dividend growth should match the expansion of the firm’s underlying profits, as a REIT needs to distribute 90% of its taxable income.   

The book-runners of the IPO have issued their analysis of HIFR.  While it may be a bit self-serving to be the underwriter of the IPO and have a “Buy” on the stock, Citigroup initiated coverage at “Buy” with a $33 price target.   RBC Capital and Wells Fargo initiated coverage at Outperform.  At its current price of $27, HIFR is anticipated to generate a 13% to 15% annual total return, including a 3.3% current yield. 

Based on a 45% equity contribution and an aggressive capital expenditure growth program, current shareholders should expect share dilution over the next few years.  As there is very little in retained earnings within the REIT structure, future rate base asset acquisitions will be financed by the PUCT–approved formula of 55% debt and 45% equity.  The Hunts could increase their share count as partial payment for future dropdowns.     

As the overall utility sector continues down its path of financial engineering and consolidation, transmission REITs may be the next wave for regulated electric utilities.  Most all electric utility investors should be cognizant of the happenings over at InfraREIT.      

While IPOs are not usually part of our stock universe, HIFR is a bit different.  Founded in 1990s and converted to a REIT in 2010, the Hunt family still owns 27% of HIFR.  The company has a sizeable asset base, its profits are regulated,  and the ability to participate in drop-down assets from the Hunts.      

Latest investor presentation can be found here:

http://infrareitinc.com/files/doc_presentations/2015/201501infrareitwebsites.pdf

This article first appeared in the April 2015 issue of Guiding Mast Investments newsletter.  Thanks for reading,  George Fisher

Controversial Apollo Global Management Offers High Yield and Much More.

Apollo Global Management (APO) is one of the world’s largest alternative asset managers with a sizeable $160 billion of assets under management AUM.   The current distribution yield is 9.9%.

 However, it is not without controversy. 

 APO specializes in managing funds in the credit, private equity, and real estate strategies.  One of its biggest relationships is fixed-annuity issuer Athene with about $60 billion in AUM, or 37% of its AUM.  

 Morningstar’s description of APO’s attributes:

Apollo Global Management's specialization in illiquid credit instruments offers substantial potential in the coming years. Banks of all sizes, under tough regulatory scrutiny following the Great Recession, are shedding risky and complex credit assets to shore up their capital ratios. We see this as a secular trend, particularly as Basel III rules force banks to shed risk, and Apollo's relationships and deep expertise in the market position the firm to earn lucrative returns.

 APO’s niche is in illiquid asset management.  Of its AUM, $41 billion is in private equity, $108 billion in credit instruments, and $10 billion in real estate holdings. 

The type of assets held in each investment category is:

Private Equity:  Opportunistic buyouts;  Distressed buyouts and debt investments;  Corporate carve-outs

Credit:  U.S. Performing Credit; Opportunistic Credit; European Credit; Non-Performing Loans; Structure Credit

Athene:

Real Estate: Residential and commercial

Global private equity and distressed debt investments:

Performing fixed income.

The relationship with Athene is interesting, profitable and unique.  Several years ago, APO purchased the portfolio and developed the relationship to manage their assets.  Athene is one of the larger issuers/underwriters of annuities.  Unlike other types of customers who are looking for a return of their original capital contribution, the fixed-annuity profile of Athene is seeking return ON capital rather than return OF capital.  This allows APO to utilize its expertise – illiquid assets that provide better than market returns.   Most hedge funds and private equity firms have a 10 year life cycle for their customer’s assets, the Apollo – Athene relationship has no such constraints.  This gives APO a leg up to other alternative asset managers as a large portion of its AUM has a very long life cycle.

 Like most alternative asset managers, APO generates income from asset management fees and performance fees.  These vary based on asset categories:

Private Equity: 98pbs + 20% performance

Credit, ex Athene: 75 bps + 15% to 20% perform.

Athene:  40 bps + 0% performance

Real Estate:  77 bps + 10% to 15% performance

 APO is expected to earn $2.01 in 2015 and $2.25 in 2016. Long-term earnings growth is pegged at 10% a year.   As a LLP and similar to a MLP, APO pays out a large percentage of reported income as distributions.  This year, APO is expected to distribute $2.08 a share and $2.15 next.  

 In 2013, APO raised one of the largest private equity funds, Apollo Fund VIII, at $17 billion.  This capital is being put to work in the depressed oil and gas sector, which should provide a high return as energy returns to more “normal” valuations over the next few years.  The normalization of the energy sector could drive higher performance fees for private equity, and to a lesser degree credit assets. 

 Several of APO’s funds are traded on exchanges and are open for individual investors.  Below is a list of these funds and the current yield:

 AINV – Business Development Corp (11.0%)

AMTG – Residential Mortgage REIT (12.2%)

ARI – Commercial Mortgage REIT (10.3%)

AFT – Senior Floating Rate Fund (6.9%)

AIF – Tactical Income Fund (10.1%)

Apollo is not without controversy.  Earnings declined 58% in 2014, mainly from a large reduction in investments and their income.  Revenue declined from $3.7 billion in 2013 to $1.6 billion in 2014.    Since peaking in early 2014, APO share price has dropped 23% over the past 52-weeks while the S&P 500 is up 12% and a peer return of 7%.  

Brokerage firms either love’em or hate’em.  Morningstar has APO rated as 5-Star with a Fair Valuation target of $44 versus S&P Capital IQ rating at 1-Star and a price target of $19. 

According to benzinga.com, in March, JP Morgan reiterated its Overweight and a target of $25.  In Feb, JPM Securities maintained an Outperform with a target of $32; also in Feb, Keefer downgraded APO to Market Perform (neutral) with a target of $27.    In Dec’14 and Jan ’15, Citigroup upgraded its recommendation to Buy and Credit Suisse maintained its neutral rating

For a speculative, alternative asset selection in the diverse financial industry, APO could provide interesting total returns, supported by its high current income. APO is well worth additional research.

This article first appeared in the April 2015 issue of Guiding Mast Investments newsletter.  Thanks for reading,  George Fisher

Mercer In't: 2nd Largest Global Northern Bleach Softwood Producer Still Has Some Oomph In Its Tank

Mercer International (MERC) is a Canadian and European manufacturer of Northern Bleached Softwood Kraft pulp that is finally hitting on all cylinders.  While it is trading at multi-year highs, MERC offers interesting long-term exposure to a basic material in short supply in some markets, such as China.

 There are two types of Kraft pulp used to add strength to paper products such as tissue paper - softwood pulp and hardwood pulp. Softwood pulp is preferred as it adds more strength per ton of usage. Hardwood pulp is characterized as having shorter fibers and is less effective as a reinforcement agent. Mercer specializes in Softwood pulp.

 One of the advantages of this specialization is showing up in current and anticipated global capacity. While hardwood capacity is expected to continue its annual increase in capacity that started in 1990, softwood capacity is expected to remain flat. In 2006, both hardwood and softwood had about equal global capacity at 23 million metric tons. Capacity of hardwood pulp is expected to grow to about 34 million metric tons this year while softwood capacity is expected to remain flat at 23 metric tons. Between 2008 and 2014, hardwood capacity is expected to have expanded at a rate of 2.7% annually vs a decline of -0.5% annually for softwood.

 Mercer has an interesting history. Assembled in the early- and mid-1990s by acquiring various German paper facilities, the company grew as an affiliate of Hong Kong-based Mass Financial Corp, a network of businesses run or influenced by Michael Smith and Peter Kellogg. While Mercer separated from Smith in 1996, Kellogg still owns 8.4 million shares or about 18% of shares outstanding. Platinum Investment Group, a money manager from Sidney Australia, own 17%.

 Mercer is one of the first pulp manufacturers to expand into the bio-mass power generating business, and this gives it a huge leg up on its competitors.  A major cost in the manufacturing process pf pulp is the cost of electricity, and MERC not only generates enough electricity to be self-sufficient but to sell the excess power on the open market.  This gives the firm not only a cost advantage but also another revenue and income stream.  Operating costs decline by about $85 million a year from being energy self-sufficient and excess electricity/chemical sales adds about $100 million in additional revenues.  With annual sales in 2014 of $1 billion and EBITDA of $245 million, it is easy to see the importance of power generation and chemical sales is to the bottom line.

 Softwood pulp is used in high end paper products such as tissue, fine writing paper and absorbent materials.  As emerging markets such as China moves up the economic ladder, tissue usage also increases, creating an ever higher demand profile for the raw material.    

 MERC benefits from a strong US dollar as explained by the CEO during the most recent earnings release, “As our operating costs are primarily incurred in Euros and Canadian dollars and our principal product, NBSK pulp, is quoted in U.S. dollars, our business and operating margins materially benefit from the current strengthening of the U.S. dollar. Our energy and chemical sales are made in local currencies and as a result decline in U.S. dollar terms when the U.S. dollar strengthens. Going forward, while we will continue to benefit from a stronger U.S. dollar, it will be partially offset as in 2015 the rapid strengthening of the U.S. dollar has put downward pressure on pulp prices as a stronger U.S. dollar increases costs to our European and Asian customers."

 As a commodity driven business, profitability is directly impacted by the selling price of NBSK.  Below are multi-year graphs of the commodity pricing for Europe and the US.  It is safe to say that MERC needs strong NBSK pricing to thrive.  

The table below lists the annual operating profit margin per ton of production from 2006 to 2014.  As shown, profitability is very volatile.

With the stock price hitting 2-yr highs, having doubled from $7 to $14, and with earnings growth expected to soften this year, investors may want to nibble at the current levels.  The firm pays no dividend.  As a basic material firm with low cost manufacturing facilities and an excellent export profile, Mercer International has a bright future.  Buying on pullbacks is recommended, but MERC is worthy of being put on your radar screen.

 Latest investor presentation can be found here:

http://www.mercerint.com/i/pdf/presentations/2015-01-15-Mercer-Presentation-CIBC-Conference.pdf

This article first appeared in the March 2015 issue of Guiding Mast Investments newsletter.  Thanks for your interest,  George Fisshe

Revenue Shares Financial ETF Outperform S&P Financial ETF, But Both Hold The Same Stocks

Revenue Shares Financial Sector ETF (RWW) is a financial ETF that is weighted based on company revenues, not the usual market capitalization.  This subtle difference has created an ETF that has substantially outperformed the S&P Financial ETF (XLF) since its inception in Oct 2008 – Even though both hold the same stocks just different allocations. 

Revenue Shares Financial Sector favors financial stocks that represent the largest revenue generators in the sector, regardless of the sub-class or market capitalization.  This focus leads to an interesting portfolio of large financial stallwards.  The weighting concentrates the portfolio with 85 stocks, but the top six positions comprise 41% of assets and the top 11 comprise 60% of assets.  Below is the latest portfolio of the top six stocks:

Berkshire Hathaway               13.33%

JPMorgan Chase                     7.29%

Bank of America                     6.35%

Wells Fargo & Co                    6.16%

MetLife Inc                              4.87%

American Insurance Group     4.61%

Rounding out the top 11 positions, Prudential Financial, Goldman Sachs Group, Morgan Stanley, Allstate, and American Express each comprise between 2% and 3% of assets.

 According to Morningstar, a $10,000 investment in 2008 would be worth almost $27,000 today compared to $21,000 for a similar investment in S&P Financial ETF XLF.  

 Below is a price chart from Nov 1, 2008 to current showing RWW increased by 162% (blue line) vs a 132% increase for XLF (red line). 

Source: bigcharts.com

 Morningstar offers the following total return calculations.  While not seeming like much, the few percentage points outperformance of RWW has translated in to a meaningful difference since 2008.  Below are annual returns per M*. 

Source: Morningstar

 The sub-industry breakdown of the top 20 positions of RWW and XLF reveals the difference in asset allocation.  The top 20 for RWW comprises 72% of assets while the top 20 for XLF is a smaller 62% of assets.  RWW has a higher allocation to insurance companies while XLF has more allocated to banks, credit card companies and REITs.  Below is a breakdown of the major sub-industry allocations of the top 20 positions of each ETF:

                                    RWW               XLF

Insurance                    38.2%              13.5%

Banks                           27.4%              34.5%

Investment Banks          5.8%                6.9%

Credit Card, REITs         1.6%                7.3%                         

Below is a list of the top 20 positions of each ETF:

Source: Morningstar, My Investment Navigator

Expense ratios are a bit higher with RWW at 0.46% vs a fee of 0.15% for XLF.

 In addition, RWW rebalances its portfolio quarterly while XLF alters only when the underlying index changes.  As specific companies increase their revenues faster than their respective competitors do, it is reflected as a higher allocation in the ETF.

 The underlying ETF index is managed by VTL Associates LLC, who has introduced several revenue-weighted ETFs.  From a 2013 article in Financial Advisor magazine concerning revenue-weighted ETFs:

“We concluded that whatever the S&P is doing, it’s doing it well,” founder Vince Lowry says. “And we further concluded that the only way to beat the market is to beat the index that is the market.”

 Lowry wanted to avoid the perceived shortcoming of cap-weighted indexes, and he zeroed in on revenue as a true measure of a company’s economic value. “A revenue- weighted strategy forces investors to purchase more shares of stocks with low price-to-sales ratios and fewer shares of stocks with high price-to-sales ratios than other strategies,” he says. “Over time, this strategy results in outperformance.”

 With its higher allocation to insurance and specifically overweighed in Berkshire Hathaway, it is surprising the ETF has not caught on.  With assets of just $32 million, RWW is a small fish in the financial ETF pond.  Nevertheless, a fish that is ripe for investors.   

This article first appeared in the March 2015 issue of Guiding Mast Investments.  Thank you for fyour time and interest,  George Fisher

FPA New Income Fund: "We Don't Like to Lose Money"

For conservative investors seeking protection of principal, FPA New Income Fund (FPNIX) should be on the top of the list.   Think back to the dark days of the last financial crisis.  Some bond and fixed income prices were being hammered along with equity prices.  FPA New Income, on the other hand, was doing its job of principal protection.   The following pie chart outlines their holdings:

Morningstar offers the following chart of the value of $10,000 invested in FPNIX and in nontraditional bond index, the classification for FPNIX.  FPNIX did not experience a loss nor cut its distribution when it was common for peers to do so.  The graph covers the period from Nov. 30, 2007 to Jan. 4, 2013. FPNIX is in blue and the index is in orange.

The fund’s website offers an interest recap of their investment approach:

Objective:  The primary investment objective of FPA New Income, Inc. (FPNIX) is current income and long-term total return. Capital preservation is also a consideration.

FPA New Income, Inc. seeks to generate a positive absolute return through a combination of income and capital appreciation. To achieve this goal, we employ a total return strategy using investments in fixed income securities that focus on income, appreciation and capital preservation. Market opportunity will dictate emphasis across these three areas.

Philosophy:  We do not like to lose money!

In order to do this we adhere to the following principles:  Absolute value investors. We seek genuine bargains rather than relatively attractive securities.

From a Morningstar review: 

This fund is very well-suited for investors seeking a safe haven, but investors looking to participate in bond-market rallies should look elsewhere.

FPA New Income’s absolute returns have lagged most of its peers, but the fund’s Morningstar Analyst Rating of Silver is based on the fund’s low volatility and strong risk-adjusted returns.

The fund isn’t necessarily designed to best its category though, as its ultra-conservative positioning is better suited for investors looking for a safe haven against bond-market sell-offs, rather than those looking for upside during fixed-income rallies. For example, the fund’s short duration helped shield it from losses during 2013’s taper tantrum and contributed to its 4.3% return in 2008 while many nontraditional bond funds posted losses that year. Low volatility is also a hallmark of the fund and its Positive performance rating is based on long-term Sharpe ratios that top not only its nontraditional bond category but also the intermediate- and short-term bond categories.

Despite a conservative bias, the fund finds opportunities in areas with unique risks. Recent examples include loans to mortgage servicers who are purchasing and working out distressed mortgage pools; and interest-only bonds structured from pools of GNMA project loan IOs. High-yield corporate bonds also make up 10% of assets. 

The goal of safe-haven positions in a portfolio is to generate the maximum protection against loss of principal.  Since its founding in 1984, FPNIX has historically accomplished this important goal.

FPNIX offers a current yield of 2.8%, in line with 30-yr bond yields of 2.69%.  FPNIX offers long treasury yields with less than 1/10th of the interest rate risk of long bond funds and 1/3 of the interest rate risk of the Barclay’s US Aggregate Bond Index, based on a current duration of 1.36.   

This article first appeared in the Jan 2015 issue of Guiding Mast Investments  Thank you for reading.  George Fisher

Glencore - Contrarian Industrial Metals Trader and Miner Is Best for patient investors

Swiss-based and London-listed Glencore (GLCNF)  is one of the world’s largest industrial miners and commodity traders adversely affected by the current decline in commodity pricing.  Glencore is one of the ten biggest companies within the London FTSE 100 Index. The firm’s industrial and marketing activities are supported by a global network of more than 90 offices located in over 50 countries.

For patient and contrarian investors looking for a pick-up in Chinese industrial demand and a stable/declining US Dollar, Glencore could a top choice.  However, over the past few years as commodity prices fell, GLNCF has greatly underperformed the S&P.  It should be noted GLNCF has outperformed its peers with a -7.6% one-year decline vs the industry at -27.1% and an average -6.6% annual 3-yr decline vs its peers at -10.6%.   

Glencore has significantly expanded its production base and marketing capabilities following the acquisitions of Xstrata and Canadian-based agricultural trading firm Viterra.

GLCNF has one of the most appealing commodity exposures. Among the diversified miners, Glencore has the highest exposure to base industrial metals and especially copper, zinc, and nickel which many believe have a positive medium- to long-term outlook. In addition, Glencore has limited exposure to recently downgraded iron ore.  GLCNF generates 55% of EBITDA from mining activities, 40% from commodities trading, and 5% from oil and agricultural. 

Glencore has the potential for strong free cash flow generation and modest debt levels.  Given the lack of iron ore exposure, the more resilient marketing business, as well as the pullback in capex, GLCNF should remain free cash flow positive from 2015 onwards even at current spot commodity prices. Below is a table outlining 2014 to 2017 proposed capital expenditures, separated between funds needed to sustain current production and anticipated growth initiatives, along with 2014 trailing current twelve month operating cash flow, in billions.

As shown, even with the current depressed commodities market, management believes in its ability to grow the underlying business.    

Concerning growth plans, Chief Executive Ivan Glasenberg recently said, "Our focus is on expansion that can generate profit, on a tidy, neat balance sheet and any excess cash we will give back to shareholders."  The firm has been keeping its promise of returning excess cash to shareholders.  The recent semi-annual dividend was increased 11%, long-term debt is being reduced, and the company has embarked on a $1 billion share buyback program. 

In its most recent Investor’s day presentation, management offers its forecast for commodity pricing going out to 2018.  As shown in the graphic below, all commodities, except oil and iron ore are expected to be higher in 2018 than 2014.  A rebound as indicated below should greatly improve shareholder returns.

Commodity prices have fallen back to their lows of 2009, which of course was at the height of the financial crisis. While global economic growth will be muted in 2015, the decline in commodity prices to panic levels of 2009 seems overdone.  Any rebound will greatly enhance Glencore’s operating cash flow and shareholder returns. 

Morningstar offers its insightful research with this recap:

Bulls say: Glencore's globe-spanning network of traders and logistics assets generates significant economies of scope.  Full access to Xstrata's mine production allows the combined enterprise to extract greater value from those volumes.  Glencore is more diversified than other large mining companies are.

Bears say: Glencore's mining portfolio is decidedly "overweight" higher-risk countries with relatively underdeveloped institutions and limited legal safeguards for foreign investors.    Despite disclosures afforded by the initial public offering and subsequent filings, the marketing business remains incredibly opaque to outsiders.  While marketing activities are less sensitive to the general direction of commodity prices than its industrial activities, the best-laid plans of traders can go awry when prices rise or fall faster than anticipated or historical correlations break down.

Investors should appreciate the market in 2015 markets will favor companies with higher revenue exposure to the US.  In addition, a strong US Dollar hurts Glencore earnings by negatively influencing commodity prices. By the conversion of earnings to USD, GLCNF could be a candidate for contrarian thinking for patient investors.

Current yield is 3.8% with a strong likelihood of a dividend increase with the May payment. EPS in 2015 are expected to be $0.43 and in 2016 $0.54 per share.    

CEO Glassenburg is actively seeking to expands its mining interest and made an offer to purchase Rio Tinto (RIO), which was rebuffed.  By British securities law, GLCNF cannot make another offer  for Rio Tinto for 6 months but Glassenburg is still on the hunt for bolt-on acquisitions.  With low oil prices, it would seem natural for Glassenburg to pick up some longer-term energy assets on the cheap.      

While it may take a while for shareholders to reap the benefits of an anticipated commodity price turnaround, new purchases or position additions at the current depressed market prices should amply reward long-term investors. 

Author's Note: This article was first published in the Jan 2015 issue of Guiding Mast Investments Newsletter  Thanks for reading.  George Fisher

Morningstar Wide Moat Total Return ETF Offers an Interesting Conglomeration of Stocks

Morningstar Wide Moat Total Return ETF (MOAT) offers an interesting conglomeration of stocks.   All the companies have one common attribute – a high barrier to entry for competitors and an undervalued stock price. MOAT offers exposure to the top 20 companies identified by Morningstar as having a “wide moat”. Below is the current list of stocks:

80% of assets are large cap stocks and 20% are mid-caps.  40% are considered Value, 49% considered Growth and the balance 11% a Blend.  Sector allocations of these holdings are:

MOAT offers a 1.2% yield and charges a 0.45% fee. 

While the underlying Index has been around since 2007, the ETF was established in early 2012 and MOAT has about mirrored the S&P 500 return. Van Gleck ETF database offers this review: 

Moat = Sustainable Competitive Advantage

Morningstar equity analysts use a time-tested proprietary process to determine if a company has an economic moat.  The Index Favors Undervalued Stocks.  Of the broad equity universe analyzed by Morningstar, currently about 10% receive a wide moat categorization; the 20 stocks with the most attractive valuations are selected for its Index.  Proven Index Track Record.  Index has generated significant excess returns relative to the overall market since inception in 2/07. 

 According to Morningstar,

“only companies with an economic moat — a structural competitive advantage that allows a firm to earn above-average returns on capital over a long period of time — are able to hold competitors at bay.” 

In addition to offering a wide moat, the Index identifies the most undervalued of these companies and incorporated the top 20 most undervalued stocks. 

An informative SeekingAlpha article written by Morningstar concerning their Wide Moat Index can be found here:

http://seekingalpha.com/article/1954541-best-ideas-a-look-at-market-vectors-wide-moat-etf

Morningstar adjusts the Index portfolio once a quarter to reflect new names that are upgraded and deletions to Wide Moat Index status.  Most of the deletions are triggered by better value elsewhere.    The latest adjustments are below:

 From its founding in 2007 to the bottom of the market crash in 2009, the Index mirrored the S&P 500 return.  However, since 2009, the Index has substantially outperformed the S&P, as shown in the graph below:

Source: marketwatch.com

The blue line is the performance of the Wide Moat Index and the red line is the SPX. 

From the graph, long-term investors in the Index have generated more than 50% greater returns than the market. 

MOAT is an easy method of gaining portfolio exposure to both the specific companies and to the investing philosophy of Morningstar.  Long-term investors should review MOAT as a core holding.    

Disclosure: Long MOAT.  Thanks for reading.  This  article first appeared in the December 2014 issue of Guiding Mast Investments newsletter.  George Fisher

BlackRock - Neutral Rated but Long-Term Core Financial Holding

BlackRock (BLK) is the largest asset manager in the world, with $4.525 trillion in total assets under management AUM and clients in more than 100 countries.  The AUM generates Fee Revenues of around $5.5 billion a year.   Product diversity and a heavier concentration in the institutional channel have traditionally provided BlackRock with a much “stickier” set of assets, or a propensity not to migrate to competitors, than its peers.  BlackRock's well diversified product mix makes it neutral to shifts among asset classes and investment strategies, limiting the impact that market swings and/or withdrawals from individual asset classes or investment styles can have on its AUM.  For example, BLK offers the iShare brand ETFs in Equity, Fixed Income, International and Multi-Asset allocations. 

Many think BLK is mainly a retail-focused firm, but they offer specialized services for the following categories of customers:

•  Investment Professionals Advisors and RIAs
• Asset Managers
• Fixed Income Professionals
• Broker Dealers
• ETF Investment Strategists
• Institutional Consultants
• Insurance
• Pensions, Foundations and Endowments

In its most recent investor’s presentation, the company offers an interesting breakdown of its client base:

Source: blackrock.com

The company outlines its philosophy on its website:

“BlackRock is the world’s largest asset manager, and our business is investing on behalf of our clients, from large institutions to the parents and grandparents, the doctors and teachers who entrust their savings to us.

We work only for our clients—period. Our promise is to offer them the clearest thinking about what to do with their money and the products and services they need to secure a better financial future.

That is why investors of all kinds entrust us with trillions of dollars, and it is why companies, institutions and global governments come to us for help meeting their biggest financial challenges.”     

Retail investors represent only about 12% of assets but generate 35% of base fee revenues.  iShares represent 23% of assets and also 35% of revenue,  The bulk of assets and fees are generated in the instructional sector with 65% of assets and 30% of fees. As shown, growth in the retail segment will drive earnings higher over time.   Management believes overall AUM can organically grow by 5% a year, driven by retail growth in the high single digits.

 Retail asset expansion is slowing from its 5-yr average growth of 11%.  iShares assets are expected to maintain its 5-yr average of 16% with mid-double digits growth projections.  Institutional assets are expected to maintain its 5-yr average growth in the low single digits. The firm also sees growth potential in its BlackRock Solutions, which is a complete risk assessment and portfolio management service for institutional investors.

Earnings per share have been growing at a 15% annual rate since 2010 and have driven dividend growth of 19% over the same timeframe.  Consensus EPS is for $18.50 in 2014, $20.60 in 2015 and $23.60 in 2016. At a PE of 15, or its EPS growth rate, share prices could reach $430. 

At a constant 44% payout ratio, the dividend could grow to $10.50 from its current $7.72.   However, if global markets do not return 6% to 7% annually and AUM growth falls below 5%, these estimates will be reduced.

Morningstar analysis offers the following observations:

Bulls Say: BlackRock is the largest asset manager in the world, with $4.525 trillion in total AUM and clients in more than 100 countries.  Product diversity and a heavier concentration in the institutional channel have traditionally provided BlackRock with a much stickier set of assets than its peers.  BlackRock's well diversified product mix makes it agnostic to shifts among asset classes and investment strategies, limiting the impact that market swings and/or withdrawals from individual asset classes or investment styles can have on its AUM.

Bears Say:  The sheer size and scale of BlackRock's operations could end up being the biggest impediment to the firm's AUM growth longer term.  Despite accounting for two thirds of total long-term AUM, institutional clients generate less than one third of BlackRock's long-term base fees given the lower fee structure attached to these large investment mandates.  While actively managed funds account for just over one third of total long-term AUM, they account for more than half of long-term base fees, increasing the pressure on BlackRock to fix its active equity and fixed-income offerings.

In addition, Morningstar offers this recent opinion:

BlackRock's $15.2B purchase of iShares from Barclays at the depths of the financial crisis could go down as the financial services equivalent of the Yankees' purchase of Babe Ruth from the Red Sox, says ETF Trends, noting iShares now offers more than 700 ETFs and is closing in on $200B in AUM.  The top three ETF providers (iShares, Vanguard, State Street) "have effectively maintained a triumvirate," says Morningstar, with 82% of the U.S. market and 70% of the global market - figures that aren't likely to change a lot in the near-to-medium term. "We expect iShares to continue to be the biggest growth driver for BlackRock in the near-to-medium term," says Morningstar, noting the unit in 2014 is expected to surpass last year's $62.2B in inflows (accounting for 56% of BlackRock's long-term flows).

Over the past 15 years, BLK has generated a 17.5% total annual return compared to the S&P 500 of a mere 4.3% return.  Going forward, BLK has a realistic potential to generate 10% annual total return for long-term investors. 

Although BLK has seen a huge run from its low of $308 just a few months ago to its current $356, the future looks bright for the firm.  Investors seeking a top-quality financial firm should consider making an initial position here and add on weakness over the next few months.

BlackRock is followed by Guiding Mast Investments newsletter.  Thanks for reading, George Fisher

Fluor: Industrial Construction Firm Getting Rave Reviews

Fluor (FLR) is an engineering and construction company focused on power plants, chemical and drug factories, bridges and other big structures.  Their boilerplate description is a great recap of FLR :

Fluor Corporation (NYSE: FLR) is a global engineering and construction firm that designs and builds some of the world's most complex projects. The company creates and delivers innovative solutions for its clients in engineering, procurement, fabrication, construction, maintenance and project management on a global basis. For more than a century, Fluor has served clients in the energy, chemicals, government, industrial, infrastructure, mining and power market sectors. Headquartered in Irving, Texas, Fluor ranks 109 on the FORTUNE 500 list. With more than 40,000 employees worldwide, the company's revenue for 2013 was $27.4 billion

 Like many large project construction companies, such as Netherland-based Chicago Bridge and Iron (CBI) and London-based AMEC (AMCBF), FLR has a substantial backlog of work.  With a backlog of over $40 billion, the company has about two years of work under contract.  Below is a recap of the backlog by operating segment:

Government                $5.2 billion 13% of backlog

Power                          $1.7 billion 4%

Industrial and Infrastructure   $9.2 billion 23%

Oil and Gas                 $24.4 billion 60%

The company’s recent awards include a multi-year contract to decommission a nuclear power plant in the UK and a gas pipeline in Mexico.  One of FLR-designed and constructed complex medical projects was named the International Society for Pharmaceutical Engineering 2014 Facility of the Year for Project Execution.   As the conversion from coal-fired power generation to natural gas marches on, the construction budgets of power companies globally will continue to be strong.  However, two sectors are dragging down investor’s interest – mining and energy. 

Investors should continue to watch the spread between new awards and revenues on a quarterly basis.  For example, during the second quarter, the company booked $5.9 billion in new business while billing $5.3 in revenue, increasing the backlog by $600 million – a positive sign for future revenues.

Morningstar offers an interesting recap of FLR’s strengths and weaknesses:

Bulls Say: Much of the world's easily accessible natural resources have already been harvested, meaning future mining and extraction projects will increasingly take place in remote areas. Fewer companies can service these types of projects, which should benefit Fluor. Fluor has a solid balance sheet with plenty of cash to spare for buybacks and making strategic bolt-on acquisitions where necessary.  Major multiyear project awards will provide top-line stability over a number of years.

Bears Say:  Fixed-price contracts will become more common in the coming years. Though they can carry higher margins than cost-plus contracts, fixed-price contracts are also riskier as they put more of the burden on the contractor to control costs and manage unforeseen circumstances like poor weather.  With more than 40,000 employees around the world, rising labor costs in emerging markets could keep pressure on Fluor's margins.  Working on large projects in remote areas of the world may create a greater chance of cost overruns and geopolitical risks. 

 With the current decline in most energy related stocks, Fluor offers interesting opportunities at its current price.  Shares have dropped about 15% since the market high in Sept and are 23% below its 52-week high of last spring.  There is concern the current drop in oil prices will curtail oil and gas infrastructure projects, negatively affecting FLR and other oil and gas E&C firms.  However, with only 60% of its business in the oil and gas business, the slide in share prices has eliminated the company’s well-deserved valuation premium. 

One consideration is management’s negative Net Return on Invested Capital.  Below is the Weighted Average Cost of Capital WACC as offered by ThatsWACC.com and the three-year average Return on Invested Capital, as offered by Morningstar.  The list includes FLR, CBI and competitor Jacobs Engineering (JEC):

As shown, FLR capital costs seem to be in line with its competitors.  With the decline of CBI’s returns post-Shaw merger, the trailing twelve months ROIC for FLR and CBI are neck-in-neck at 14.2% for FLR and 13.8% for CBI.  

With a 2015 forward PE of 13 and a growth rate of 13%, the PEG ratio is 1.00, or fairly valued.  Earnings should grow from $4.02 in 2013 to $5.62 in 2016.  With a yield of 1.2%, the anticipated total annual return of 18.7% over the next 24 months will come from its share prices moving back over its previous high of $87.

Barron’s recently published an article on FLR titled “Oil Slump Makes Fluor Stock a Potential Double.  Sliding crude prices have put shares of the biggest U.S. engineer in the bargain bin.”  From their article:

Long-term Fluor shareholders have made out handsomely, with a yearly total return of 12.7% over the past decade, versus 8% for the Standard & Poor’s 500 index. However, year-to-date, Fluor has flopped, selling off 19% while the S&P 500 has gained 4%.

Earnings estimates have moved lower, but not nearly as fast as the share price. For example, back in July analysts predicted Fluor would earn $5.15 a share next year. Now they say $4.97, or 3% less. One reason forecasts have held up better than the shares is that Fluor has a $40 billion backlog of upcoming projects, enough to supply it with 21 quarters worth of revenue.

About 80% of the backlog consists of “cost-plus” jobs, where visibility on profits is high, according to investment bank D.A. Davidson. It initiated coverage of Fluor shares at the beginning of this month with a Buy recommendation and price targets of $85 over the next 12 to 18 months, and $150 over five years. The nearer-term target is about 30% above Fluor’s recent price of just below $65. The longer-term one is 130% higher.

The article can be found here:

http://online.barrons.com/articles/oil-slump-makes-fluor-stock-a-potential-double-1414146666

Investors looking for a large-cap growth company with exposure to expanding oil and gas infrastructure should review Fluor as a core holding in the energy sector.  The current market weakness should provide a good entry point for new positions. 

Disclosure: Long FLR.  FLR is  followed by Guiding Mast Investments newsletter.  Thanks for reading, George Fisher

Johnson Controls: Auto Batteries and HVAC Make Strange Bedfellows

Johnson Controls is an industrial company with diverse interests in automotive, heating and air conditioning. Johnson Controls is really three companies in one. Already one of the leading automotive seating and interiors suppliers, Johnson Controls continues to diversify. Growth in its building efficiency and power solutions group helps offset vicious cyclical declines in the automotive experience group.

The automotive segment contributed 51% of fiscal 2013 sales, down from 69% in fiscal 2005, which shows the company's increasing diversification.

Building efficiency in fiscal 2013 was a $14.6 billion business, contributing 34% of sales compared with 21% in fiscal 2005. The 2006 acquisition of York, manufacturers of heating and air conditioning equipment, made Johnson Controls a much larger player in HVAC equipment and service. This depth allows the company to market itself as a one-stop shop for service, controls, and equipment, which differentiates JCI from other large providers. Eighty-three percent of segment sales come from repeat business, but the company seeks to increase its exposure to more profitable HVAC product sales for a 50/50 product and service segment mix.

Power solutions is highly profitable, with 15% of fiscal 2013 sales and an operating margin over 15% in fiscal 2013. The segment has 36% share in the lead acid automotive battery market. This business is also a good diversifier because 80% of segment sales are to the replacement market, which makes battery demand more inelastic and gives the company strong pricing power. Johnson is the dominant player in start-stop vehicle technology thanks to its leading position in absorbent glass mat AGM batteries. Power solutions should benefit from automakers needing more fuel-efficient vehicles to meet environmental regulations.

There is tremendous growth and profit potential in AGMs because the batteries sell for twice the price of a normal lead acid battery. AGMs also generate 50% better profit margin. European auto production is forecast to increase the use of advanced lead acid batteries, such as AGMs, to 75% by 2015 from 40% in 2011. North American auto production is forecast to increase advanced lead acid use to 59% by 2015 from nearly zero in 2011. Globally, management expects start-stop to be 50%-60% of powertrains in new vehicles by 2020, up from 14% in 2012.

At the current price and a 15% anticipated EPS growth rate, JCI is trading below its earnings growth rate with a 2014 PE of 13.  JCI has been paying a dividend for decades and the current price offers a dividend yield of 2.0%.  JCI has a 5-yr dividend growth rate 7.9% and a 3-yr growth rate of 13.5%.  Management recently announced a dividend increase of 16.1%.  However, reported EPS over the same timeframe have been rather flat, mainly due to restructuring charges. 

JCI has a price target of $56, about 35% above its current price of $41.  While EPS have been stagnant over the past few years due to restructuring and charges, management should be about complete with its realignment of their businesses.  The underlying strength in the automotive and construction industries should help turn earnings around.   After being negative in 2010 and 2012, Free Cash Flow (operating cash flow minus capital expenditures) turned positive in 2013 to the tune of over $1.3 billion, and continues positive YTD.  Management believes free cash flow could top $2.0 billion by the end of 2016.

From Morningstar’s JCI report:

Johnson Controls has 15,000 HVAC service providers, making it 3 times the size of the second-largest player.

More governments wanting green buildings and the company's unique ability as a one-stop shop will keep the building segment growing and profitable, especially in emerging markets.

Increases in lead prices are mitigated by the fact that 100% of the lead price pass-through has been standard contracting with battery retailers for more than 70 years.

The company still gets about half of its sales from the very cyclical auto industry, and the market perceives it as an auto-parts supplier.

Commercial property servicing is very fragmented, and it could take time to capture significant share in the middle-market segment.

About 20% of battery sales are to automakers, which further exposes Johnson Controls to declines in auto production.

Investors looking for a high quality industrial company for the long term should review JCI.  Stock valuations have been consistently near the top of our universe.  More information can be found in JCI’s most recent investor’s presentation:

http://www.johnsoncontrols.com/content/dam/WWW/jci/corporate/investors/2014/JPMorganAugust2014.pdf

First appeared in the Oct 2014 issue of Guiding Mast Investments newsletter.  Thanks for reading,  George Fisher