Sunday, June 29, 2008

3 weeks later.....

Well I didn't expect that -- to take a 3 week break from writing. Certainly knew a week off because of a trip but the rest was just getting too busy and not finding the time.



Why was I busy? part of it was looking into a few new secular trends to decide about potential new investment ideas.



First -- on a trip out west I saw the longest train ever -- container after container load. It was at that moment that I realized why rails have been doing so well -- why Buffett bought them. I just couldn't see it before -- I saw railroads as slow growers that could never earn their cost of capital and would produce negative free cash flow forever. That's changed -- consolidation has reduced competition within the railroads and rising energy prices has reduced competition outside of rails. Globalization has created lots of new trade, which is driving up demand too. The stocks have all gone up huge in the last several years but they probably have more room to go especially if energy prices stay high.


don't know enough to understand, which rail is best or what the differences are between them. Probably won't buy one but its something to keep in mind.

Next I was reading a conference call transcript from a call given by the CEO of Alliance Bernstein -- one of my largest holdings. He made a comment about the coming electrification of the automobile and the impact that might have on various industries. It reminded me that a couple of guys -- Peter Huber and somebody named Mills have written an investment newsletter for several years about power. So I searched on google and at forbes.com for awhile and realized they have written a book. The Bottomless Well that basically says we have unlimited amounts of energy its a question of what form its in.

They make the case that electricity is the real secular growth story within energy. Over the last several decades the amount of electricity used has been steadily rising. Certain processes on the industrial side that used to be mechanical in nature now use electrical parts -- one example is a steel mill which now uses an electric arc furnace rather than one driven by burning coal -- i.e. a blast furnace. All the computers, networks, data centers, etc. -- they all rely on electricity. Their case is that improvements in power semiconductors would translate into an electric drive train partly out of energy efficiency but mostly because electricity is easier to control than mechanical processes -- you can more fine tune the process.

so that leads to multiple thoughts on how to play this secular trend.

1. Utilities -- especially ones that produce non-regulated or wholesale power using a low cost fuel option such as nuclear, hydro or wind. Utility prices are often set by the fuel costs used for producing peak power. Since natural gas is most often what is used for peak power, that means has natural gas prices rise, power prices rise too -- even if that power is produced by nuclear, wind or hydro (none of them have fuel costs that amount to much).

After some review, I chose FPL -- florida power and light because its one part regulated and one part non-regulated. This provides some risk reduction since I am buying in after utilities have outperformed for years. FPL's regulated territory has been growing -- they gained 1 mill new customers in the last 10 years or about 33% growth. Their fuel for the regulated side is nat gas, coal and nuclear.

They have a merchant power business that sells power all over the country -- large part is nat gas but the rest is nuclear and wind -- they are growing their wind production from 5 gigawatts to 13 gigawatts over the next 5 years. Other large merchant companies don't have diversified territories or their fuel is not low cost or their valuation is high or their stock has been an unbelievably strong performer.

2. electrical equipment manufacturers -- for me their are only 2 possible answers here -- Emerson Electric or Eaton. Emerson is my main choice because they have been well managed for decades. Eaton is more of a turnaround. Trouble is that even though Emerson has incredible management and strong prospects and an attractive valuation, its stock returns have been mediocre at best. over 20 years the stock barely keeps ahead of the market. Now the good news is that it is ahead of the market. The bad news is that many of the utility stocks I was researching outperformed Emerson over long periods -- boring utilities yet they have strong performance. As the stock drops I continue to think about it.

3. Power semiconductors -- most of these are commodities but there is one company -- Power Integrations POWI -- that is a differentiated product that sells power supply chips based on an integrated solution -- majority of current solutions are discretes or other older technologies. they are cheap and low cost but take up space and are not energy efficient. Power Integrations has a similar cost but its partly due to much fewer components. I'm still researching and debating this one.

Also trying to determine how to come up with the cash to invest in these kind of ideas. I realize now that I have too much in financials -- MCO, FDS, CME and AB -- although they aren't lenders and aren't caught up in the problems of today, their growth potential is tied to the size of financial services in general -- MCO is about growth in debt during a deleveraging period. FDS is about giving employees the tools they need to do the job so employment in money management is key. CME is providing a market for traders to trade derivatives -- fewer traders means less derivative trading.

that's plenty to think about tonight -- will hopefully have more to say this week.

Sunday, June 8, 2008

catching up

This one will be quick updates on various stocks and maybe a market issue or two.

CME -- stock has just been dropping like a rock. Finally dawned on me that almost half their trading related revenues come from fixed income products -- interest rate futures. its a huge portion of volume but lower pricing means its only half of revenues. Just realizing that potentially that's a problem -- as the fixed income market deleverages -- banks, brokers, hedge funds, CDOs, etc. -- they might use less hedging -- as in less futures. In addition, while we all got excited earlier this year about the volume that comes from high levels of volatility, bear markets usually mean less volume. So you get a spike in volume and then everything flattens out for awhile. so now we have two reasons to see less volume and potentially lower eps estimates. Then you realize that they went from being an organic growth story to a roll up and you realize that the future won't be as good as the past -- sure stinks to figure that out now some 150 points below our cost. ugh.

Not intending to sell it at this price -- stock is pretty cheap even if you assume the estimates drop. don't forget its still an almost 60% operating margin business with lots of free cash flow.

MCO -- well it didn't take long for the market to decide that cover up of wrong ratings wouldn't be a big deal. I know the deal with the NY attorney general and the analyst day were mostly responsible but if everyone was still concerned about the cover up the stock would never have gone up $8 off the bottom. The deal with the NY AG is critical because while it removes a conflict of interest -- ratings shopping -- it also could have the affect of reducing competition. Not to mention they will now get paid for due diligence when in the past they wouldn't. I wrote some more calls when the stock was $40 -- next day could have gotten a dollar more but then came Friday's whack and I'm in the black again. Analyst day showed me that they have a lot of growth drivers to get the business growing in the 10% range. Add share buybacks to that and its not bad. I thought about selling the $45's but decided to do the $40's instead. Hoping to get lucky on these to sell at a profit and maybe over time shift my selling to the $45's. I think its going to work its way slowly higher -- presuming we don't have another financial panic or a big rout in the market.

BLUD -- FY 2009 guidance -- no big deal. hoping they were conservative and that there will be good upside after they report in a few weeks. still wondering about this one.


New ideas again ---

Ritchie Bros Auctions -- RBA -- all that cap ex that I mentioned last note is for their 30+ facilities around the world. They are auctioning used heavy construction and farming equipment so it takes up a lot of space. They have 25% of their winning lots online but the rest is bought in person at the facility -- the buyer has kicked the tires on the actual piece of equipment. So in some sense they are like a retailer -- always growing stores and also fixing up their stores. Their cap ex is running near 17% of sales -- this compares to someone like FLIR which is near 7% -- that's 10% less for shareholders. Moody's probably runs around 3% of sales for cap ex in most years. Analysts are arguing that they will not be affected by the economic cycle -- maybe true but they are affected by the industry cycle -- boom times for heavy equipment which supports equipment prices by having plenty of buyers. When the infrastructure boom ends, who are all the users going to sell their now excess supply of equipment to? Right now the slowdown in the US is not a big deal because they can sell the equipment to overseas users in the mid east and asia. What happens when the mid east and asia slowdown and the US can't absorb it all? bummer.

Hope is that when that time comes the analysts will still be pushing the no problem thesis and you can get out at a higher price than you should be able to. Trouble is to spot the slowdown before everyone else. Now truth is that every stock I could buy will face a slowdown so that's not a reason to exclude these guys. But its also true that heavy equipment demand is going through a really strong cycle, which means the downturn will be bad when it comes. For me its key to understand the secular drivers for the company and the cyclical ones -- once the cyclical (current heavy equipment demand) wears off what will be left of the secular -- enough to be a reason to own the stock? Especially when that stock comes at 30X earnings -- ouch. When the cyclical runs out this thing will be at 20X if we are lucky.

All that said, I like the way RBA is managed -- like a family owned business that knows how to take care of customers. that is what you want in a management team.

market -- obviously the whack on friday was ugly -- could be the beginning of something uglier. banks have been hitting new lows and lots of talk about Lehman's future -- they are at 30x leverage. they raised $8 bill last week but who cares -- tell me when they either shrink to $400 bill in assets from $700 bill or when they raise another 30-40 billion in capital. at that point the leverage will be too low rather than ridiculously too high. Oil prices -- we may be getting near a point where the economy finally can't handle the high price -- we would see demand fall off and that should put a lid on the price of oil but then again I have invested the last 5 years betting against those that made that argument so take it with a grain of salt.

got to run

Monday, June 2, 2008

potential new ideas

I recently received the quarterly report from Baron funds run by Ron Baron. He is definitely a bit promotional about his stocks and his funds but if you look through that he has a great track record. His process is close enough to mine that I can often find great ideas -- He owns Factset (I didn't get that from him, I'm a user of the service), CME, FLIR, CLB, etc.

This report mentioned a few interesting ideas -- Ritchie Brothers Auctioneers (heavy equipment), an industrial distributor whose name escapes me (MSM is the symbol), CoStar (commercial real estate data base) and MSCI (MSCI indexes and Barra).

MSM is a great business but it is completely tied to the US. They are about using the Internet to reach more customers with more products. The stock got crushed during March but then they beat numbers and it exploded upward. Perhaps on another pull back but now it seems fairly valued.

CoStar -- great looking business that has way too high expenses -- supposedly to build out their infrastructure. They have built a database of info on 3 million commercial real estate buildings in the US and UK. Now that they have finally reached good coverage they are trying to boost revenues without growing expenses -- operating leverage. They should have margins about 2X what they are based on other similar businesses -- Factset and Navteq. Trouble is when I went to the yahoo message board to see what was there all the discussion is about what a horrible place to work it is and how there is constant huge turnover of sales people (like 60% a year). That's not good -- the business is good enough so that it doesn't hold them back too much but its bad enough that I don't want to get involved -- too many other choices that don't have those issues.

MSCI -- another one whose margins should be higher -- they have just recently been spun out of Morgan Stanley so their margins are still ramping. They dominate international indexes to serve as benchmark's for funds as well as ETF's -- they get fees for access to index data and they get asset based fees from the ETF's. Its a great buisness as long as ETF's based on these indexes keep growing. They probably will but the risk is more growth in more actively managed ETF's of the power.... something funds or with the Wisdom Tree type funds. Those ETF companies use their own indexes. They also have the Barra business which is a risk analytics type business -- pretty good except its all based on mathematical models which rely on standard deviation -- as you know I believe standard deviation is a concept that should be banned from finance because there are no normal distributions to be found anywhere. I would have to swallow my high horse and just focus on the business prospects regardless of whether I thought it was a good product or not to buy into this stock. Of course the index business represents most of the profits anyway. but this is the one I'm most likely to think about buying.

Ritchie brothers looks interesting except they have very heavy cap ex spending -- need to understand why because as an auctioneer I wouldn't think they would have a lot of cap ex needs. stock has a perfect chart.