In this Newsletter
- Book Of The Month
- Stock Contest Update
- Portfolio Performance
- Portfolio Readjustment
- Culp Inc.
- Printer Friendly Version
SINLetter – November 2009
Welcome to edition 48 of Suria Investment Newsletter (SINLetter), a free monthly investment newsletter. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks and other financial instruments so that you can research them further before deciding to add them to your portfolio or not. If you are reading this and are not a subscriber, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.
Book of the Month: Fooled by Randomness by Nassim Nicholas Taleb
|Hedge fund manager and professor Nassim Nicholas Taleb rose to prominence after publishing his book Fooled by Randomness about the role chance plays in our lives and the market. Along with Dr. Doom Nouriel Roubini, Taleb was one of the market observers and participants who anticipated the upcoming crash by explicitly stating that the risk management practices of most Wall Street firms were grossly inadequate. However unlike Dr. Roubini who stayed invested in the market through the crash, Taleb’s hedge fund bets on the probability that something will go wrong, horribly wrong, just as Wall Street is least expecting it. He is looking at the extremities of the Gaussian Bell Curve that most quant models had assumed was flat and inconsequential, for rare and unlikely events to occur. In the markets, the 100 year storm that most people don’t plan for occurs with surprising frequency.|
Using the example of a black swan that people living in the Northern Hemisphere did not believe existed simply because all the swans they had seen until that point had been white in color, Taleb illustrates how the sighting of a single black swan in Australia proved centuries of common belief to be wrong. Fooled by Randomness is a must read book to understand the impact of random events in our (investing) lives but it can also sometimes leave you with an unsatisfactory feeling as it attributes most of the success people have to luck rather than skill. If you have not read Fooled by Randomness or Taleb’s follow on book Black Swan, I would recommend reading the former and skipping the latter, as it most rehashes what was already covered in a much more entertaining fashion in Fooled by Randomness.
Stock Contest #3 Update
“Raja” continues to stay on top of the stock contest rankings with gains of 128.39% in less than 7 months followed by a new runner up d2cold. Since Raja already won twice, this month’s book Fooled by Randomness by Nassim Nicholas Taleb will go to d2cold.
Prizes: With just two months left to go in the contest if you would like to displace Raja from his throne click here to enter the stock contest. Each month we plan on reviewing an investment related book and the monthly winner will receive this book along with a free one year subscription to the SINLetter Special Reports, a $120 value. The grand winner at the end of the year will get all the books reviewed in these newsletters from April through the end of the year, a lifetime subscription to the SINLetter Special Reports and a surprise gift.
For the month of October we were essentially flat with a tiny 0.18% loss and on par with the Dow, which was also flat. The S&P 500 and Nasdaq went on to give up some of their impressive gains from September with losses of 1.98% and 3.64% respectively. We continue to outperform the indices on a year-to-date basis with gains of 38.81% in 2009 and since the inception of this newsletter in August 2005.
|Performance Metric||Dow||S&P 500||Nasdaq||SINLetter|
|Since Inception (Aug 2005)||-8.57%||-16.12%||-6.84%||84.69%|
The Pfizer – Wyeth merger arbitrage opportunity discussed in the March 2009 newsletter closed on October 15, delivering gains of 27.34% including dividends in 7.5 months. On an annualized basis gains were 43.77%. Since this trade was added to the Special Reports portfolio instead of the SINLetter model portfolio, the gains are not reflected here. I plan on retaining Pfizer (PFE) for the long-term but will put the rest of the capital to work in another merger arbitrage opportunity that would provide gains of 16% if the deal closes. Gains on an annualized basis might be even better than the Pfizer – Wyeth merger as the deal may close in three to four months. I will send out an update to special report subscribers should I decide to act upon this arbitrage opportunity.
Our previous stock pick Safeway (SWY), went from the red to post profits of 10% by the end of October after reported results that were better than expected, receiving analyst upgrades and retaining its full year forecast for earnings of $1.70 to $1.90. The company is also maintaining it full year free cash flow outlook of $1.1 billion to $1.3 billion and did not cut its dividend unlike competitor Supervalu, which cuts its dividend by 50% after earnings declined 42% year-over-year. Safeway did feel the effects of the recession with sales down 7% and earnings down 36% year-over-year. Same store sales slid 3% as much of the 7% decline was related to falling prices. I still believe Safeway is one of the best grocery chain stocks and will perform well coming out of this recession.
I am going to add 1,500 shares of Culp Inc. to the model portfolio as discussed below. To hedge against a falling market, I am also going to buy four contracts of the June 2010 105 put options on the S&P 500 index. I purchased these options for my personal portfolio in early October and figured I would do the same for the model portfolio. These trades will be executed based on the market closing prices on November 2.
Culp Inc (CFI) $5.75
The Story: Some of the hardest hit companies in this great recession were the ones that either directly or indirectly had something to do with real estate. These were companies that made for the perfect shorts going into 2007 and 2008 and in many ways rebounded the most during the great stimulus fueled bounce of 2009. Having made money buying LEAP puts in mortgage lender Countrywide Financial and shorting now bankrupt RV manufacturer Monaco Coach, I listened with skepticism when a friend recommended a company called Culp (CFI) that made furniture upholstery and mattress fabrics. Shorting furniture companies was one of the five themes I had listed in September 2007 to hedge a long only portfolio. Along with other furniture makers and related suppliers, Culp had bottomed just as my friend mentioned the company to me in early 2009. Upon taking a closer look I realized that while the fundamentals of the industry had not yet turned around and sales were still declining, Culp’s laser sharp focus on reducing operating costs as well as debt was helping it emerge stronger out of this recession than it was going in. Not only were insiders buying when the stock was under $2 in December 2008, they have continued accumulating shares as the stock has risen to its current price of $5.75. Oddly enough while the Dow dropped 250 points and the S&P 500 shed nearly 3% on Friday, Culp shot up 7.28%.
The Numbers: With over 1,000 employees and sales of $200 million (fiscal 2009 ended May 2009), Culp has a market cap of $74 million, giving it a price/sales value of just 0.36. The price/sales value is highly dependent on the profitability of a company and it stands to reason that investors value the sales of companies that are unprofitable or facing declining sales growth (Blockbuster for example with a P/S of 0.04) at much lower multiples than the sales of profitable companies that are growing their revenue (Intuitive Surgical with a P/S of 10.08). While sales at Culp are still declining, the company has once again achieved profitability over the last two quarters and expects to post pre-tax income in the range of $2 to $2.8 million for the current quarter ending next week. My preferred valuation metric, enterprise value/operating cash flow for Culp is 3.135. Even traditionally low margin businesses like our last pick Safeway have an EV/OCF numbers of 6 or more. Culp posted operating margins of 6.27% and profit margins of 4.13% last quarter.
In recent months, the company has paid down the debt on its balance sheet by reducing inventory and selling other assets. The company is almost at a net cash positive position and expects to get there when it reports results for the current quarter. The balance sheet current has $15.5 million in cash and $16.89 million in debt. The current ratio (current assets/current liabilities) is 2.12.
- Looking through Culp’s annual reports from before the start of the real estate boom (fiscal 2002) and near the peak of the boom (fiscal 2006), it does not look like there is much scope for expanding operating or profit margins.
- The stock has a low float and average daily volume of just 17,339 over the last three months. This is much lower than the 142,830 average daily volume of our other microcap pick Towerstream (TWER). As a result it may not be easy to acquire a large position and at the same time the stock could be susceptible to high volatility.
- While the company has managed to restore profitability and has reduced debt significantly, sales are still declining, albeit at a slower pace.
|Stock||Symbol||Number of Shares*||Cost||Current Value||Diff ($)||Diff (%)||Date Added|
|Companhia Siderurgica Nacional||SIDemail@example.com||$8,630||$6,632||$-1,998||-23.15%||04/30/08|
|Powershares Water Resources||PHOfirstname.lastname@example.org||$8,840||$6,288||$-2,552||-28.87%||10/31/07|
|Procter & Gamble||PGemail@example.com||$10,008||$10,440||$432||4.32%||06/30/06|
Voluntary Disclosure: From the stocks that are currently in the model portfolio, I own shares of Safeway (SWY), Activision Blizzard (ATVI), Towerstream (TWER), Lionsgate Entertainment (LGF), PowerShares Water Resources (PHO), Suntech Power (STP), Teva (TEVA), Alvarion (ALVR), Unilever (UL), and BlockBuster (BBI).
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