Things that make me happy......

Recently ran across an interesting article talking about the trend of nice restaurants putting a table in the kitchen. Here is a relevant quote

In the United States, the honor of the first restaurant to feature a kitchen table is claimed by Charlie Trotter's restaurant in Chicago.

"The Kitchen Table dining experience is a way to make everything transparent," Trotter said in an e-mail.
"In the old days, seeing inside the kitchen was forbidden. I wanted to do the opposite - stand it on its head - not only see and tour the kitchen but have the opportunity to dine inside the kitchen. We try to elevate and showcase the 'behind the scenes' and the high level of professionalism that exists inside a kitchen."

Trotter's kitchen table, seating four to six, was introduced more than 20 years ago and is now the restaurant's most requested spot.

How is this related to investing? and why does this make me happy?

Well, its this king of thinking that I believe separates the truly great investors and entrepreneurs from the mediocre. To have the ability to go completely against every conventional wisdom and current trend is in my opinion one the most important characteristics that the truly great investors have.

It also makes me happy to know that there are people out there thinking up new ideas and willing to take risks to be successful ......

BOOT -- 2nd Quarter Earning Analysis

When I last wrote about BOOT I stated that going forward I will be looking for:

“trends in gross margins and SG&A as % of sales and if revenue is trending above or below the 8% level set by management as the goal”

BOOT reported on July 30th and while I am in danger of plagiarizing myself it looks like the quarter was mixed but with more positives than negatives.

The blow out was on the top line with total sales up 14.6% and substantially ahead of the 8% set by management as the de facto benchmark. Sales to the work market were up 6% and up 26% to the outdoor market with new products driving sales.

The only black mark was gross margin which came in at 39.2% and was down 60bps YoY due to an inventory write-down. SG&A margins came in better than last year at 33.3% of sales vs. 35.2% of sales in Q2:2006.

EBITDA was up 40% YoY with EPS up 36% when adjusted for an 8c tax related gain in Q2 last year. Looks like analysts don’t expect the strong YoY eps growth to continue in the last two quarter of the year which account for almost 75% of earnings. Despite two consecutive earnings beats analysts did not budge their 2007 estimates which are currently at $1.17 per share.

I bought a tiny 1.5% position in BOOT in the Best Ideas Marketocracy portfolio at $17.13 and at current prices of roughly $20 per share I am not compelled to add more or to sell. While I am very glad to see the stock continue to surprise on the upside I think the shares are fairly valued and don’t provide much margin of safety. If the stock pulls back to $17 per share I will add another 1% to the Best Ideas portfolio and hope that the momentum of the first two quarter carries into the third quarter.

If BOOT reports similar sales growth in the seasonally important 3rd quarter than estimates will surely go up and the stock will have a strong up side move.

Going forward, I will be watching for trends in gross margins and SG&A as % of sales and if revenue is trending above or below the 8% level set by management as the goal.


* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

More pain on the way?

I have been thinking a lot about the speech given by Robert Rodriguez, which was the subject of my previous post. With perfect timing the LA Times ran the following story ominously titled "Foreclosures may spur price drops: On L.A.'s edges, soaring repossessions could set off a downward spiral." (may require a free subscription)

Why shouldn't I just file this story under what I like to call the "new tires effect" which describes a strange phenomenon where I only notice, remember, and take interest in ubiquitous tire commercials exactly 1 week before I get new tires and than promptly forget them after the new tires are installed?

The reason why I think this story is of particular interest and why it dovetails nicely with the speech given by Mr. Rodriguez is because it describes carnage in the real estate market which has not yet occurred and I believe many investors (including myself) may not be factoring into their models for housing related stocks -- home builders, mortgage REITs, mortgage insurers, regional and super-regional spread lenders like WM.

The thing that made this story particularly interesting and different from many of the other "pain in the real estate market" stories that I read almost every day is that the future tense is used as opposed to the present or the past. The authors -- using data from First American which I believe is the same source that Mr. Rodriguez quotes in his speech -- make the point that the cracks are just starting to appear.

The article argues that the marginal ZIP codes in California that should be the first in the nation to experience the real pain have not entered the cycle of spiking repossessions that swell lender's inventories of unsold homes causing them to flood the market which in turn forces individual sellers to lower prices.

Here is an a quote that sums up the tone of the article nicely:

"We're going to have a bear market in housing for a while," said Christopher Cagan, director of research for First American CoreLogic in Santa Ana. "It's going to be bad to be a seller or someone forced to refinance in the impact zone."

Notice that he says that its "GOING" to be bad to be seller which I believe is different from the common perception that right now is the worst time to be a seller and we are now at or close to the bottom of the market and things will turn around before soon.

As I mentioned in my last post, I am taking this opportunity to better educate myself on publicly traded homebuilders. I think homebuilders represent great long term investments since they have a built in growth rate of 6% (3% from population growth and 3% from inflation), their product will never be outsourced, and the industry is still unconsolidated so the top guys can easily grow at 10% to 15% for years to come by taking market share and/or consolidating. However, it seems that the wises thing to do for anyone looking at homebuilders is to adjust their models for the possibility of the real estate market taking longer than a one or two years to recover and adjust their required margin of safety accordingly.

Absence of Fear

As as a portfolio manager I read a lot of market commentary and market research written by other money managers and the elite of Wall Street.

I would say that 99% of "macro" commentary/research that I read falls into one of two categories:

1) this is really good stuff because it reaffirms my opinion, 0r
2) this makes sense but I don't agree with it and the author did not present enough evidence to change my opinion

Once in a while I am lucky enough to come across a piece that looks at a commonly discussed topic and actually provides some original thinking.

A friend forwarded me this text of speech given by Robert Rodriguez to the CFA Society of Chicago. Mr. Rodriguez is the President and CIO of First Pacific Advisors and runs large equity and fixed income mutual funds as well as institutional money. This guy has been managing money longer than I and most of the people currently running money have been alive and has seen many a cycle in his career.

In this speech Mr. Rodriguez covers everything from subprime to private equity to energy prices and as you would expect for a guy holding 40% cash and 20% energy stocks in an equity mutual fund he is pretty bearish.

The great insight for me came in the section titled "Securitization Contamination." All the usual suspects of greed by banks and complacency by rating agencies are there. What I did not realize is that all the MBS models used by rating services assume a ZERO chance of home price DEPRECIATION for anything more than a year or two. To a certain extent this makes sense and based on the recent 50 years of history home prices falling or staying flat in nominal terms for more than a year or two would really be a black swan event.

But is it impossible? Mr. Rodriguez makes the argument that it is in fact possible to envision home prices falling or staying flat in nominal terms for an extended period of time. And if this happens or the market start believing that this can happen than we will really see blood on the streets.

How did this insight change my thinking? For one, I have started educating myself about mortgage REITs and homebuilders by reading annual reports and trying to get my hands around the accounting. Up until this point, I have thought about valuation and margin of safety with the mindset that there will be some pain for a few years but things will revert back to normal by around 2010 give or take 6 months and the strongest players will emerge stronger and with more market share.

Now, I have no choice but to model in the possibility of a serious contraction in mortgage lending and with it a necessary decline in housing starts for a longer period of time than a couple of years. I will have to adjust my margin of safety to assume that what happened in manufactured homes market where lenders backed away after gorging themselves and have not returned after nearly 5 years can happen in the broader housing market.

There is way to much other good stuff in this speech to summarize, so I will strongly encourage that you spend 10 minutes and read the entire thing. But here are a few tastes to get your appetite wet .....


"[we asked] what if HPA [home price appreciation] were to decline 1% to 2% for an extended period of time? They [Fitch's MBS rating group] responded that their models would break down completely."

Here is another great line .....

"when others are having headaches and need Tylenol, on other words, liquidity, we will provide it to them but at a very, very high price"

Keep in mind that many of the people in the audience were the "others" he was reffering to.....Ballsy!

And the coup de grace for anyone thinking that this guys is just a talking head or a pundit trying to capitalize on a correct market call .....

"We are willing to bet our firm and our reputation to be right. This may lead to investor defections, but that is the price one has to be willing to pay to be right."

This guy is the cream of the crop of investment business, both for his investment acumen and willingness to take career risk to do right by his clients. I feel lucky to be able to watch and learn.

FTAR .OB-- 2Q Earnings Analysis

FTAR announced Q2 earnings today and filed the 8K, actually this company does not announce earnings to any of the major news wires.

Before I dive into the earnings analysis here is what I was looking for when I last posted on the company:

"I will be watching for in the next earnings report are the trend in SSS, trend in K-Mart closings, and Gross and EBITDA margins."

I would say that the latest quarter was mixed but with more positives than negatives.

Looks like overall sales were down 9% YoY with SSS at Shoemart (these are the K-Mart stores that make up 98% of revenue) down 8% with Rite-Aid reporting a horrific 14.5% decline. Looks like no Shoemart stores were closed in the quarter which is good news. For the first six months total sales are down 5%.

The company blamed weak Easter and poor April sales...blah, blah, blah. When I initially posted on the company I used a 10% sales decline as the "Worst Case Scenario" assumption. If things continue at this trend we may hit that worst case scenario.

However, the rest of the report was nothing but good news.

Gross margin was up 80bps to 35% in the quarter and up 90bps to 33% for the first 6 months. This is tracking ahead of my "Best Case Scenario" assumption of 50bps improvement in GM.

SG&A expense fell more than revenue declined providing 50bps increase in margins for the quarter. For the the first six month SG&G as % of revenue is at 24.7% for a 30bps improvement. This is improvement is more or less in line with my Best Case scenario assumptions.

The margin improvement provided for positive EBITDA growth of 1% to $23.6 negating the 9% sales decline. EBITDA is basically free cash flow for FTAR since it does not pay taxes, have any debt, or CAPEX.

If the company can continue to offset sales declines with margin improvements, I believe my previous target price range of $3.5 - $7.5 per share is still valid and provides substantially more upside than downside at current price levels. As I mentioned before, the free option on the contract extension with K-Mart becomes less valuable with each passing day and I have personally assigned it a zero dollar value at this point.

Again, next quarter I will be watching for the trend in SSS, K-Mart closings, and EBITDA margin improvement.


* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

JCTCF -- Final Thoughts

I can’t believe it has been a month since I wrote my first post on JCTCF.

In that time the stock is up 12% after hitting an intraday high of $12.10 which represented a 48% upward move. Also, the company reported quarterly earnings that once again confirmed the potential of the non-wood business to drive earnings going forward.

While the strong earnings in the latest quarter are nice to see they do not negate the fact that JCTCF still gets most of it revenue and profits from selling commodity wood products. Revenues and profitability of this business fluctuate wildly and JCTCF is currently facing headwinds from the slowing housing market.

Despite these very real negatives, it seems that the current valuation and the continued growth of the non-wood products business make the stock attractive. The company announced several store wins for its high end dog kennel line and other non-wood products. This is and example of how JCTCF expects to grow its non-wood products, by getting shelf space from its current customers in the DYI market and from new customers. It looks like another sales channel was opened as the company announced today that they will distributing their dog kennels in Europe. http://biz.yahoo.com/prnews/070807/cltu055.html?.v=101

So how do I look at valuation?

Well, I look at valuation the same way I look at the company -- to me JCTCF at this point is the non-wood business and everything else. The problem is that the company does not break out how much of “Lumber, building materials & other” is attributed to wood and non-wood products so we can only come up with ball park figures.

Based on the latest 10Q (filled on 7/11/07), here is the net income for the last 3 quarters breakdown for each business segment:

JCLC ..................... …......…. $1.531M

Greenwood…......………………$0.79M
Seed Processing ….................$0.220M
Industrial Tools.. ……………..$0.01M
Corporate Expenses………….$(0.99)
Total Excluding JCLC ….$0.912


Estimated net income for non-JCLC businesses in fy Q4 = $0.304 ($0.912 / 3)
Estimated net income for JCLC in Q4 $0.461 (assumes JCLC has same net income as in the previous quarter)

Full Year NI for non-JCLC businesses = $1.22M
Apply multiple of 7.5x (half of SPX current multiple) = $9.12M

Full Year NI for JCLC = $1.99M
Apply multiple of 15x = $29.88M

Total Estimated Market Value = $39M
Estimated fair value per share = $16.38 / share
Apply 40% margin of safety = $9.83 / share

Keep in mind that the company filled an S-1 saying that they are willing to sell shares at $13.33 (this is the $20 price adjusted for the 3:2 split). This is in the ballpark with my rough estimated fair value of $16.4.

I think that at current prices the company provides very good value and substantial potential upside from continued growth in the non-wood product segment. This company has no debt and due to large insider ownership by active management I have confidence that it is less likely to do stupid things. I will adding JCTCF as a full position (8%) to the Best Ideas Marketocracy portfolio.

Going forward, I will be watching the growth and profitability of the JCLC business like a hawk. I will also be watching the extent of the deterioration in the Greenwood business.


* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

JCTCF -- “Da Bulls” -- Part II

In the previous post I made the case that the only reason to own shares of JCTCF is due to the company’s growth and high profitability of the company’s non-wood products segment that is hidden within the company’s commodity wood business.

I also believe that there is evidence that management--who are the largest shareholders with 37% of the stock and effectively control an additional 16% owned by the ESOP--thinks that the stock is worth a lot more than the current market value.

Now, we all know that a management team that SAYS their stock is worth more than the current share price is easier to find than a Democratic politician bending over for the labor unions or a Republican paying homage to the religious right ayatollahs.

However, I think in the case of JCTCF there is some tangible evidence that management really does believe that a minority share of their little company is worth more than its current price.

The company re-filled an S-1 form in September 2006 notifying shareholders that they are looking to sell 500,000 shares to the public which if completed would increase shares outstanding by 25%. The shares would be sold at $20 per share which based on pre-split figures represented a roughly 50% premium to market price and 170% premium to book value.

There are a few nuggets in the filling that give me a warm fuzzy feeling. For starters, this is being done on the cheap. This is a self-underwritten offering with the company spending $125,000 which is 1.25% of gross proceeds and substantially less than the 6% or so ibanks charge.

Also, I could not find any evidence that management is going to be selling their own shares as part of this offering. This means that management is not cashing out and is willing to accept 25% dilution in the ownership of the company. I can only think of one reason why they would do this which is that they believe the cash can be successfully reinvested (this must surely be to grow the non-wood business) and they will be better off owning a smaller portion of a much larger pie.

Finally, this stock will be sold only in two states Washington and Oregon and only by Donald Boone (who is the President and CEO and owns 24% of the stock), Michael Nasser (who is the Secretary and owns 13% of the stock), and two other directors. They will personally solicit potential shareholders with the “intended offerees will be friends, family, and business associates of the our Management.” The filling does state that a broker-dealer maybe engaged to sell the shares, but I don’t believe this has been done yet.

What is so important about people asking their friends and family for money? This happens every day.

The important part is that when you have to pick up the phone yourself and call someone you have a personal relationship with and ask them for money you think differently about the offering price and the outcome than you would if you let Mr. iBanker sell to Mr. Fund Manager. When you are selling to people you know and presumably want to keep knowing, you are much more likely to charge them a fair price which leaves a lot of room for upside. You are also much more likely to be careful with the money they give you.

I should note that management has been unsuccessful in getting this offering done since at least 2004. Does this concern me?

I am not happy about it primarily because I am bullish on the company and think a lot of money has been left on the table.

However, I am glad to see that the offering price has been increased to $20 from $7 (see 2004 S-1)

Also, as a current shareholder it gives me confidence to know that management is willing to sell the stock to friends and family at a much higher price than the shares currently trade. I think the only reason they would do that and be willing to accept dilution of their ownership stake is that they truly believe their stock is worth more and they can successfully reinvest the cash.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

JCTCF -- “Da Bulls” -- Part I

The entire bullish case for JCTCF hinges on the growth of the company’s non-wood products division which is part of the company’s Lumber, Building Materials & Other (JCLC) group. I believe the non-wood products business is a hidden asset and will allow the company to grow the bottom line despite the slowdown in demand for commodity wood products.

There has been several headlines in 2007 that provide a glimpse that things are happening with non-wood products. For example, in January the company announced that it will sell its high-end dog kennels in 900 Petsmart stores. A few weeks later the company announced that they acquired patents and manufacturing rights to a vinyl gate system -- another non-wood product. In February, the company announced that Fred Myer will sell the high end dog kennels in 117 stores.

Here is another positive announcement related to non-wood products in March:

JCTCF “announced that the Company has received initial orders from two large national home centers for the Company's proprietary gate system for wood fences”

That’s a lot of positive headlines that have gone basically unnoticed as the stock is essentially flat year to date. Keep in mind that at the end of 2006 the P/E ratio was at only 12x-13x for a company with ROE north of 15% and almost zero leverage.

Headlines are one thing, but what do the numbers look like?

Here is where things get interesting. EPS for the last nine months (the fiscal ends in August) is $0.57 vs. normalized eps of $0.57 for the same period in fy2007 (the normalization removes a 16c gain in last years figures due to sale of a distribution facility).

So, what’s so great about investing in a company with zero earnings growth? Consider the fact that earnings are still flat while

1) this company sells wood products and the cost of lumber has plummeted. I don’t have exact statistics and JCTCF did not give any numbers in their latest filling but if you were to look at the latest filling from UFPI which I am a shareholder and have mentioned before you would see that lumber prices have fallen by at least 15% year-to-date.

2) its most profitable business segment last year (Greenwood) has experienced a 17% YoY sales decline and profits for that segment are down almost 50%

3) the company made no money in the “industrial tools” business which accounted for 4c of earnings last year at that time

When you consider that all these notable items have been completely offset by the more than doubling of profits in the JCLC segment and that all that increase was driven by non-wood products a different pictures start to emerge.

For the first nine months of the year, sales in JCLC are up only 2% while operating income for the unit is up 140% …..here is the single most important line from the 10Q

“this reflects a sizable increase in specialty metal products that slightly more than offset a sizable decrease in wood products sales. Operating income was up $889,886 [+140% YoY] reflecting the fact that the gross margin on specialty metal products is much higher than on wood products sales.”

I guess I am not sure what else I can say to get my point across.

When you buy shares of JCTCF you are getting a fast growing business segment with a huge potential market that is currently stuck in a middle of a pile of garbage. My bet is that either that garbage will be swept away over the next few years (lumber prices return back to normal levels) revealing the great business segment within. Or the business will continue to grow so much that it will be noticed while still surrounded by garbage.


* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.