Tuesday, June 15, 2010

June 15, 2010 The King of Linkage Has Left The building.


June 15, 2010 The King of Linkage Has Left The building.

After a long and successful western music singing career, and playing the unforgettable Las Vegas Billionaire Willard Whyte in 007 Diamonds Are Forever, Sausage King Jimmy Dean Passed away on the 13th of June. Now that guy knew about linkage.

Since we are talking about food today, it was brought to my attention by one of our readers that Cramer was pimping Del Monte. They made a good case for the stock, but I have to do my own homework so I thought I would share what I found out.

DLM Del Monte has a good brand name in the market place. One of the attractive things about the stock is the price to book value. It is about 1.7 which is low for such a recognized brand. Its multiple is OK at 11.7 and that is cheaper than the industry average of 17 making it affordable. Its revenue growth over the last three years has been flat. You (The reader) cited a new product which triggered your interest in the stock. Just keep in mind that they have annual sales of 3.7 billion dollars across approximately 18,000 SKUs so any one product is not really going to make a difference in the value of the stock.

Strategically Del Monte, recently (2006) bought a series of pet food companies and that is becoming a more important part of their mix.

So they will grow by acquisition and basic economic growth. The do not have a lot of free cash flow so acquisitions would have to be debt arranged. Their long term debt, is not bad but it would take about 7 years out of current income to pay it down. I did discover that some of their long term debt are two bonds with 2015 and 2019 maturities. They are 6.75% and 7.5% respectively. You might consider that versus owning the shares.

Here is my reasoning. Their operating margin is 13.9% which is slightly better than the industry average of 12.4% but their net margin is 6.6% compared to the industry average of 10.0%. We own GIS, same sector and their financials are little sexier, and their margins are almost double. Here is why this is important. We are having a period of very little inflation and low commodity costs. As those rise, and they will, DLM will be in a tougher position to maintain those margins and those dividends. Remember a company will cut dividends before considering not meeting their bond obligations.

The good news is despite the economy people continue to spend more on their pets and DLM has some good grocery real estate in that sector. (Think Milk Bones, Kibble’nBits, 9 Lives etc,) They are also growing their organic offerings which is gaining traction as (in America) 67% of Americans are clinically obese (30 % or more BMI).

It is selling for about 15 a share and I am coming up with a value of about 11-11.50. If you factor in a 3-4% growth factor and a 2% increase in commodity costs, the margin is going to get pinched. They also get 34% of their income from sales to Walmart. That is risky. Especially since WalMart is notorious for dumping vendors over a point or two in pricing. At the top of the heap you have a tenured executive, but he is wearing the both titles of Chairman and CEO, (Personally I don’t see the problem with that LOL) which is less common now a days in public companies. The entire executive team only owns about 3.5% of the company so they are not well vested in the stock.

Here is my take. Buy the bonds. You will get about 7% return every year you own them and you don’t have to worry about the daily fluctuations of commodities like sugar, corn, oil, etc which will play havoc with the stock. The company should have no problem meeting their bond obligation.

BBY, Best Buy did disappoint and they did it in a big way. The consensus was 50, we pegged earnings at 48 cents and Best Buy came it at 36 cents. The market nailed them today, but the overall market did not pick up the cause indicating a positive sentiment in the larger trading environs. ooohh I liked that. The explanation was unusually high general and administrative G & A expenses which are expenses of operating a business that are not directly linked to the company's products or services. They include salaries, rent and payments to utilities generally known as overhead. Anyway we called it here Sunday but not that bad. Ironically the unusual G & A expenses were about 10 cents a share putting the miss at 46 cents a share earnings much closer to the 48 cents a share we prognosticated.

What else moved the market today. The tea leave readers were out today as the S & P 200 day moving averge got breached and that helped the market stay up. That is the first time since about Mid May it has broken the 200 MDA. The Euro came up a couple of points which helped. Boeing has some good news. Hope you been reading our pimping of the stock as it was up 4% today. (Hint-It is still cheap). And for the ever diligent of you homework people, take a look at the international inflo of cash into the treasury today. Commonly called the TIC flows was up showing confidence in US Debt.

We are always looking for the next possible investment. In the last few days, we have seen really sad pictures of birds in The Gulf of Oil. Have you noticed that almost all of the rescue people use DAWN soap. Apparently they say it’s the only thing that works on wildlife. PG, Proctor and Gamble makes Dawn. I did some homework and it’s a nice company. It is well situated both vertically and horizontally to whether bumps and grinds of consumer behavior. Rightly Dawn would not be the reason to buy the stock, but it has us looking. They priced themselves out of many market in 2009 and lost market share and are in the process of winning back customers. Their new CEO is really investing in strategies that will help their already strong 16.2% net margin. Their debt is very manageable and they are trading at the low end of their value range at 61 a share. We are coming up with a value of 71-73. We are initiating a July 60.00 call. It appears as though a bunch of fold will have to buy their way out of short positions in the next for days so this may be a good call. I am looking to turn this in a week at a 5% gain. Long term the stock look nice if you can get in now around the 62 level.

This is not linkage because I could not get three degrees of separation. Today’s news about Boeing’s 737 program was good news for industrials. One of the companies that bodes well when Boeing is making airplanes is welding and welding machine companies. Two of the bigger brands in the market place are Miller and Hobart. Both are own by ITW. I won’t bore you with the details, but ITW, Illinois Tool Works has some good financials. They are a dominant brand in many of the infrastructure programs in China and India. In the first quarter of 2010, ITW Asian business was up 37%. Their accounting protocols are very clean, no games as far as I could tell. And do you ever snap a buckle on a backpack or vest type jacket with those black nylon snaps and say gosh I wish I had though of that, ITW did and they still own the patent. Look at their three month chart and the 46 dollar price looks attractive. This is below its apparent of value of 71-73. Even conservative target prices has it pegged at 61. (Credit Suisse). We have an October call at 45 for 3.50 if I can catch it tomorrow.

Do your homework and look for the linkage.

Salve Lucrum


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