Sometimes, some investors just buy or own stuff that just resonates with me, like that time Nehal Chopra of Ratan Capital was on CNBC talking about Post Holdings and Charter Communcations. I owned (and still own) both of them. Apparently, Chopra dumped POST when it tanked but bought back recently. I rode it all the way down without selling anything and am nicely in-the-money on it now.
At the time, I had no idea who Chopra was.
This is sometimes why I post about certain investors. If they do something that interests me, I will make a post about it. And if it happens three times in a row, well, so be it. Surely, other investors have made more interesting buys recently. This is just what jumps out at me. By the way, I don't own BAM, SCHW or AME.
Anyway, AMETEK (AME) has been mentioned here in the past (by readers) as an outsider-CEO-type company; growing through acquisitions etc. Maybe you can call it a DHR-like company. I guess "outsider-CEO-like company" might not sound so great now after VRX, but whatever.
And by the way, I know it's been a while since I posted. I never make a post and then say, OK, I'm going to take a break for a month or two from blogging. It's just that time passes and then it's like, wow, I haven't posted in more than a month! Well, all sorts of things happen, some travelling, obsession with other things etc. But my main thing is still investing; it's just that sometimes time flies without me having made a post even when some ideas pop up (and I never bother to make the post for one reason or another).
Simpson Buys Big
So check this out. Simpson had no AME shares earlier this year (and never showed up in any 13-F for SQ Advisors recently).
Number of shares of AME in SQ Advisors' 13-F:
3/31/2015: 0
6/31/2015: 1.8 million
9/31/2015: 8.1 million
So that's kind of huge. The 13-F as of September-end showed $3.0 billion in U.S. stocks, and more than 14% of the portfolio in AME (this excludes cash and other assets that are not U.S. listed stocks).
Lou Simpson Portfolio
My last couple of posts related to Simpson were about BAM and SCHW, and AME is even bigger than those. It's also interesting that Simpson added to VRX in September, but this was before the real crash in the stock. I wonder what he did after that. It is interesting how Munger can really despise this company and Simpson can like it enough to make it such a large holding (he has owned it since (at least) 2011 and actually owns more shares now than in 2011; 2 million shares as of September 2015 versus 1.2 million back in 2011).
AME
AME has been run by Frank Hermance (now aged 66 or so) since 1999. He became President and CEO in September 1999 and Chairman and CEO in January 2001. AME aims to double the size and profitability of the company every five years. 1/2 to 2/3 of their growth is to come from acquisitions.
From their 10-K, this is what they do:
Products and Services AMETEK’s products are marketed and sold worldwide through two operating groups: Electronic Instruments (“EIG”) and Electromechanical (“EMG”). Electronic Instruments is a leader in the design and manufacture of advanced instruments for the process, aerospace, power and industrial markets. Electromechanical is a differentiated supplier of electrical interconnects, precision motion control solutions, specialty metals, thermal management systems, and floor care and specialty motors. Its end markets include aerospace and defense, medical, factory automation, mass transit, petrochemical and other industrial markets.
Competitive Strengths
Management believes AMETEK has significant competitive advantages that help strengthen and sustain its market positions. Those advantages include:
Significant Market Share. AMETEK maintains significant market shares in a number of targeted niche markets through its ability to produce and deliver high-quality products at competitive prices. EIG has significant market positions in niche segments of the process, aerospace, power and industrial instrument markets. EMG holds significant positions in niche segments of the aerospace and defense, precision motion control, factory automation, robotics, medical and mass transit markets.
Technological and Development Capabilities. AMETEK believes it has certain technological advantages over its competitors that allow it to maintain its leading market positions. Historically, it has demonstrated an ability to develop innovative new products that anticipate customer needs and to bring them to market successfully. It has consistently added to its investment in research, development and engineering and improved its new product development efforts with the adoption of Design for Six Sigma and Value Analysis/Value Engineering methodologies. These have improved the pace and quality of product innovation and resulted in the introduction of a steady stream of new products across all of AMETEK’s lines of business.
Efficient and Low-Cost Manufacturing Operations. Through its Operational Excellence initiatives, AMETEK has established a lean manufacturing platform for its businesses. In its effort to achieve best-cost manufacturing, AMETEK has relocated manufacturing and expanded plants in Brazil, China, the Czech Republic, Malaysia, Mexico, and Serbia. These plants offer proximity to customers and provide opportunities for increasing international sales. Acquisitions also have allowed AMETEK to reduce costs and achieve operating synergies by consolidating operations, product lines and distribution channels, benefitting both of AMETEK’s operating groups.
Experienced Management Team. Another component of AMETEK’s success is the strength of its management team and that team’s commitment to improving Company performance. AMETEK senior management has extensive industry experience and an average of approximately 23 years of AMETEK service. The management team is focused on achieving results, building stockholder value and continually growing AMETEK. Individual performance is tied to financial results through Company-established stock ownership guidelines and equity incentive programs.
Business Strategy
AMETEK is committed to achieving earnings growth through the successful implementation of a Corporate Growth Plan. The goal of that plan is double-digit annual percentage growth in earnings per share over the business cycle and a superior return on total capital. In addition, other financial initiatives have or may be undertaken, including public and private debt or equity issuance, bank debt refinancing, local financing in certain foreign countries and share repurchases.
AMETEK’s Corporate Growth Plan consists of four key strategies:
Operational Excellence. Operational Excellence is AMETEK’s cornerstone strategy for improving profit margins and strengthening its competitive position across its businesses. Operational Excellence focuses on cost reductions, improvements in operating efficiencies and sustainable practices. It emphasizes team building and a participative management culture. AMETEK’s Operational Excellence strategies include lean manufacturing, global sourcing, Design for Six Sigma and Value Engineering/Value Analysis. Each plays an important role in improving efficiency, enhancing the pace and quality of innovation and cost reduction. Operational Excellence initiatives have yielded lower operating and administrative costs, shortened manufacturing cycle times, higher cash flow from operations and increased customer satisfaction. It also has played a key role in achieving synergies from newly acquired companies.
Strategic Acquisitions. Acquisitions are a key to achieving the goals of AMETEK’s Corporate Growth Plan. Since the beginning of 2010 through December 31, 2014, AMETEK has completed 26 acquisitions with annualized sales totaling approximately $1.4 billion, including five acquisitions in 2014 (see “Recent Acquisitions”). AMETEK targets companies that offer the right strategic, technical and cultural fit. It seeks to acquire businesses in adjacent markets with complementary products and technologies. It also looks for businesses that provide attractive growth opportunities, often in new and emerging markets. Through these and prior acquisitions, AMETEK’s management team has developed considerable skill in identifying, acquiring and integrating new businesses. As it has executed its acquisition strategy, AMETEK’s mix of businesses has shifted toward those that are more highly differentiated and, therefore, offer better opportunities for growth and profitability.
Global & Market Expansion. AMETEK has experienced dramatic growth outside the United States, reflecting an expanding international customer base and the attractive growth potential of its businesses in overseas markets. Its largest presence outside the United States is in Europe, where it has operations in the United Kingdom, Germany, France, Denmark, Italy, the Czech Republic, Serbia, Romania, Austria, Switzerland and the Netherlands. While Europe remains its largest overseas market, AMETEK has pursued growth opportunities worldwide, especially in key emerging markets. It has grown sales in Latin America and Asia by building, acquiring and expanding manufacturing facilities in Reynosa, Mexico; Sao Paulo, Brazil; Shanghai, China; and Penang, Malaysia. AMETEK also has expanded its sales and service capabilities in China and enhanced its sales presence and engineering capabilities in India. Elsewhere in Asia and in the Middle East, it has expanded sales, service and technical support. Recently acquired businesses have further added to AMETEK’s international presence. In recent years, AMETEK has acquired businesses with plants in Germany, Switzerland, the United Kingdom, Serbia and China as well as acquired domestically located businesses that derive a substantial portion of their revenues from global markets.
New Products. New products are essential to AMETEK’s long-term growth. As a result, AMETEK has maintained a consistent investment in new product development and engineering. In 2014, AMETEK added to its highly differentiated product portfolio with a range of new products across each of its businesses.
And from the annual report, a snapshot:
It looks pretty impressive. Nice growth, and new highs after the 2008/2009 recession pretty quickly. I dug up some figures going back to 1999 when Hermance became CEO to see how he has done, and it is pretty impressive:
Financial Summary of AME since 1999
Net sales grew 10%/year since 1999 while operating income grew around 15%/year, and EPS around 16%/year.
As with DHR, free cash flow has been higher than net income throughout the period by around 1.2x.
The interesting thing about AME is that these figures are not "adjusted" or anything like that. Unlike, say, VLX, AME's EPS is plain EPS.
As of the third quarter, guidance for the full year 2015 was $2.55/share, up 5% over 2014. With the stock at around $54/share, it's trading at a P/E of around 21x.
Conclusion
AME does seem to be facing some macro headwinds. Oil and gas hasn't been too much of an issue as they don't have that much exposure to upstream, but slowing growth in Asia and emerging markets are holding back their growth this year and probably into next year. So there is some risk there.
The stock is certainly not for cheapskates at 21x P/E, but they do have good free cash flow conversion and growth potential. Their operating margins are higher than say, DHR or CFX too (with similar business models). AME isn't leveraged at all, either, with long term debt of $1.6 billion against 2014 EBITDA of $1 billion. With the junk bond market tanking and rates going up, this may be a good thing.
There are plenty of 20+ P/E stocks with very little growth prospects (and the whole market at close to 22x P/E), maybe this is not a bad idea. Historically, AME has traded at around 20x P/E.
Have you seen the short thesis here? Any thoughts?
ReplyDeletehttp://www.sprucepointcap.com/reports/ame_research_thesis_11-13-2014.pdf
No, thanks for the link. I will take a closer look at it later. I am not that familiar with AME and haven't been following it closely for any period of time so I don't know what to think yet. But at first glance, a lot of it is not so alarming. First of all, the whistleblower is about $2 million in sales? I know, maybe it's not the size, but that it happens at all. But I don't know.
DeleteAlso, the analysis of foreign entity filings reminds me of where I used to work and where we had a lot of entities too, and most of them made no sense at all. If you looked at them independently, they would be shocking, but often they were not meant to be really stand-alone; it only made sense as part of a whole (for example sometimes you don't want equity to grow. Sometimes you want to keep things minimally capitalized. Sometimes entities are there just for regulatory purposes so you can say you have an entity there etc...). So to look at some of these things that seem very small on their own, I don't know if they mean all that much. They might, though. I'm just saying from what I remember from my situation, we had entities that made no sense at all on their own, but our company was, overall, fine.
What else? Oh, the high percentage of intangibles/goodwill on the balance sheet is not a problem for me at all either. If you are an acquisitive company, then you're gonna have a lot of intangibles. They may be right that things are amortized too slowly and overstate earnings. That's a valid argument, of course. But the goodwill/intangibles on their own isn't a problem. The question, as Buffett would say, is if there is any value there. Alleghany pointed out that they have less goodwill/intangibles on the balance sheet than, say, Berkshire Hathaway. But Buffett would tell you that the goodwill at BRK is very valuable etc...).
So I don't know. Maybe there are problems, but so far, nothing jumped out at me as being totally alarming.
I'll read all 1,000 pages soon and if I have anything to say, I'll post here.
Again, thanks for the link.
OK, I got through the main part of the presentation. The rest is just financial filings etc. The two things that stuck out to me is the amortization problem (20 years to amortize customer relationships) and the whistleblower thing.
DeleteFirst of all, the amortization problem shouldn't be an issue when looking at EBITDA, right? Or as they say, just look at the cash; they are generating a lot of cash (and spending it too on acquisitions, but at least they are generating the cash).
Also, the report says that if you adjust for that aggressive amortization, EPS would be 2.5% lower. That doesn't seem like a huge issue to me. But yes, of course, it might reflect the culture so may not be a good thing.
Also, the whistleblower issue sounds alarming but when you actually read it, the financial controller involved is not a big financial controller at AME headquarters or anything. He was the financial controller of a $30 million division in Oklahoma. It's a tiny division. Sure, fraud is not good anywhere in any company, but this is hardly indicative or proof of widespread, systemic fraud at AME, which is what shareholders would worry about.
Hmm... what else? The analysis of foreign entities was certainly very interesting, but a lot of times they only show one year-to-year comp and say revs aren't growing. Like for one company, it's 2011-2012 that was down, at another it was 2012-2013 that was down. For some, they show multiple years.
There is informational value there, but on the other hand, you can't really look at 20% of someone's equity portfolio and say, gee, he is down in all those names, he must be an awful fund manager and fraud is the only way he is posting positive returns! Well, that is reaching a little bit.
So anyway, I will dig in some more and let this information digest/settle in my head. But at this point, I am not seeing anything shocking or alarming.
The big risk here, though, as the report states and which is true for all of these roll-ups, is that at some point acquisition opportunities disappear. But AME is still pretty small. The other issue is the macro headwinds they say they are facing. This can be a bigger issue over time if the economies don't do well; the recent rally in the economy has sort of been in response to the shock therapy by the Fed/central banks around the world, and when that tapers off, we have yet to see what the sustainable, normal rate of growth globally is going to be. And if that turns out to be lower than we expect, it can be a problem for AME for sure.
Anyway, it's very interesting and I love when people put out fat reports on companies, bullish or bearish. There is so much to learn from them. In this case, since I don't own AME yet, I don't even really have a horse in the race.
This is one of the great things about writing a blog; I put something up and others point me to things I might be interested in. Because of this blog post I made yesterday, I now know more about AME!
I agree with all that you write kk. I’d also add the following points which Spruce omitted to mention in his report:
Delete1. The so-called whistleblower, Theron T. Matthews (also goes by the name Tim Matthews) was not new to litigation:
- Foreclosure proceedings against him:
http://law.justia.com/cases/oklahoma/supreme-court/2012/108427.html
- Wrongful termination of employment proceedings initiated against former employer Labarge. His case was dismissed.
http://ca10.washburnlaw.edu/cases/2011/01/09-5171.pdf
- Then came the case Matthews brought against Ametek which was also dismissed. I was not able to find a copy.
- Matthew’s Linkedin profile:
https://www.linkedin.com/in/tim-matthews-62301211?authType=NAME_SEARCH&authToken=RQct&locale=en_US&srchid=618208281454025952655&srchindex=1&srchtotal=1&trk=vsrp_people_res_name&trkInfo=VSRPsearchId%3A618208281454025952655%2CVSRPtargetId%3A38842875%2CVSRPcmpt%3Aprimary%2CVSRPnm%3Atrue%2CauthType%3ANAME_SEARCH
2. Spruce paints a picture of insiders “racing to the exit” and dumping their stock. He talks about insider ownership as a percentage of outstanding shares being down from 2007-2014. That’s correct but Spruce forgets to mention that a number of directors and former executives with big shareholdings dropped out of the insider ownership computation over the same period. Take directors Sheldon Gordon and David Steinmann who together held 8.5% of the insider shares in 2011 but were no longer part of the insider ownership computation in 2012. Or former CFO Molinelli who owned 14.5% of insider shares in 2012 and then dropped out of the computation in 2013. If you adjust for these changes then the fall in insider ownership percentage is much less dramatic. I’d also point out that Hermance (CEO), Zapico (COO) and Mandos (CFO) have seen their shareholdings increase over the period. Hermance owns 1.5% of the business which is a sizeable amount.
3. Finally, here’s a link to what Oppenheimer had to say about Spruce’s report and which debunks a few of the remaining points
http://www.streetinsider.com/Analyst+Comments/Ametek+(AME)+Defended+at+Oppenheimer/10011195.html
I entirely agree with you regarding the downside risk facing this roll-up story. I’d say it would be important to size up the market opportunity and also AME’s capabilities to acquire and integrate larger businesses over and above the $250m revenue range. I’d be interested in your views if you have any on this.
If management can be trusted, then I think AME is an excellent business and quite cheap at today’s price considering their track record and their objectives over the next 5 years. I don’t know management. I wonder if Lou Simpson would get to know them before putting 14% of his fund into the business. I expect he’d want to. I saw that AME’s former CEO Walter Blankley who started the roll-up strategy (just before Hermance took over in ~2000) lives in Naples, FL which happens to be where Simpson also lives I believe. It’s quite a small city so perhaps there’s a link there.
Anyhow, I think this Spruce guy produced a weak report.
Thanks for the followup! Nice work!
DeleteThis business is above average, no doubt. It way even be excellent if the competitive advantages articulated by management prove correct. Its track record is clear and impressive. The risks concerning future growth, whistle blowers, intangible accounting and future end market conditions are par for the course for such an industrial roll up - there is nothing existentially problematic here. I like the business, but not the stock. Its not cheap. Its not a nose bleed, but its fully priced for sale - in real estate parlance. At almost 4 times net assets (including intangibles), despite a potential 15-20% p.a. return on stockholder funds going forward, these just no room for either a mistake (unforced error), a deterioration (forced error) or for a 15-20% return. At up to 3 times book, the conversation might be different. In my view, this is not that hard to pass on. You've got to keep turning over stones to find the 1 foot hurdle. I enjoyed the post though Brooklyn, thank you for presenting the stones.
ReplyDeleteYeah, it's not cheap. But Simpson is known for owning growthy names, not dirt cheap value things. For example, he owned Nike for many years despite the high valuation.
DeleteSo the fact that he bought into AME so hugely must mean that he sees a lot of runway ahead for these guys to grow.
Colfax Corp trades at less than eight times pre-tax income (ex-FX) 2014, and roughly ten times pre-tax income (again ex-FX) 2015. Some similar dynamics there, offered at a more attractive valuation. Don't you think ?
ReplyDeleteColfax is a lot cheaper but they are also getting hit a lot harder now in their end markets and recovery might take time. I do like CFX, though.
DeleteThis comment has been removed by the author.
DeleteWhere do you see the value in this?
ReplyDeleteIf you assume growth and profitability for the next ten years is equal to that of the last 10 years you get:
Current MV = 12600
Current earnings = 584
average 10y ROE = 18.2%
average 10y payout ratio = 11.4%
P/E in year 10 = 20
You get a pre-tax IRR of 5.54% (including dividends).
Sorry pre-tax IRR = 6.98%. You get 5.54 if you assume normal scenario 20 P/E and bad scenario 15 P/E (averaging). Anyway, I struggle to see the value - definitely doesn't not look like a home run and a lot of things have to go right.
DeleteHi,
DeleteI don't understand your math. Both EPS and net earnings have grown around 18%/year over the past 10 years, so in order to get returns as low as you suggest, (assuming similar growth rate over the next ten years as the past ten), you would need to see some serious P/E compression...
This comment has been removed by the author.
DeleteNo - it is a homerun, and not alot of things have to go right at all.
DeletePaying 20x p/e for a company that consistently grows at 20%/yr is literally nothing. Actually, if you flip to pg 359 in your '61 edition of Security Analysis, BG highlights what p/e you should be willing to pay for various growth rates and various amounts of time (e.g., what p/e you should pay for 10% growth for 5 yrs, 7 yrs, and 10 yrs...or, what you should pay for 15% growth for 5, 7, and 10 yrs, etc -> where the years is how long it can grow for). 15-20% growth for 10 years should command a considerably higher p/e than 20. The beauty is, as long as NI continues to grow, you don't need multiple expansion at all.
Hermance purchases niche companies at 2x sales, has been doing it for 15 years, and ROIC has actually expanded over this timeframe. He buys companies that produce a product that the customer literally cannot live without. He spoke on the 2q call (I think) about how the strong USD had a fairly minor impact on sales volumes - customers come and ask for a price, and b/c of high USD it is too expensive, and they can't purchase it. So, they go back to corporate, tell them the situation, and then come back to AME 3 months later with the cash. It doesn't seem like there are really even viable alternatives for some of their products.
And, you don't even need to know what their products do (note: lots of big words). You just need to know what kinds of acquisitions Hermance makes and what the returns are over a 15 year period. That will tell you alot.
Also, just b/c it is so glaring, look at their operating margins in 2009. The worst year for industrials in recent history, and Operating Margin actually expanded. Also, look at gross margins and OpEx (as % of rev) over past decade. Both have continuously expanded. He is an insanely good operator and capital allocator.
You mentioned DHR. This company also reminds me of Amphenol (APH). They are actually very similar in terms of enterprise value, markets served (on the surface), M&A-driven growth strategy and free cash flow level. At first glance, APH has higher returns but lower margins. Might be worth exploring further...
ReplyDeleteThanks. That's worth a look.
DeleteAmetek's 10k has been sitting in my pile for some time, and with Simpson's stake and your post, I decided to finally read through it. Still haven't finished, but I'm a little wary of the FCF #'s. I believe the FCF measure they're using is simply OCF - CapEx, which is a little too liberal for my blood.
ReplyDeleteAmetek adds back share-based compensation (like Amazon), and while it isn't as large an expense as Amazon, it's still ~$20m a year over the past three years. But the bigger issue I have is they ignore acquisition costs in FCF #'s. For a company that isn't as acquisitive, I can live with this, but for a serial acquirer like Ametek, I'm a believer that it should included in the FCF calculation. Over the past 3 years, acquisition costs have averaged 97% of their FCF #! Were they not acquiring businesses, they'd have to expense this via R&D in order to grow, so it's a real cost in my opinion.
I'm leaning towards being in the camp of a solid company, with growing margins (gross, operating, and net), that smartly acquires, but is currently fairly priced. The market might be discounting their growth potential as I intimately know a few companies that have been acquired by them and they are market leaders in their respective niche. I think of them like the P&G of niche-industrial and scientific equipment, that has high margins and high barriers to entry so they can probably raise prices over time, which would fall directly to their bottom line.
I have to do some more research, but just wanted to share my first glance thoughts. Was also curious how you felt about the acq costs being ignored in FCF.
Hi,
DeleteGood point about share compensation. As for FCF, I also see your point. I'm OK with the FCF excluding acquisitions, because that is clearly a capital allocation decision, like share buybacks or dividend payments. Also, acquisitions are clearly investments for growth.
In non-acquisitive, regular companies, free cash is calculated as operating cash flow less maintenance capex; capex required to keep the business going (and exclude investments in new stores, factories etc. for expanding capacity, increasing sales etc).
So in that sense, the FCF excluding acquisitions is consistent with that.
The problem is, of course, if you look at FCF as totally distributable, and then also assume that they can grow 15-20%/year. That would obviously be wrong as the FCF can either be distributed, or invested (or some combination of both).
Earnings growth is ROE x retained earnings and when a company is earning 20% ROE and then can continue to invest at that rate, then you actually as an investor want the company to reinvest and not pay free cash out. Most would prefer to own a company growing earnings 15-20%/year and paying no dividends rather than a slow grower paying some dividends. (well, growth investor vs. value investor argument aside).
As for valuing the company using free cash flow, I think the assumption is that you can look at the FCF as a steady state, sustainable level for free cash without acquisitions. This is one reason why organic growth is so important. If you have organic sales growth of 2% and you buy a stock at 5% free cash flow yield, you are looking at a conceptual 7% return on that stock with no acquisitions. If organic growth is 4%, that's a 9% return. You can add cost cuts too as many of these companies get more efficient over time. That's the return that you might achieve if the company stopped acquiring other companies and just paid out free cash to shareholders.
To further illustrate the importance of free cash, even excluding acquisitions, is to think about companies that have positive earnings and don't grow much, but when you look at their free cash flow, there really isn't much; most of the earnings have to be reinvested into the business just to stay in place.
The FCF figure at AME (and other companies like it), excluding acquisitions, is telling you that these guys are creating excess capital every year that can be reinvested in the business to actually grow, and not just to maintain business and stand still.
Anyway, those are some of the things I think about when looking at these figures...
Oh yeah, and to further the point. In this environment especially, you can see how something like AME can be attractive. If they paid out their free cash as dividends, then investors have a choice of earning 2% in treasuries, nothing on cash, or maybe 5%-6% in stocks. Or they can let AME reinvest at 20% ROE.
DeleteOops, I should clarify that op cash less maintenance capex is one of the ways people look at free cash flow.
DeleteThanks for the follow up and your insight. I tend to shy away from acquisitive companies since I find them harder to value, but so long as an investor doesn't fool him/herself that the earnings growth is free, they should be in good shape.
DeleteKind of a tangent, but have you ever read any Stephen Penman?
No, I haven't.
DeleteIf you're in the market for a good accounting textbook, I'd strongly recommend his "Financial Statement Analysis and Security Valuation". He teaches at Columbia Business School, and based on a lot of your posts, I think you might enjoy some of his stuff. It leans towards an academic approach, but a lot of the frameworks can be applied in practice; more so than other finance books I've read.
DeleteHey there. great article as usual. Have you ever written anything about Lou Simpson's investment in UPS? What are your thoughts on his investment in UPS? Why do you think Lou sees in the UPS investment?
ReplyDeleteHi, the reply button doesn't work for some reason on this laptop, so I'll reply in a new comment to Sang Park.
ReplyDeleteThanks for the comment. As for UPS, I've never posted anything about it and I don't know too much about UPS even though I've looked at it on and off over the years. The main idea, I think, is that retail is moving online and UPS is one of the main beneficiaries of that (along with the USPS and FDX). So in that sense there is a long runway of growth for them as more and more retail moves online.
And the other idea is that UPS is more and more moving into logistics. There is an overlap there too, of course; taking over more of the logistics of businesses moving online too.
Anyway, I've always thought it's an interesting idea but never pulled the trigger on it... and it wasn't ever really that cheap.
Funny thing, though, is that they are profitable with decent returns on capital despite a huge subsidized competitor (USPS).
Maybe a future post idea. Thanks for dropping by...
AME is the closest industrial comp I know of that actually adds value from its acquisitions. If you go back through Frank Hermance's tenure, they generally buy very good technology from engineer founders and then take their operational excellence programs to improve margins. There is usually very significant margin improvement within a year that makes most of their acquisitions look very cheap once they are integrated.
ReplyDeleteStill holding OZM bag ?
ReplyDeleteI bought some the last time it got down here; believe it or not, I'm in the money on it, even with the stock down here. But it's not a large position. All of these alternative managers are getting killed, as I assume people are afraid of not knowing who is holding bombs in their portfolios as more things start to blow up.
DeleteI didn't really think about it earlier, but I realize now that alternative managers might get killed on the other side too, not just on the investment side. Some of these guys raise a lot of capital over in the Middle East, and with oil at $30, the sovereign wealth funds won't be getting any bigger... they will start turning into sovereign poor funds, and will need to be liquidated to fill budget deficits etc...
So the model where all the money goes to the middle east at $100, and those SWF's in turn invest in U.S. private equity/hedge funds, might start to unwind and that's not good for the alternative managers.
Anyway, over time, I expect they will do well, but it can be tough going for a while.
Having said all of that, I bet a basket of these guys bought around here would do well over the next 5-10 years... (I still don't have much allocation there, though)
So you publish the article on September 28, (and for you to be in money) purchased around Nov 18 ~ 20 ?
DeleteHmmm....
If you look back at my articles, you will notice that I don't own or buy most of what I write about. I don't own any AME, BAM or SCHW, all of which I wrote about.
DeleteI had no intention of buying OZM because of the reservations I had that I mention, but then the stock tanked and got cut in half. I still have my reservations about it (especially the alternative asset bubble) but when a thing is cut in half I thought I had to at least take a nibble.
I write about things I don't own or buy because if I only wrote about things I bought or own, then my number of posts would go down dramatically and I decided that that is not what I wanted. I will write about stuff I find interesting whether I want to buy it or not... of course I prefer to write about something I want to buy a ton of or own a bunch of...
I think for many investors acquisitions have negative connotations due to all the value-destroying, empire building deals that have received a lot of publicity. Think HP/Automony, Time Warner/AOL. However, there are many smaller companies, particularly in the industrial space which have used acquisitions to create enormous value, such as Ametek, Danaher, Transdigm, Heico, etc. For me it really boils down to whether or not the company in question has proven whether or not it knows what it is doing when it comes to making deals. These companies make good investments when you can buy them at a price that doesn't include a premium for superior capital allocation abilities.
ReplyDeleteDoes anyone have a Grant's subscription by chance? I'm looking for someone to help me get the mentee subscription price.
ReplyDeleteHi kk,
ReplyDeleteGood article but i have an off topic question here. What do you think about the Texan bank CFR? It seems really cheap. Last year Geoff Gannon wrote that it was worth $141.
Really appreciate your thoughts.
Thanks.
Hi, I'm not too familiar with small regional banks. It may very well be a well-run, decent bank. I would just be careful about their energy exposure. Even if direct energy exposure is not that big, there are secondary effects too; like real estate. I would be a lot of commercial real estate would be to energy/energy service companies etc.
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DeleteKK,
ReplyDeleteThanks for your answer and the warning.
KK,
DeleteI currently read Kay's "Other people's money" and wonder where I got the idea from. Was that you by any chance? I am looking for someone to discuss a thing or two.
Eddie
Basically, sales growth comes from 2 places: 1) acquisitions, and 2)organic growth. How much did each contribute? In 2010, sales were $2.47b. Since then, sales have grown to $3.975b. We also know that acquisitions over the past 5 years contributed $1.3b in sales. So, 3.9-1.3=2.6. The difference between 2.6 and 2.47 is organic growth...obviously 130 million over 5 years isnt alot, but there's probably a significant FX impact here. This $130m in sales can come from two places: new product development (e.g., higher volumes), and pricing.
ReplyDeleteSo, let's look at new product development. New products introduced over the past 3 years contributed $950m in revenue. But, we know that organic growth (ex-acquisitions) was only $130m. This means that $800m of their product development sales were cannibalistic. in 2010 they had $2.4b in sales, and by 2015, AME had replaced $.8b of those revenues with new product revenues. Why is this important? For AME, product development is defensive. Whenever they release a new product that cannibalizes sales of an old product, they also make their competitors' offerings obsolete.
AMe’s R&D/prod. Dev expertise gives us some comfort that AME's core operations aren’t declining. The equipment they mfr is critical – customers can put off demand, but eventually they need to make the purchase. Their markets aren't exactly high-growth, either, but that’s ok bc we grow with acquisitions.
Now, growth. Growth comes from 3 sources: acquisitions, margin expansion, and organic sales growth. Acquisitions since 2010 contributed $1.3b in sales, and organic growth contributed $130m (not adj. for fx or anything), so the pace of acquisitions and organic sales growth has added $1.43b in sales over 5 years (lets call it 60% total sales growth over 5 years). If OpIncome increases with sales, e.g. excluding margin expansion, OpIncome shold have increased by 60%. Since Op Income was $480, it should increase to $768 from sales growth.
The other source of growth is margin expansion. margins were 19.5% in 2010, and 22.84% in 2015. So, they expanded by 3.34%. If we take 3.34%, and apply it to 2015 sales of $3.9b, we get another $132 in Op Income growth from margin expansion.
$480 OI in 2010, 288 in OI from acquisitions/internal sales growth,and 132 in OI from margin expansion gets us to ~$900 in OI. Which is exactly what AME's OI was in 2015.
Basically, ROICs don't expand. Tax-adjusted ROIC (apply this years tax rates to prior year NOPAT, as taxes have been decreasing) is always 13%. But, AME grows by 12-15% per year. All of its growth comes from growing the Invested Capital number.
Mgmt has a 17yr track record of allocating capital/M&A. If we know that their core business is in niche markets, and that they aren't losing market share, and that the equipment they manufacture is non-discretionary for its customers, and we know that all growth comes from Invested Capital growth, and we know that mgmt has a 17 yr track record of capital allocations...you know what im getting at, i hope. there's no mystery or black boxes here; the company's growth is limited by its pace of acquisitions. I consider its base businesses to be no growth businesses, and then allow pricing power/new product dev to boost organic growth by a couple percent/yr (10% total over past 5 years). Once you understand this, and its competitive position, the question is just how quikcly will it grow. And the answer is as quickly as management can deploy capital.
Love to hear your thoughts, thanks!
Thanks for the detailed analysis. Sounds good to me!
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