Friday, May 11, 2018

Bought Cardinal Health (CAH)

This week, bought 417 shares @ USD 53.55 at a total cost of USD 22,332.

CAH released bad earnings early this month, due to write offs in its newly acquired medical equipment distribution.  This drove the stock price down 20%, allowing me to buy at just below 12X FCF.



Thursday, May 3, 2018

Selling Kering. And Inner Peace.

Sold my Kering shares at Euro 477.50 on 31st April.  Profit was SGD 57K, or 180%.  Over 4 years.


Since I bought Kering in early 2014, its main brand Gucci has transformed from a bland, logo-driven luxury brand to a young, exciting one.  Unknown designer Alessandro Michele took over and revitalised the brand, making it younger, more colourful, and gender neutral.  I don't understand any of this fashion crap, but sales are up double digits for the last 7 consecutive quarters:

The brand's transformation is best captured in pictures.

Severed head at fashion show:


Collaboration with graffiti artist Gucci Ghost:



Handbags - the bread and butter of the industry - now with colourful prints:
Now Gucci is a trendy, hip brand, popular with millennials.  It is the hottest fashion brand in the world.


Hard to know if the decision to sell was correct.



At a PE of 30, Kering is now reasonably expensive.  But the trend is still up - both the stock price and fashion trends - and I cant see any sign of it stopping.  Its easy to see the stock doubling again from here due to increased sales combined with operating leverage.  OTOH, a lot of good news is already priced in.  Fashions come and go.  Trees don't grow to the sky.  Especially for a company that sells handbags - its not the next Google or Facebook.

I chose to sell because of:
  • Valuation
  • The chart was going parabolic.  Theres no real support to tell when the uptrend breaks.
  • I want to lighten up on stocks near the end of the business cycle.

Someone once told me, even when a stock shoots up after you sell it, you should be happy for the guy who brought it from you.  Because even if he makes money that you could've made, he's still taking a greater risk than you.

Inner peace.


Tuesday, April 24, 2018

Bought McKesson (MCK)

Bought 150 shares last night at USD 150.57 for a total of USD 22,590.44.

I'm wary of buying stocks this late business cycle.  But the drug distributors' revenues did not fall in the last recession.  Their profitability depends on the supply side, not demand. Their profits - and stock price - have fallen in the past few years due to generic drug price deflation.

The main long term risk is the consolidation of their customer base, which causes price competition.  But I think its already priced into the stock price.  I don't see a catalyst now for the stock or its earnings to go up, but by the time I do, so will everyone else.  I'm willing to hold this for a few years, through the next recession.  When a company is part of an oligopoly, has recurring revenue from an essential good, and is selling at 11X FCF, how can you not buy it?


I'm now 50% invested:


Looking to sell the banks in the next 6-12 months as we come to the end of the business cycle.

Gazprom

I entered a small position in Gazprom, the Russian gas company, last year.

Gazprom is an indispensable supplier of piped gas to Europe, trading at a single digit PE.  It (and its underlying currency) trade in accordance with crude oil prices.  It was a 1% speculative position, due to the risk of forced privatisation.

This was based on a previous recommendation from Capitalist Exploits.  They turned negative on it due to increasing geopolitical risk: US shareholders have been given a deadline to dispose of their Rusal stock/bonds, and Gazprom could be next.

Sold it last week.  Profit around USD 600.


Sunday, April 22, 2018

Covered FMG Short

Covered my FMG short at on 20th April at AUD 4.69.
It had closed above the 4.50-4.55 support level for several days.
Loss of AUD 2.8K.

Monday, April 2, 2018

Short Fortescue Metals Group

I am expecting Iron Ore to drop.  Most IO is used by China for building and infrastructure.

In the long run, China is trying to move away from infrastructure and manufacturing.  Over the years they brake, accelerate, brake, accelerate...as they try to slow down without causing a recession.

In the medium term, I think they are in the brake stage now.  They will be slowing down now, so they can stimulate in 2020 for Xi's election the year after.  China's growth credit (Total Social Financing plus Bonds) is slowing:


Source: MB Webinar - Nucleus Wealth Mgt (abt 30 mins in).

In the short term, there are record iron ore stocks at Chinese ports.   Most of it is low grade ore, unused because of China's pollution restrictions.

FMG is the 4th largest global iron ore supplier after Vale, BHP and Rio, and also 4th place on the cost curve.  It produces mostly lower quality 58% ore, versus high-quality 62% ore from the other three, and low quality 30+% from domestic Chinese producers.  Upgrading their mix will take time - meanwhile they have have to accept discounts.

FMG's stock price has recently broken support:

I am short 6,600 shares of FMG at AUD 4.27.  This is a short term trade, hoping to make 20-30%.

Main risks are:
  • In the short term, the market shoots upwards if the correction ends.
  • China may rescind their pollution curbs.
  • In the long term, steel may be used for OBOR.  Or for buildings/infrastructure for the booming US economy.  Including a big, beautiful wall.

US Drug Wholesalers again

Another look at US Drug Wholesalers: Cardinal Health (CAH) and McKesson (MCK).  These companies are part of an oligopoly in an industry not affected by recessions or trade wars, and are cheap now.

Cashflows

These 2 companies have been highly profitable.   Lets look at their past numbers.

I use Cashflows From Operations (CFO).  Since they are distributors with large yearly swings in working capital, exclude working capital changes:




Sustaining capex (mostly PPE) is extremely low, so free cashflows almost matches CFO:



But both companies spend a lot on acquisitions, which consists of the majority of their Cashflows from Investments (CFI):



Here's a look at CFO vs acquisitions and disposals.  In some years, all CFO is used for acquisitions:


Why are they spending so much on acquisitions?

I wonder if some of the acquisition spending is actually part of sustaining capex.  In a fast changing industry that is constantly growing, do you need to constantly acquire new companies to maintain market share?  Running to stand still...

Valuation

FCF per share is below.  Again, I'm excluding working capital changes to smooth things out - this will inflate CFO a little, as more and more working capital (eg: inventory) is required as a business expands over time:



At $140, MCK is trading at ~11X estimated FCF, and at $60, CAH is around 12X.

Risks

Although their past numbers are really good, there are some risks not reflected in them.  Most of these are from the DrugChannels 2017-18 Economic Report on Pharmaceutical Wholesalers and specialty Distributors.

Their pharmacy end customers have been consolidating, putting pressure on Margins.  Operating margins for large pharmacy chains are estimated at ~ 0.5%, versus 1.5% for independent pharmacies.

Generic drugs account for an estimated 70% of their operating profits.  Pricing is horrendously complex, and is a set percentage of the Weighted average Cost price (WAC) - see pages 11 and 13 for examples - which means that rising generic drug prices boost profits.   Starting in 2011-12, there was a boom in generics drug prices due to an artificial shortage.  This has since been resolved, and prices have been coming down since 2016.  We need to keep this in mind when looking at the charts of the historical profits/cashflows above.  The report estimates that 1 in 5 generic drug prices have yet to fall, and that generic drug prices will continue on average to fall in the next 6-18 months.

Although spending on specialty drugs in set to increase, this is not expected to help wholesalers as most specialty drugs are prescribed through large chains and hospitals.  ie: their low margin clients.

Finally, there is a risk of litigation due to the opioid crisis, where the wholesalers were not monitoring - or just ignoring - suspicious orders.  I think McKesson is more vulnerable as they've been sued a lot before.

Conclusion

The positives are: this industry is an oligopoly with a defensible moat.  And pharmacy spending is not affected by recessions.

MCK has better historical numbers and trades at a slightly lower valuation.  But has more litigation risk. 

The stocks are trading at low valuations now due to:
  • A price war last year, bought on by a consolidating customer base.
  • Falling profits in 2016 dues to generic drug deflation.
These trends may continue.  I see no catalyst to move the stocks higher now.  But the industry is cheap.  Are the above risks already priced in?