Northern Value? — Notes from the Value Investing Conference

By Travis Johnson, Stock Gumshoe, October 17, 2011

The Value Investing Congress is always an interesting place to hear about ideas and strategies from some of the better money managers and analysts around, but I’m finding it particularly valuable this year … when the market is going through crazy gyrations and moving up and down on macro news like European debt or unemployment jitters, it is somehow very comforting to sit down, turn off your market data feed, and think carefully about a specific company, why it makes money, and how much it ought to be worth. We can make decisions about what stocks to buy and believe that we’ve thought about it in a different way than others, or that we are more patient than others and that this adds value … but when you’re trying to move your portfolio around based on giant macro moves in the global economy you can’t help but feel like you’re getting into the race about four laps behind the leaders.

Oh, and in case you’re wondering: yes, apparently the Occupy Wall Street folks made it up to Times Square today and must have been milling around right in front of my hotel … not sure what exactly was on the agenda that had them hitting Times Square, which as far as I can tell is now just a Disneyland for European tourists, a place where you’re not allowed to smoke anywhere but somehow everyone still smells like cigarettes … but, it being Times Square, I didn’t notice the protesters. I had to catch it on the local news. Not that I’m unsympathetic to their anger at the large banks or the government or any number of other things, but I do wish I understood their goal.

But anyway, I am unerringly focused on learning about interesting ideas this week, not on worrying about the big picture — and in the small picture, I heard some interesting arguments about individual stocks today, so I thought I’d share one of them with you this evening. I earlier jotted a little note about value index investing and some thoughts about Joel Greenblatt’s talk, but I thought the Irregulars might be intrigued by the pick proposed by Guy Gottfried.

Gottfried analyzes Canadian stocks at his Rational Investment Group, and he appears to be about 11 years old (he’s 30). He argues that value investing is under-practiced in Canada and that the market is less efficient — partly because it’s smaller, and partly because the investment industry in Canada is overwhelmingly focused on the natural resources industries that the country is known for (despite the fact that they make up less than the half of the Toronto Stock Exchange listings).

And his investment idea? A former Canadian income trust that almost went bust, and that is looking cheap on cash flow, with good management in the midst of what he calls a dramatic recovery. The company is one of Canada’s leading furniture and appliance retailers and, apparently, a well-known brand up there (haven’t spent much time in Canada since 1980, I’d never heard of them): The Brick (BRK in Toronto, BRKQF on the pink sheets).

Gottfried’s argument is that the company is still hated by investors because of their failure a few years ago due to overleveraging and underinvesting in operations at the same time that they spent a lot of money expanding distribution for business that disappeared in the late 2000s, tainted by the fact that they stopped paying the high dividend that investors had come to love. Oh, and, like their competitors, they posted weak same store sales this year because of a tax credit that expired last year. And in addition, no one follows the stock — he says that there was only one person on the last conference call, despite the fact that Prem Watsa owns about a third of the shares (Watsa makes value investors swoon, he runs Fairfax Financial, which I last wrote about in May). So that, and and that high insider ownership, got me interested.

I can’t give you the full story here, just wanted to share an idea that you might find interesting — the shares did jump today thanks to the attention from Gottfried, but if he’s right then the 11% jump shouldn’t be much of a deterrent (and it might fall right back down). It’s a small company, with a market cap around C$350 million and a trailing PE of about 9, and he said that the shares are now trading at about 6X free cash flow but at only about 4.5X what he thinks the “normalized” cash flow will be after they either pay off their high-yield debt or repurchase a lot of shares, either of which could happen in the next year (they’ve been steadily buying back shares already).

And though they’re cheap, Gottfried says that he thinks they have tremendous potential for growth in their underappreciated franchise business as they reach out to smaller Canadian cities (they have about 170 company stores and 58 franchises now). The franchises bring in very high margin free cash flow (they get a cut of revenues, not earnings, and the benefit of broadening their brand and getting better deals from suppliers), and they also have a large finance division that’s doing very well on credit insurance (for their branded store card) and extended warranties, which apparently sell even better during weak economic times despite the fact that they’re pretty much all incredible rip-offs that serve little function other than to pad retailer margins. So Gottfried’s pitch is that the finance division and the franchises should be worth enough, using industry comparables, that you get the core of the business, Canada’s largest specialty retailer, for free.

The opportunity is that they are becoming overcapitalized now after their turnaround, with cash building up, and that free cash flow should increase as they improve operating margins, and that their continued focus on stronger capital allocation means they’ll be buying back shares, paying off debt, and focusing on expanding the franchise store count fairly quickly in the coming years … and, if things continue on the path Gottfried thinks they’re on, they could have the free cash flow to again pay a big dividend, in the neighborhood of 7%, in the not-too-distant future.

Of course, this is against the backdrop that everyone is getting a bit worried about the Canadian real estate sector and a possible housing bubble, particularly in the big cities — and slowdowns in new home building or in home sales always hit appliance retailers. Gottfried says real estate is overvalued up North, but that he doesn’t see it imploding the economy or blowing up the way our own delightful real estate market did (thanks to recourse mortgages, no liar loans, rock-solid banks, etc.).

So … I haven’t dug into the shares much yet, but I find it interesting, and there are certainly times when a little company can stage a big turnaround without many investors noticing. There is one person who posted a short note on them on Seeking Alpha a few weeks ago, and their investor relations page is here. The latest quarterly earnings report, from August, is here.

Any interest? Worries or excitement? Feel free to share your thoughts with a comment below. I’m gathering up all the interesting ideas I’m hearing about at the conference and will be focusing on one of them as our “Idea of the Month” pick on Friday — I doubt The Brick will end up at the top of the list, but you never know …



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October 26, 2011 12:06 pm

In the recent past (less than 8 years ago), I first heard of The Brick when I moved to Ottawa; at the time it was infamous for a court wrangle over its name-similar to another retailer̵