by Travis Johnson, Stock Gumshoe | April 5, 2013 1:05 pm
I’ve got a handful of updates for you, including one on a stock that I bought yesterday and a few other notes about recent quarterly reports from stocks I follow, but first … a teaser to solve …
When I wrote about Marc Lichtenfeld’s pitch for “Spread Trusts” yesterday, I promised to also try to take a look at the cancer drug he was touting as one of his add-on ideas. Here’s how he teased it:
“Earn Fat Dividends From the Biggest Cancer Breakthrough in 39 Years
“I spent years as a trader in San Francisco. During that time, I built up my Rolodex with some of the biggest names in tech and biotech.
“I still use those connections to generate countless double- and triple-digit winners for my readers.
“And I’ve just identified the next huge winner. It’s a dividend payer that meets all the criteria of my 10-11-12 System. But it’s also rolling out the most important cancer drug in 39 years, according to my estimates. I can’t give too many details here, but in the most recent quarter, this little-known drug generated $178 million in sales. And I can almost guarantee you haven’t heard of it – yet.
“That’s why the time to get onboard is now…
“I’ll reveal all the details, down to the stock symbol, in another special report called Earn Fat Dividends From the Biggest Cancer Breakthrough in 39 Years.”
Well, if it’s going to be fat dividends in the conventional sense — and I suspect it is — then I’m pretty sure he’s touting a major pharmaceutical company here … one with a new cancer drug that he thinks will become substantially more important. That 10-11-12 system that he touts looks like it’s mostly a long-term dividend growth strategy, here’s how he puts it:
“During rigorous back-testing and real-world trials, it has proven to provide investors with annual 11% dividend yields… plus at least 12% annual total returns… every 10 years… like clockwork….
“Every month, my system will help me pinpoint the single best company poised to bring huge gains, and huge dividends, in the days ahead.
“You don’t have to lift a finger, or worry about your income going down anymore.
“In fact, with 10-11-12 we focus mainly on companies with a long history of RAISING their dividends, through all markets.”
So I read that as being similar to what many dividend growth and dividend-reinvestment strategies look for — companies that pay a decent dividend and that can raise their dividends every year, leading to long-term compounding performance that leaves you with large (10%+) dividends in ten years based on your initial investment. It’s a good strategy, as long as you pick the right companies and are patient — if you had bought Johnson and Johnson roughly ten years ago, for example, you’d have paid about $55 and gotten a yield of just under 2%, along with the knowledge that JNJ was consistent about increasing that dividend. Fast forward, compound those dividends, and you’ve added maybe 15% more shares to your holding with those reinvested dividends and the dividend has risen from 96 cents to $2.44 a share, so the annual yield on your original investment is something better than 7% now (and, of course, you’re sitting on a capital gain of 50%+).
My guess is that this kind of idea is what Lichtenfeld is looking for. And if we’re talking about a large dividend grower with what some folks think is a breakthrough cancer drug that had sales of $178 million in a recent quarter … then I think the best candidate is Yervoy, the new skin cancer treatment from Bristol-Myers Squib (BMY).
That’s not a 100% certain match, to be sure — but it’s the best one I’ve found. Metastatic skin cancer — and skin cancer in general, really — is a huge disease that’s hitting a growing number of patients, and the treatment options have not been particularly effective at prolonging lives or curing the late stage versions of the disease (some flavors can often be cured if caught early, but not all … and it’s not always caught early). And I know that BMY has been a favorite of Lichtenfeld’s for quite a while, he’s written positively about it before.
It’s a bit early to put BMY in the consistent dividend growth camp — they’ve raised the dividend by a penny per quarter in each of the last several years, but they’ve also had several years in the last decade when the dividend stayed flat year over year. And Yervoy did book sales worldwide of $179 million in the last quarter, which meant it was growing much faster than most of their drugs (that’s revenue growth of almost 50% for this one drug, though it’s still a small piece of the pie — BMY had revenue of $17 billion in 2012). Some predictions have Yervoy becoming a billion-dollar drug, and the news flow seems to be in their favor with good long-term survival data released this year, so the hope is that and BMY’s other emerging drugs plug the holes that are left when older drugs go off patent — but it is an infused drug, and it has taken time to grow into the big market potential (it’s been approved for about two years for late state metastatic melanoma), so this won’t bring an instant spike in BMY revenues.
I don’t own any big pharma names, but with an aging population and increasing insurance coverage you can certainly make an argument that they should do well — particularly if new drugs can justify their existence with substantially better results than the existing therapies. This is the first time I’ve looked at BMY in years, I think, so I won’t confidently urge you to rush out and buy the stock — I’ll just tell you that this is my best guess as the solution to Lichtenfeld’s teaser for dividend growth from this “biggest cancer breakthrough in 39 years”
In case you want a second opinion on BMY, here’s what Morningstar’s analyst said back in January:
“Bristol’s Recently Launched Products and Pipeline Help Mitigate the Company’s Patent Cliff.
“Bristol has created a strong pipeline and brought in partners to share the development costs and diversify the risks of clinical and regulatory failure. We believe diabetes drug Onglyza (partnered with AstraZeneca AZN) represents the most important new drug for Bristol. Additionally, anticoagulant Eliquis could potentially develop into a major new drug; Bristol is co-developing the drug with Pfizer PFE. Bristol discovered these drugs internally, but we like the firm’s strategic partnering decisions, as the moves reduce risks and development costs. Further, the high conviction by partners gives us more confidence that the drugs will reach the market.
“Bristol’s pipeline becomes even a bigger safety net for the company as it faces a plethora of patent losses over the next few years. Between 2012 and 2013, Bristol will lose approximately 40% of its current sales to likely generic competition, including blockbusters Plavix and Avapro. Further, the patent on the company’s blockbuster antipsychotic drug Abilify expires in 2015….
“We are slightly increasing our fair value estimate for Bristol-Myers to $31 from $29 per share. We are increasing our fair value estimate largely based on lower expectations for the company’s tax rate over the long term. Bristol was able to restructure its organization to reduce its long-term tax rate by close to 200 basis points. Further, the loss of Plavix sales caused a higher-than-expected long-term impact on the tax rate.
“In looking at the whole company, we expect 3% average annual sales growth during the next 10 years. However, we expect high sales volatility with minor growth until late-2013 followed by sharp declines due to patent losses. We expect operating margins to fall as the company loses high-margin drugs to patent expirations over the next 10 years. Diabetes drug Onglyza represents the biggest uncertainty in Bristol’s product line. A stronger-than-expected launch could add a few dollars to our fair value estimate.”
So … a pretty positive assessment, but the stock is well above their “fair value” estimate now, it’s over $40 after climbing 25% during the blue chip rally in the first quarter of the year. Like most big pharma stocks now, it’s looking pretty expensive with a PE well above the market average and growth expectations that dont’ come close to justifying a premium PE (the PEG ratio is between 3-4, similar to names like Pfizer and Merck, meaning that the PE ratio is more than 3X the expected earnings growth rate). May work out fine, but perhaps too popular to be all that enticing right now.
On to some updates …
MFC Industrial (MIL)
I wrote back in February that MIL was looking pretty resilient at its new higher share price near $10, and that it was looking good for initial nibbles but “hopefully we’ll see some dips for future buying opportunities.”
Well, here you go. I don’t know if 20% counts as a dip, it’s more of a fall down the stairs, but the stock is cheaper after their recent earnings release … and I bought a few shares myself late in the day yesterday. I also have an order in to buy a bit more if the stock falls by an additional 4-5%.
You can see the MFC Industrial earnings release here, and the conference call transcript here. They had a substantial change of opinion about whether or not their Indian iron ore mine will be allowed to restart production (following more lawsuits and clarification, and knowing the decades-long length of the expected fight in the Indian courts), so they’ve now written off the Goa iron ore assets they owned and taken on an impairment of 68 cents a share. Even with that writedown, book value is now at $12.11 per share — so investors are buying MIL now for about 2/3 of book value. They have some expensive projects in the works, but development will be slow and probably driven by partner participation or deals of some sort, especially for their natural gas projects (the US iron ore mine they’re developing will, I expect, move even more slowly, and in the current pricing environment they’ll probably be reluctant to spend a lot to speed up development). They’ve already enjoyed some of the benefit of the Compton acquisition, turning their tax losses into a shelter for their Wabush iron ore royalties that had been written up earlier, and they’ll probably do additional deals this year even beyond marketing or partnering some of their natural gas assets.
Their goal is to build up to revenue of a billion dollars a year, and they’re about halfway there. MIL won’t soon become easy to value based on earnings, partly because they engage in so much tax and balance sheet adjustment thanks to shifting values and shifting deals and partly because they’re acquisitive, but they are generating a lot of cash flow and building up the value of the company as they tack on additional trading businesses (they posted earnings of 19 cents a share last year, not including the balance sheet stuff, and while I do expect a little earnings growth it would be surprising if that number is dramatically higher in 2013). The major earnings generator for MIL remains the royalty on the Wabush mine operated by Cliffs, and the expectation is that they’ll continue producing roughly three million tonnes of iron ore from that mine, which, depending on the price of iron ore, should mean that their revenue from Cliffs is pretty consistent in the $20-30 million range (it was $29.1 million in 2012). That gives them a great base for covering their corporate and operating expenses, and with the integration of their newly acquired businesses helping to improve both margins and revenue in 2013 I think we should see a substantially better share price by next year to go with our current 3% dividend. Any potentially dramatic upside catalyst would probably not come for at least six months or so, though it’s possible for news to come sooner, but I think news about the development of their midstream processing assets in natural gas or about the sale of the $100 million in Compton assets that they’re holding for sale is likely to be the next big impact on the share price.
This is a commodities marketing business that’s trying to become ever more integrated, with captive supply of natural gas and NGLs to go along with iron ore and their many marketing and middleman trading businesses, so earnings performance will fluctuate with those commodities and with the fluctuating value of their inventories, but I think management is on the right track and they have a proven ability to manage the balance sheet well as they grow. I hope we see another dip down so I can build this position, but I’m quite happy to own it at this valuation with potential upside if they’re able to make additional good deals or if iron ore or natural gas prices improve over time.
Brazil Fast Food (BOBS)
Brazil Fast Food, owner of the Bobs restaurant chain and other fast food outlets in South America, released their quarterly report this week — and they continue to do quite well. They had a particularly excellent fourth quarter, partly because the comparables to the 2011 Q4 were easy (that was a bad quarter), and they have had excellent revenue growth from both their own stores and from franchisees. That’s mostly because of very strong store openings, which should continue with the store count expected to grow about 15% in 2013, but they also did have strong same-store sales growth from their KFC and Pizza Hut franchises and 3% growth from their core company-owned Bobs stores. Inflation continues to be a concern for food prices and for labor in Brazil, as does the value of the Brazilian Real when we consider their earnings and share price in dollar terms, but the trend for fast food in South America is definitely in their favor — and with the World Cup next summer and the Olympics two years later I think we’ll see resurging interest in this stock. It might be possible to sell at a nice premium in the next year if investors get excited about BOBS in the runup to the World Cup, but even without that they’re operating much better, raising revenue, and cutting costs and reorganizing to maximize the value of their various brands, so I’m happy to continue holding here at this valuation, and following this quarter’s report I might even consider buying more. At current exchange rates, their BR$2.55 in earnings for 2012 translates to $1.26, which at a $10 share price means a trailing PE of 8.
I’ve mentioned Arcos Dorados (ARCO) and Burger King Worldwide (BKW) in the past, and while both are also aiming to compete more aggressively in Brazil they’re both less appealing to me still than BOBS is now. They also pose the largest risk to the Bob’s chain, since both McDonald’s and Burger King as strong brands with much better financial backing, but right now I still prefer BOBS, which I think has already positioned itself for stronger performance — partly because BKW is pretty expensive following all the hedge fund attention, and ARCO is really still, I think, trying to figure out how to get earnings growth when they’re saddled with a strong US dollar and a big check due to McDonald’s every year.
CVD Equipment (CVV)
CVV had an almost comical two quarters to end 2012, with the move that wouldn’t end. I’m sure this probably rings true to anyone who’s had to move a household lately, but the process of packing up your stuff, getting settled into a new place, closing on the new place and selling the old place always takes longer and costs more than you think … and that was certainly true for CVD Equipment as well. This manufacturer of high-tech lab and small scale production equipment (mostly chemical vapor deposition machines) for advanced researchers and small startups in semiconductors, nanomaterials and graphene saw a need and opportunity to expand production and consolidate divisions by selling their two primary facilities and moving into a new combined building. So they bought the new building … then realized they pretty much had to stop selling for several months because they couldn’t fulfill orders, and moving the equipment and staff took longer than they expected, and they took a loss on the sale of one of their buildings and haven’t closed on the sale of the other one yet (that one should book a gain, for something like break-even), and meanwhile they’ve crushed what had been a steady period of revenue growth by effectively operating the business on crutches for more than six months.
Well, that’s now at last coming to an end in the second quarter (so, one more quarter of lousy numbers, probably). I think I’ve said that before, and they have, too, but it appears to actually be true this time. That doesn’t mean that the company will snap back immediately, however — they essentially just moved in to the new facility last month, so the first quarter report is likely to be a continuation of the same low revenue and low to nonexistent earnings. The key for CVV will be whether or not the sales come back now that they’ve started actively trying to book orders — they are saying good things about the quote levels being high, and expected rebound in the bookings, but I am treading a relatively thin line between continuing patience and a wariness about how fast they can re-ramp the business. Right now I’m still expecting that they should be able to get back to their 2011 numbers by this year, but they’re not going to be on pace for that in the next quarter they report. I’m slightly concerned that their backlog continued to decline in the last quarter, and if that continues and they don’t have something far more optimistic to share about second half orders in 2013 when they report next I’ll become genuinely worried.
I’m holding my shares, not buying more, and looking to see what they say about orders coming back over the next quarter to see if I’m willing to continue holding after the next quarter — this is a tiny company with attractive products in a growing industry, with a market cap of only $70 million, so they should be able to turn much more quickly than they have … but on the flip side, that should mean that they can ramp sales back up again and have a meaningful impact on their income statement in a short period of time. I’m not willing to take a substantial loss on CVV if the new facility doesn’t begin operating effectively and they can’t resume growth, so I’m putting a mental stop loss on the shares at 25% (meaning, I’d sell them personally if they drop to much below $8.50 given my cost basis of $11 or so … I first wrote about them as an “Idea of the Month” near $12.50 about a year ago, so that would be more like a $9.60 stop loss). Do keep in mind that the stock is tiny, so intraday swings of 5% or more are not uncommon — which is one reason not to have a stop loss recorded with a broker for stocks like this, it could get snagged on a swing even if the stock doesn’t close near your stop price. The next quarterly update will come in about six weeks, in mid-May, so we don’t have very long to wait.
Gold Royalties Stocks
I wrote some about gold royalties stocks this week, both in response to some reader questions about Sandstorm Gold (SAND) and in my article about the Frank Curzio teaser for Royal Gold (RGLD) and Altius Minerals (ALS.TO ATUSF). Most of those stocks have been clobbered over the past few months, though they did bounce back quickly from the beating they took early this week with gold prices falling, but the basic thesis remains the same: Gold mining is a lousy business that depends on excellent management, luck, cost controls, government regulation and permitting, and gold prices, being a discriminating financier to gold miners is a great business that depends much less on the operating problems of building and running a gold mine … but the value of the stocks still depends on the gold price. And, perhaps more importantly, on investor expectations about future gold prices.
Our little watchlist stock that I own personally, Americas Bullion Royalty Corp (AMB.TO AMBCF), is down quite a bit from where I purchased because the operating half of the business, their Yukon exploration and production ambitions, got slapped down with a delay and investors don’t want to own gold explorers, so that didn’t get spun off as planned but got written off as almost valueless by investors instead. They did get some good news last week with the Pan Project from Midway Gold (MDW) moving a step closer to reality with a permit — if Midway Gold gets the Pan Mine opened and producing next year and operates as expected, and if gold doesn’t fall too much further, then AMB is a no-brainer good buy in the 25-30 cent range, assuming they don’t do a massive equity offering to dilute shareholders (hopefully any dilution will be attached to specific deals to acquire more royalties). I personally have a lowball bid offer in to increase my position if it falls 20-25% from here, for full disclosure.
If gold recovers and sentiment improves, there will probably be some gold miners that do spectacularly well — but I think owning the royalty companies is still the saner and more conservative choice for equity gold exposure. Sandstorm Gold (SAND) is still my favorite pick in that world, with Royal Gold (RGLD) an increasingly close second after their fall in price … and if you want the additional volatility of silver, then Silver Wheaton (SLW) is the only streaming stock that you can confidently call “inexpensive” on current earnings (and they’re getting into gold now a bit, too). This is my gold exposure, and I don’t put more into it than I want exposed specifically to precious metals — everyone has different criteria for that, but for me the total precious metals exposure in my investment portfolios and savings is about 15-20%, with about half of that in physical metal and half in equities (mostly SAND and SAND warrants). Most advisers would probably say that’s on the high side, most hard asset enthusiasts would probably say it’s on the low side. I don’t think global currencies will stop their long-term trend toward further depreciation, which should support gold as a preservation of value “safe haven,” but that doesn’t mean other kinds of businesses can’t thrive just fine along the way — and gold exploration and mining, as we’ve seen on plenty of occasions, can be a really lousy business even with good gold prices.
The fight between management and activist hedge fund Jana Partners over the future of Agrium has turned more to the incumbents than I expected (perhaps I was naive), and though the proxy battle is still going on (votes are due next week, I believe) it doesn’t currently look like Jana Partners is going to get many (maybe any) board members added at AGU. I wasn’t expecting them to actually convince Agrium to really break the company in two … but I was expecting them to move the push along for more “realized value” a bit better than they have, and I thought that institutional investors would be more supportive of Jana’s arguments than they have been.
Investors have lost steam on this one, and it looks like we’re falling short of what had been my goal ($120 by this Spring — we topped out at about $115), though we will have to wait and see. I continue to have a small position in these shares and I’m putting a stop loss on them at $90, I think the stock is probably still undervalued here relative to other agriculture service/fertilizer companies, but if they don’t change much about the company it could remain undervalued for a long time. AGU has always been cheaper than its major competitors, which is why there was fertile ground for Jana Partners to find potential for far better returns. The stock is certainly more investor-friendly than it was a year or two ago, with more focus on increasing dividends and a management team that, while dismissive of Jana’s ideas, should be looking over their shoulder at least a little bit — but my plan was to profit from AGU gaining quickly over the first half of this year and the chances of that have dropped quite a bit, I think. Still a valuable set of assets, still a sector that should do well over the long term, but I wasn’t looking for a long term investment in AGU so I won’t hold much longer if this stock reacts badly to the conclusion of the proxy battle.
Right now AGU is back to being the company that trades at 10X earnings, and with a dividend of 2% — that’s the same AGU we could have bought a year ago, and with earnings still expected to be flat or falling slightly in both 2013 and 2014 I am not particularly confident that AGU might not lose another 20% if the proxy battle ends with little change and Jana starts to liquidate their holdings. So if it falls below $90, I plan to sell — if it survives the proxy battle without dropping another 5% from here, I’ll keep holding and see how the company does during this planting season.
That’s my story and I’m sticking with it. At least for now. Enjoy the weekend, and keep your fingers crossed that we don’t learn about the “next Cyprus” before Monday.
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