The value investor in me tends to spill over into other aspects of my financial life. I hate getting ripped off and love a good deal, even if I have to think out of the box a bit to find it. Case in point was my family’s recent desire to get back to Japan for a visit with relatives. We try to do this every year and a half or so, and our last trip back was in November 2014.
Will We Stay Or Will We Go?
This year, as our kids’ spring break approached, I was giving up hope that we’d find anything close to affordable. Over the years we’ve typically had to cough up $1-2K/seat to fly the 12 hours from Detroit to Tokyo or Nagoya. As I trolled around on Kayak.com and Priceline.com, the cheapest seats I could find for direct flights were $2,200 apiece. Ouch! I thought we might have a shot at a better rate given the decline in oil prices. After all, jet fuel costs account for something like 30% of all airline operating expenses. Apparently they didn’t feel like sharing any of these cost savings, which is probably one reason why airline industry profits are back in the black for the time being (see chart).
Just as my wife and I were resigned to postpone our trip and spread out our visits a bit longer to cope with the higher ticket prices, I took one more look at a broader range of flights. What I found was that if we were willing to put up with an extra leg on our journey, we could save some big dough. So that’s just what we did. Instead of one 12-hour direct flight to Japan, we took a 14-hour flight to Hong Kong and stayed overnight at an airport hotel there. Then, we flew a second, four-hour leg from Hong Kong back to Japan the next day. As we have friends in Hong Kong we could visit, this worked out great socially, but financially it was also pretty sweet. Instead of $2,200 a pop to fly direct to Nagoya on one flight, we ended up taking two flights over two days for a price of only $900/ person inclusive of the hotel both ways. Multiply out the price differential by four Liggetts, and despite the extra fuel, staff, in-flight entertainment and bags of peanuts it took to fly us to Japan via Hong Kong, Cathay Pacific charged us thousands of dollars less!
When Speed, Comfort and Convenience Get Overpriced
My family’s willingness to take an alternative route to Asia has parallels in the investing world. Sometimes it makes sense to forgo the speediest, most comfortable and most convenient “routes” to investment objectives when the price for doing such is just too steep. For example, many annuities sold today appeal to a saver’s desire for guaranteed payouts that exceed what could be had with a similar portfolio of “risk-free” CDs or Treasury notes. Yet, the price for these insurance products, when considering sales charges, hidden fees and the loss of principal at death, can be very expensive.
Similarly, the comfort of big blue chip stocks and the exchange-traded funds (ETFs) that package them up for easy investment consumption can also carry a very high price. Since the end of the Fed’s quantitative easing in late-2014, for example, the price per unit of earnings investors have paid for the 200 largest U.S. stocks has expanded from 16x to just under 19x. This higher multiple has come despite stagnating earnings per share growth (see chart). Effectively, investors are paying a fairly large “stability” premium to be in the mega-caps, despite their larger exposure to a clearly slowing global
economy and falling earnings growth rates. Might we be better off looking for individual stocks in categories beyond the giant U.S. blue chips where pricing is more attractive relative to forward growth prospects? Our team certainly thinks so, and has structured our equity exposure across a wide range of geographies, sectors and company sizes.
And then there’s the question of what to do in bond-land during this historic period of ultra-low interest rates. In many countries, rates have even turned negative, meaning that investors are effectively paying rather than receiving interest for the comfort of investments that promise to pay regular coupons and return principal at maturity. This seems like a recipe for returns that at best trail
inflation, so our team has instead been navigating throughout the closed-end fund world. There, we can find extra sources of potential return not available in traditional bond investing, such as the normalization of ultra-high discounts to NAV back to their historic levels.
I Feel the Need … the Need for Speed
On the issue of speed, our team is very aware of the fact that the world’s corporations and investors have developed a Maverick/Goose-like addiction for faster and faster results. The spider web of somewhat perverse incentives that permeate our economy and financial system seem at least partly to blame for this addiction. These incentives and linkages among money managers, investors, corporations, policy-makers, big banks and financial media are captured well in The New York Times illustration left. The need for instant results by these various actors has driven a culture of myopic thinking and destructive behavior that works against long-term economic and social resilience. While some of Wall Street and Washington’s most influential power players have publicly paid lip service to the short-termism problem (see quote box below), I see little reason to expect that a cure is coming anytime soon. As such, I’m pretty confident that we’ll have to continue to navigate through the consequences of these warped incentives for many years to come.
Two such consequences that I come across quite frequently while analyzing potential investment ideas are pockets of extreme financial engineering and substandard corporate financial reporting. With the former, for example, it is not unusual to come across companies that leverage up their balance sheets to fund “shareholder candy” initiatives like unsustainably high dividends and shareholder buybacks. On the latter, it is generally the exception rather than the rule to find shareholder reports that give sufficient discussion to current and forward-looking strategic considerations. Instead, most reports overly emphasize short-term, past-period results that may have little bearing on the future outlook that investors should care most about.
And May I Ask Why You Are Selling Today?
I also remain confident that the market demand for comfort, convenience and speedy results will continue to cause market dislocations that provide our team with ample investment opportunity. The chart above illustrates the changing trend in average stock holding periods. It suggests to me that when we buy a stock or bond, we are more likely than not buying from a market participant with incentives far different than ours and much more short-term in his orientation. Maybe the seller is an index fund that must follow its rules and divest when a stock no longer fits its purely quantitative criteria. Or maybe it’s a mutual fund manager that needs to “window dress” her portfolio at quarter-end to look good for consultants or advisers reviewing her fund. Or perhaps it’s just a retiree self-managing an account who decides to bail on a stock when Cramer says “Sell! Sell! Sell!”
While the holding period for decades after the Roaring ’20s averaged nearly four years, today’s stocks are barely in one set of hands for more than four months. It appears that there are many market participants who trade to satisfy quantitative rules, emotion or short-term bonus potential. In other words, for reasons that are very different from our trading, which is driven solely by our desire to optimize long-term, risk-adjusted return potential for our client portfolios.
To wrap this up, let me just reiterate my belief that convenience, comfort and speed are not the only factors we should consider when making financial decisions. As we always say around here, price matters, and this is just as true when making travel plans as it is in investing. Our team is trained to hunt for bargains and to be wary of investments promising a quick and turbulence-free journey to prosperity. Sometimes it just makes good common sense to take an alternative course, even if doing so means a few less “traditional” investments in a portfolio or an extra trip with the family through airport security.
Paying Lip-Service to Short-Termism
I am deeply distressed about quarterly capitalism because I think it is causing businesses to make decisions that are not helping the long-term profitability of American corporations or the success of our economy.
– Hillary Clinton
We recognize that the culture of short-term results is not something that can be solved by CEOs and their boards alone. Investors, the media and public officials all have a role to play. In Washington (and other capitals), long-term is often defined as simply the next election cycle, an attitude that is eroding the economic foundations of our country.
– Larry Fink, BlackRock CEO
The IRS recently launched a campaign called “Taxes. Security. Together” to raise awareness and educate consumers on how to better protect their financial and tax data from identity thieves and cybercriminals. By taking a few simple steps, you can better protect your personal and financial data online and at home.
These are all scams, and they are persistent. Don’t fall for them. Forward IRS-related scam emails to phishing@irs. gov. Report IRS-impersonation telephone calls at www.tigta.gov. In the unfortunate event that you find yourself an identity theft victim, you should reach out to us immediately so we can put the necessary protections in place for your investment accounts.
As a note, the Michigan Office will be hosting an Identity Theft Workshop with guest speaker and expert Carrie Kerskie on Wednesday, June 22, 2016. If you are interested in signing up, you can do so by calling our office or by visiting www.fimg.net.
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SunOpta, Inc. (Ticker: STKL, www. sunopta.com)
Share Price/Market Capitalization (04/19/16): US$5.35/ US$458M
Company Description: SunOpta is the North American market leader in organic and natural food ingredient sourcing and production.
Investment Thesis: SunOpta gives us exposure to the strong secular growth trend in healthy food and a company-specific turnaround plan at an attractive price. Management has a clear road map to drive higher capacity utilization across recently expanded facilities and acquired companies. This should improve profitability, which has lagged for several years, and accelerate earnings growth beyond the solid outlook for top-line trends.
SunOpta is well-situated to benefit from growing consumer trends toward “cleaner” food (including consciousness toward GMO, food additives and allergens) and the major demographic forces that are driving these (Boomers and Millennials). Sales of organic and non-GMO food and beverages in the U.S. are projected to grow at high-single-digit rates for many years to come as consumers become more conscious about their health. SunOpta operates a vertically integrated platform with two distinct segments: Consumer Products and Global Ingredients. The Consumer Products segment involves the mostly private-label production of healthy beverages (including fruit juices, almond
milk), healthy fruits (including preparations for smoothies and individually quick frozen (IQF) fruit), and healthy snacks (including protein bars and fruit snacks) in a variety of packaging formats. On the Global Ingredients side, SunOpta sources organic and non-GMO ingredients globally for food industry customers as well as its own internal needs.
Competitively, SunOpta holds leading positions in non-dairy aseptic beverages, premium refrigerated private-label orange juice, private-label IQF fruits and premium health food snacks. It provides customers like Whole Foods, Target, Costco and Trader Joe’s with security and integrity of supply, product innovation, and a nationwide platform of high-quality manufacturing and ingredient supply.
SunOpta’s management team has a three-pronged strategy to grow the business. First, it will grow its “two-touch” vertically integrated supply chain where it utilizes both its unique sourcing advantages and its internal product innovation capabilities. Second, it will grow its customer list by delivering comprehensive category solutions for retailers that are looking for partners like SunOpta to deliver healthier store brands to their customers. Third, it will focus on integrating its operating platforms to reduce cost and deliver higher-quality service. We believe that the strategy is credible and that $100M+ in EBITDA (earnings before interest, taxes, depreciation and amortization) is achievable by next year as profit margins expand and top-line growth stays solid.
Although acquisitions and capacity expansions in the last two years led to higher balance sheet debt levels, we believe that this debt will come down over the next three years. This will effectively transfer business value from debt holders to equity holders and draw more debt-averse investors back into the stock. Today, SunOpta trades at about 8x our conservative estimates of FY17 EBITDA. We believe that this multiple can expand to 9x as management executes on its plan and shows that its platform can achieve operational leverage. As we do not expect a dividend for the foreseeable future and given the relatively early stage of its turnaround, we are prioritizing investment in our Growth and Balanced strategies for the time being.
Data Sources: Company Filings, Bloomberg
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