Buyback Champion at a reasonable price?? - Gap Inc

GAP, Inc (GPS)

Highlights:

Asset Light Business: The Company has a net equity of $2.6 billion, produces $1.4 billion in annual free cash flow with a Return on Equity of more than 50% with a modest financial leverage.

Great Brand image: The Company owns brands like Gap, Banana Republic, Old Navy, Athleta, and Intermix.

Emerging Market Growth: The Company has franchise agreements and huge growth plans in emerging markets, especially in China. They are likely to fuel the revenues and cash flow growth.

Management: Incentivized/long tenured management in place to take advantage of the opportunities. Fisher Family owns more than 26% of the shares outstanding.

Market Price: The Company is selling in the market for 8 times of their current annual free cash flow which translates into 12% initial free cash flow yield.

Stock Buyback: The Company bought back more than 55% of their shares outstanding in past 10 years and 35% in past 5 years.

Dividend: The current dividend yield is about 3.3% with ~30% payout ratio.

Business profile:

Gap Inc. is a leading global apparel retail company which offers apparel, accessories, and personal care products for men, women, and children under the Gap, Banana Republic, Old Navy, Piperlime, Athleta, and Intermix brands. Portfolio of distinct brands across multiple channels and geographies gives them a competitive advantage in the global retail marketplace. In January 2015, The Company announced their decision to close the Piperlime brand due to the return on capital employed not being sufficient.

Revenue distribution by Geography and Brands ($ millions):

	2014	2013	2012
United States	$12,672	$12,531	$12,194
Canada	$1,137	$1,128	$1,095
Europe	$917	$891	$870
Asia	$1,502	$1,397	$1,310
Other	$207	$201	$182

	2014	2013	2012
GAP	$6,165	$6,351	$6,254
Old Navy	$6,619	$6,257	$6,112
Banana Republic	$2,992	$2,868	$2,890
Athleta, Intermix	$729	$672	$395

Selected historical Financials ($ millions):

	2014	2013	2012	2011	2010
Net sales	$16,435	$16,148	$15,651	$14,549	$14,664
Net income	$1,262	$1,280	$1,135	$833	$1,204
Total assets	$7,690	$7,849	$7,470	$7,422	$7,065
Stockholders’ equity	$2,983	$3,062	$2,894	$2,755	$4,080
Total long-term debt	$1,332	$1,369	$1,246	$1,606	$ —
Weighted-average number of shares	435	461	482	529	636
Cash dividends paid	$383	$321	$240	$236	$252
Earnings per share	$2.90	$2.78	$2.35	$1.57	$1.89
Operating Cash flow	2,129	1,705	1,936	1,363	1,744
Cash used for purchases of property and equipment	$714	$670	$659	$548	$557
Free cash flow	$1,415	$1,035	$1,277	$815	$1,187
Number of Company-operated store locations	3,280	3,164	3,095	3,036	3,068
Number of franchise store locations	429	375	312	227	178
Total number of store locations	3,709	3,539	3,407	3,263	3,246

The company has been growing revenues and profits nicely. The company is great at allocating capital by going through franchising business model in emerging markets, which essentially reduces the capital at risk. The number of franchised stores has been growing at 25% for the last 4 years. Online sales have been growing at double digits. They also have used their free cash flow to buy back their shares aggressively as the shares have been selling cheaply for last few years. The Company has bought back more than 55% of their shares outstanding in last 10 years and 35% in last 5 years. The shares outstanding are currently at 410 million as of June 2015. As of August 1^st, the company has $695 million authorized for share re-purchases.

Management & Partners:

Arthur Peck, 59, Director and Chief Executive Officer since February 2015 after Glenn Murphy; President, Growth, Innovation, and Digital division from November 2012 to January 2015; President, Gap North America from February 2011 to November 2012; Executive Vice President of Strategy and Operations from May 2005 to February 2011; President, Gap Inc. Outlet from October 2008 to February 2011;

Fisher family collectively owns about 107,500,000 (26%) of the shares outstanding. With their large ownership, as the famous saying goes ‘They eat their own cooking’. Eddie Lampert (Sears Holdings chairman) used to own 5% of the company and sold out as the share prices appreciated last year. Now, he is starting to buy again as the shares are in bargain territory. He owns more than 2 million shares now.

Valuation ($M):

Market Cap	11,400	Market Cap/ FCF	8.1
Net Debt	0	Interest Expense	75
Enterprise Value	11,400	Enterprise Value / EBITDA	4.6
EBIDTA	2,460	P/E	9.80
FCF	1,400	Interest Coverage	32.80

The company has ample cash interest coverage ratio (33 times) and it trades for 8 times the free cash flow.

Major shareholders:

Shareholders	No of Shares	Percentage
Fisher Core Holdings LP	107,500,000	26.22%
Vanguard Group, Inc.	16,283,881	3.97%
Goldman Sachs Asset Management, L.P.	14,089,987	3.44%
J.P. Morgan Investment Management Inc	11,305,884	2.76%
State Street Corp	10,773,611	2.63%
Glenview Capital Management LLC	5,994,495	1.46%
ESL Investments	2,057,403	0.50%

Potential Risks:

Ø  Miss on the fashion trends in one or more of their brands may threaten their free cash flow generation in short term.

Ø  Management/leaders of divisions leaving for better opportunities may cause temporary transition issue within the management.

Conclusion:

The company is a great cash flow machine relative to their assets and equity. Free cash flows are used to pay dividends and repurchase the shares as they don’t need lot of reinvestment in their assets to grow further. The company’s shares are selling in the market for 8 times the free cash flow, which yields about 12% shareholder return initially. The buyer of shares at these prices ($28/share) will be rewarded greatly in the long term ownership of this business.

Disclosure:

I / partnerships that I manage own shares of Gap Inc. This is not a recommendation to buy or sell above mentioned securities. Please conduct your own research to make any investment decisions.

Clarke Inc - Canadian Holding company - Run by Owner/Operator

Clarke Inc (TSE: CKI)

OVERVIEW & STRATEGY:

Clarke is an investment company based in Canada. It owns the following assets (publicly traded securities/company shares) with wonderful characteristics to increase the shareholder value over time. Long standing president of Clarke Inc, George Armoyan's

own words are "Our objective is to maximize shareholder value. While not the perfect metric, we believe that Clarke’s book value per share, together with the dividends paid to shareholders, is an appropriate measure of our success in maximizing shareholder value over time." 

The company's investments/assets are undervalued relative to their book values and free cash flows. When they get repriced, the company's book/shareholder values will increase.

The company's book value per share is $13.28 as of March 31, 2015. 

Assets:

Holloway Lodging Corporation(40.7% owned): - $47M

Holloway’s core business is hotel ownership & it owns 35 hotels comprising of 3,967 rooms. As of March 31, 2015, Clarke owned 40.7% of the outstanding shares of Holloway and $11.6 million principal amount of 6.25% convertible debentures. 

Selected Financial Information (audited) Year ended December 31, 2014 ($M)

Total assets - 382.4

Total liabilities - 264.5 

Shareholders' equity - 117.9 

Total revenue - 97.5

Net income - 27.3 

P/E - 4.2

Clarke's portion of Net Income - 11.11

Terravest (27.6% owned): - $32M

Terravest is engaged in (i) the manufacturing of residential and commercial tanks and pressure vessels, (ii) the manufacturing of wellhead processing equipment for the oil and natural gas industry, and (iii) well servicing for the oil and natural gas industry in Southwestern Saskatchewan. As of March 31, 2015, Clarke owned 27.6% of the outstanding shares of Terravest. 

Selected Financial Information December 31, 2014 ($M)

Total assets - 165.3 

Total liabilities - 82.2 

Shareholders' equity - 83.1 

Three months ended December 31, 2014 ($M)

Total revenue - 53.0 

Net income - 5.3  

P/E - 5.42

Clarke's portion of Quarterly Net Income - 1.46

Northern Frontier Corp:

The company provides civil construction and maintenance services in Eastern Alberta (with a focus on SAGD oil projects) and hydrotesting, fluid transfer and water management services throughout Western Canada. In early 2015 it appeared the company’s shares were being sold simply because the company was associated with the oil and gas industry; Clarke Inc, acquired as many shares as they could before the company implemented a poison pill to deter Clarke from acquiring additional shares. The following are several attractive characteristics of the company: it operates niche businesses that are skewed towards maintenance activities (rather than expansion activities); it has the opportunity to take business from weak competitors; it generates significant free cash flow, even in the current depressed environment; and it is using its free cash flow and any working capital releases to repay debt. Purchase price results in a greater than 50% free cash flow yield based on recent performance and in excess of a 100% free cash flow yield based on performance in a recovered oil and gas environment. Clarke currently owns 15% of Northern Frontier. It's worth $1.7M based on the current market price.

Keck Seng Investments Ltd. (“Keck Seng”): 

During the first quarter of 2014, the Company started to acquire shares of Keck Seng, a Singapore-based, Hong Kong-listed real estate company. The company’s assets include hotels in major cities around the world (including Saigon, Osaka, Ottawa, Toronto, New York and San Francisco), a portfolio of investment properties in Macau and cash. The company has a long history of entering into accretive transactions and growing its book value per share. In our view, investors are meaningfully undervaluing Keck Seng’s assets. Investors seem to be paying for some of the hotels or some of the Macau investment properties, but certainly not both. While there are no defined catalysts that will crystallize the value of Keck Seng’s shares, we believe there are several opportunities for the company’s shares to be revalued higher by investors. First, we believe the company will begin to sell its Macau investment properties following the completion of new infrastructure projects that are intended to improve connectivity between Hong Kong and Macau. Such sales should result in significant gains as these investment properties have been held on the company’s books for several decades at their historical cost which is substantially below their market value. Second, we believe the company will continue to direct its cash flows to US real estate investments (its last two acquisitions have been in the US) and that such investments will be made on a 100% basis rather than with partners (which often obscures their financial contribution to the company); doing so should provide investors with more transparency and greater comfort in the value of the company’s assets. Given the substantial discount to book value at which Keck Seng’s shares trade, we would be thrilled if the company used its cash on hand to repurchase shares as well. The company owns 3,908,000 shares of Keck Seng; it is worth $4.8M as of March 31, 2015.

Management:

Mr. Armoyan is President of Geosam Capital Inc. and Executive Chairman of Clarke Inc. Mr. Armoyan is an entrepreneur with extensive experience in mergers, acquisitions and capitalizing on turn-around opportunities. He has led a number of companies to solid business results over the last 32 years. He owns about 12.6% of the company. The below graph gives us the history of value creation over time and share price response.

Conclusion:

Clarke Inc, is massively undervalued(at $199M, $12/share) company/shares based on the assets/cash flow of their publicly traded investments and the $77M net cash which provides a large optionality to invest in public markets or buyback their own stocks. The company has bought back and cancelled around 2M shares in the last year and a half as the shares were selling less than the book value of the company at that time. The company's shares are still selling for less than the current book value although the discount has narrowed a little. So, here we are,

• The company has undervalued public investments with huge upside
• Run by wonderful owner/operator efficiently allocating the capital both investing as well as share repurchases
• Selling cheap based on the sum of the parts, earnings, cash flow and book value

Disclosure:

I / partnerships that I manage own shares of the companies/securities mentioned in the research above.

Holding Company at a discount?? Steel Partners Holdings LP (NYSE: SPLP)

     Steel Partners Holdings LP (NYSE: SPLP) 

 Steel Partners Holdings L.P. ("SPLP" or the "Company") is a global diversified holding company that engages in multiple businesses, including diversified industrial products, energy, defense, supply chain management and logistics, banking, food products and services, sports, training, education, and the entertainment and lifestyle industries. Table below indicates the value of each businesses (Except WebBank) based on the publicly traded companies without taking NOL assets into account.

The company(SPLP) trades in the market for $527M, while the net assets of the company is approximately $757M. We have an opportunity to purchase the net assets at 70 cents on the dollar. The table below indicates the ownership and their worth in the public market today. Majority of the holdings are undervalued in the market which is another layer of margin of safety.

Holdings	Ownership Percentage	Worth ($M)
Handy & Harman Ltd	66.20%	298.562
GenCorp Inc	7.5%	106.575
DGT Holdings Corp	82.70%	39.696
CoSine Communications, Inc	48.30%	12.558
API Group PLC	32.30%	16.473
JPS Industries, Inc	38.70%	35.991
ModusLink Global Solutions Inc	27.70%	56.785
Nathan’s Famous, Inc	9.9%	32.67
SL Industries, Inc	24.10%	40.97
Steel Excel Inc	57.90%	145.329
WebBank	100%	110
Aderans Co. Ltd	27.70%	106.091
Mudanjiang Heng Feng Paper Co., Ltd	12.37%	51.8303
		1053.5303
Debt		296
Net worth		757.53

Holdings information:

API Group PLC (API.LN):

API Group PLC (“API”) is a leading manufacturer of specialized materials for packaging, headquartered in the United Kingdom. SPLP owned approximately 32.3% of API, with a market value of $30.8 million. For the trailing twelve months, API had revenue of about £110 million. The balance sheet is strong, with net debt of only £5 million pounds and an underfunded pension plan of about £13 million. The company began to pay a dividend in late 2013.

CoSine Communications, Inc. (OTC: COSN.PK):

CoSine Communications, Inc is seeking to invest its cash in one or more operating businesses with the potential for generating taxable income and/or capital gains. This strategy may enable CoSine to realize future cash benefits from its NOLs. SPLP ownership interest of approximately 48.3% in CoSine. It has approximately $357.1 million of NOLs.

DGT Holdings Corp. (OTC: DGTC.OB):

DGT Holdings Corp. (“DGT”), formerly Del Global Technologies Corp., is now a company with cash, marketable securities and real estate. SPH owns approximately 82.7% of the company

GenCorp Inc. (NYSE: GY):

GenCorp Inc. is a manufacturer of aerospace and defense systems, and also has a real estate business. SPLP owns approximately 7.5% of GenCorp

Handy & Harman Ltd. (NASDAQ: HNH):

Handy & Harman Ltd. (“HNH”) is a diversified manufacturer of engineered niche industrial products with leading market positions in many of the markets it serves. Through its operating subsidiaries, HNH focuses on high margin products and innovative technology and serves customers across a wide range of end markets. HNH manages its group of businesses on a decentralized basis, with operations principally in North America. SPH owned approximately 66.2% of HNH, has NOLs of approximately $107 million.

JPS Industries, Inc. (OTC: JPST.PK):

JPS Industries, Inc. (“JPS”) is a major U.S. manufacturer of extruded urethanes, polypropylenes and mechanically formed glass substrates for specialty industrial applications. SPLP owns approximately 39.3% of JPS, with a market value of $27.3 million. JPS has NOLs of approximately $55.5 million.

ModusLink Global Solutions Inc. (NASDAQ: MLNK):

ModusLink Global Solutions Inc. (“MLNK”) is a comprehensive supply chain and logistics services company. MLNK is a trusted and integrated provider to the world’s leading companies in consumer electronics, communications, computing, medical devices, software, luxury goods and retail. Their operating infrastructure is supported by more than 25 sites across North America, Europe and the Asia/Pacific region. SPLP had an ownership interest of approximately 27.1% in MLNK, with a market value of approximately $59.1 million. MLNK has a market capitalization of $218.5 million and has federal NOLs of approximately $2.0 billion as of July 31, 2013

Nathan’s Famous, Inc. (NASDAQ: NATH):

Nathan’s Famous, Inc. (“Nathan’s”) products, which include beef hot dogs, fries and other products, are currently distributed throughout the world. Additionally, Nathan's restaurant system currently consists of 313 units, comprised of 308 franchised units and five company-owned units. Nathan’s continues to grow its store count and cash flow, and continues to be debt free with substantial cash reserves. SPLP owns 9.9% of Nathan’s, with a market value of approximately $24.5 million.

SL Industries, Inc. (AMEX: SLI): 

SL Industries, Inc. (“SLI”) designs, manufactures and markets power electronics, motion control, power protection, power quality and specialized communication equipment that is used in a variety of industries. SPLP had an ownership interest of approximately 24.1% in SLI, which has a market value of $24.4 million.

Steel Excel Inc. (OTC: SXCL.PK):

Steel Excel Inc. (“SXCL”) has two operating subsidiaries; Steel Energy Ltd. (“Steel Energy”) and Steel Sports Inc. (“Steel Sports”). SPLP owns approximately 57.9% of SXCL, with a market value of $211.6 million and had NOLs of approximately $146 million. The company has been repurchasing shares every year as the shares continued to be undervalued.

WebBank (100% Ownership); 

SPLP owns 100% of WebBank, an FDIC insured, Utah-chartered industrial bank located in Salt Lake City. The bank is engaged in a full range of banking activities, including making loans, issuing credit cards and taking federally insured deposits. It is also a leading provider of national revolving and closed end consumer and small business financing programs. Revenue is largely derived from strategic partnerships that provide fee income and interest income on loans held. The bank had pretax income of $13.1 million in 2012. The bank reported net income of $11.3 million for 2013 and a return on average equity of 34.8%. The bank made a $7.5 million dividend payment to its parent in 2013, and paid an additional dividend of $2.5 million in January of 2014. The bank’s December 31, 2013 total assets and equity capital were $171.0 million and $32.1 million, respectively. It could be worth 10 times after tax earnings conservatively, that is $110M.

SPH Services, Inc. (SPLP’s corporate services subsidiary) 

SPH Services, Inc. (“SPH Services”) owns 100% of SP Corporate Services LLC (“SP Corporate”), a subsidiary that was created to consolidate the executive and corporate functions of SPH and certain affiliates, as well as provide services, including legal, tax, accounting, treasury, consulting, auditing, administration, compliance, environmental, health and safety, human resources, marketing, public and investor relations and other similar services, to other affiliate companies. Through the consolidation of corporate overhead and back office functions, we continue to realize cost savings for our affiliated companies, while at the same time, we are able to deliver more efficient and effective services. SPH Services operates through its wholly owned subsidiaries, SP Corporate and Steel Partners LLC. SP Corporate currently has management services agreements with certain affiliates including SXCL, SPH, DGT, WebBank, CoSine, SLI, iGo and Steel Partners, Ltd.

Steel Partners Japan Strategic Fund L.P. Steel Partners Japan Strategic Fund (“SPJ”) owns 27.7% of the outstanding shares of Aderans, and is Aderans’ largest shareholder. Josh Schechter and Katsuyoshi Tanaka serve on the board of directors of Aderans and oversee initiatives that are aimed at improving corporate and shareholder value. The value of Aderans co ownership today is $105M

Aderans Co. Ltd. (8170: Tokyo):

Aderans Co., Ltd. (“Aderans”) is a leading manufacturer, distributor and retailer of wigs, hair systems and extensions throughout the world. SPJ owns 27.7% of the outstanding shares of Aderans and is the company’s largest shareholder. SPJ has been invested in Aderans since 2004. Aderans has a strong portfolio of hair loss related brands including Aderans and Fontaine in Japan, and Hair Club and Bosley in the US. Aderans also holds the license for Revlon wigs. In April 2013, Aderans acquired Hair Club for $163.5 million. Hair Club is the only provider of “all proven solutions” for hair loss in the US. Hair Club and Bosley are the two premier brands for surgical and nonsurgical hair restoration in the US. They have been working diligently to integrate Bosley and Hair Club. They have already integrated a number of corporate functions including marketing, call center, legal and HR. Hair Club offices are now offering hair transplantation and Bosley is now offering key non-surgical services such as hair therapy and Biomatrix hair systems. Both companies are working together to address the expanding women’s market. Sales and profitability have continued to improve at Aderans. For the fiscal year ended February 28, 2014 sales were ¥67.8 billion and net income was ¥4.3 billion, up 32.6% and 29.7% over fiscal 2013, respectively. 

Steel Partners China Access I L.P 

Steel Partners China Access I L.P. currently holds a 12.37% interest of Mudanjiang Heng Feng Paper Co., Ltd. (“MHFP”) stock code 600356, down from 13.47%. During May and June 2013, Mudanjiang Hengfeng Paper Industry Group Co. Ltd., a subsidiary of the Mudianjiang State-owned Assets Investment Holdings Co., Ltd. converted a majority of its convertible bond holdings of MHFP. This conversion caused a dilution of our interest from 13.47% to 12.37%. MHFP released 2013 results on April 29, revenues increased 4.7% to 1,518 million RMB and net profit decreased 18.8% to 74.3 million RMB. The decrease in net profit was mainly due to higher interest expense and finance charges related to the convertible bonds. The paper industry is in a low growth environment with high competitive pressures and demands for sustainable product development. Cigarette paper specifically is under continued pressure, as brands of the world tobacco market are highly concentrated and controlled by a few large groups. Domestic demand may face some pressure, as regulations on smoking in public places are contemplated and overall general health concerns from tobacco smoking has increased. MHFP continues to be the largest domestic cigarette paper supplier with a 32% market share. In response to these market dynamics, MHFP is increasing its focus on cost controls, operating efficiencies, new product development and a greater international sales effort of its specialty paper products. Product development includes hand-rolled paper, low ignition paper, Bible paper and coated paper products. SPLP’s 12.37% interest of Mudanjiang Heng Feng Paper Co., Ltd is worth $52M in the market today.

Management:

Warren G. Lichtenstein is Chairman and CEO of Steel Partners LP. He has served as the Chairman of the Board and CEO of the general partner of Steel Partners Holdings L.P. since 2009.

Conclusion:

The company (SPLP) trades in the market for $527M, while the net assets of the company is approximately $757M. We have an opportunity to purchase the net assets at 70 cents on the dollar with a good margin of safety. Management has proven that they can create value over long term. When they do so in the coming years, the discount will narrow or we have an option to purchase this security at even more cheaper.

Disclosure: 

I / partnerships that I manage own shares of this company.

Investment Criteria/Checklist

This is the general criteria/checklist that I go through each time when I examine an investment opportunity.  This is neither an exhaustive enough list to cover all the possibilities nor specific enough to cover each aspects of individual companies. Not all the points are applicable in all cases.

• Honest, competent and minority shareholders friendly management who owns portion of the company

• Decentralized corporate culture geared to keeping employees focused on customers and management focused on shareholder value over the long run

• Industry with little risk of being disrupted by new technology or changes in consumer preferences in future

• Product or service that is unique for customers it seeks to serve and from competitors

• Reasonable ability to increase the price of the products

• Large addressable market size and dominant market share

• Low financial leverage

• Little required capital investment

• Return on invested capital greater than 15% over long period of time and likely to continue in the future

• Selling for a price which is less than 7 times pretax income 

• Reporting in a country with regulatory protection for minority shareholders
• Other respected value-oriented investors as shareholders

2014 Portfolio Performance

Happy New Year everyone!

My portfolio value increased by 14.2% as of 31st Dec 2014 since the beginning of Jan 2014. Overall, 2014 was a good year for my portfolio both absolutely and also relative to the S&P performance (13.4%). There were few costly mistakes(at least it appears so) in the oil and gas sector and CTC Media made the investment returns for 2014 not so great.

Major contributors for the performance were,

Direct TV (+48.97%)
PNC & COF bank Warrants (+32%)

Fairfax Financial (31%)
Fiat-Chrysler Automobiles (+29.6%)

First Service Corp (+18.8%)
Infinite Computer Solutions (+17.5%)

Major detractors were,

Exco Resources (-59%)

Biglari Holdings (-22.87%)
CTC Media (-18%)
Transocean Ltd (-11%)

Here are the top 10 holdings in my portfolio for 2015. You may have noticed some of the investment write ups and my reasons for the below holdings in this blog. The portfolio companies for 2015 are both qualitatively better, cheap and diversified compared to my 2014 portfolio. I expect the return for 2015 should be better than 2014 although one year performance is too short to measure any success/failure.

The holdings below are all have a durable businesses, have large opportunity to grow both revenues and profits, run by competent managers and priced cheaply relative to their assets and earnings.

Biglari Holdings (13%)
Infinite Computer Solutions (6.7%)
South Indian Bank (6.4%)
Fairfax Financial (6.1%)
Jammu and Kashmir Bank (5.1%)
CTC Media (4.9%)
COF, PNC & WFC bank warrants (4.7%)
Leucadia National (4.2%)
FirstService Corp (3.75%)
Liberty Boradband (3.5%)

As always, feel free to contact me if you have any questions.