Alacer Gold Stock Analysis – Why I bought and why I sold

 

  • I sold Alacer because it is not a value play anymore, it is more of an exploration play now.
  • What the market didn’t see last year was positive growth, what the market is missing now, might be a negative in the form of lower future ore grades.
  • However, there are still 3 catalysts that could push the stock price higher; a dividend, more exploration success at Aldrich and, as always, higher gold prices.

In 2018 I did a comprehensive analysis of gold miners, I spent more than a month on them and deeply researched about 40. I wasn’t pleased with what I found but Alacer Gold (ALIAF) (ALACF) looked good. We can say it was my favorite gold miner in 2018 as it was not just a bet on gold, but a value play with a nice business proposition thanks to the Copler sulfide project.

Since then things have changed, most significantly the stock price increased as the market noticed what ALIAF has been doing.

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As the exploration results led to a new resource that will feed the old oxide plant, the management increased guidance and said ALIAF could become a 300k to 400k ounces producer.

alacer management

Source: SA Transcript

However, the path towards such high production levels is long and the ore grades of the sulfide ore aren’t really indicative of higher, sustainable future production. But this doesn’t mean there are no catalysts for ALIAF or that it now is a bad investment. The catalysts that could push it higher in 2019 are a dividend or buybacks, new successful exploration results and higher gold prices.

For me, when the stock price increases and reaches my intrinsic value, the risks are higher and the rewards lower so I prefer to find other, less risky value investments with a margin of safety.

You can hear more about why I sold in my video discussion.

0:43 My Alacer Ownership

1:57 Why did I buy Alacer

3:35 Sum of parts value

4:28 What changed recently for ASR

5:28 Stockpile and ore grade difference

6:33 Ardich expansion and exploration

7:30 Cash flow model

7:58 3 future catalysts

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ADM – A dividend stock to own for the long term

Contents

ADM company overview

Investment strategy

A few notes from the last conference call

My personal opinion

I analysed Bunge, as it seems like the cheaper stock between the two, but ADM looks like a better business.

ADM company overview

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Source: ADM investor presentation

Unlike Bunge, they grow by acquiring smaller players and including them into their business model and possibly scaling the smaller acquisition.

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Source: ADM investor presentation

Operating profits are stable.

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Source: ADM investor presentation

And earnings per share too.

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Source: ADM investor presentation

The return on capital is 300 basis points (3%) higher than Bunge’s and 200 basis points above their cost of capital.

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Source: ADM investor presentation

They plan to increase the dividend pay-out ratio by 30% in the medium-term range.

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Source: ADM investor presentation

The increased dividend payout should lead to constantly higher dividend yields. Thus, what is now 3.24%, could quickly become 5%. 

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Source: ADM investor presentation

The last dividend is their 349th consecutive quarterly payment and an uninterrupted record of 87 years.

Net debt is smaller than Bunge’s and the available liquidity allows for flexibility. 

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Source: ADM investor presentation

Investment strategy

If ADM continues to grow as it did in the past given that it has the foundations to do so, plus the acquisition potential, I would assume its operating profits could reach $5 billion per year over the next 10 years.

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Source: ADM investor presentation

This also means that distributions to shareholders would be 50% higher than in the last 10 years where the dividends paid out were $5.5 billion and buybacks $6.1 billion. Thus, over the next 10 years, allowing for the normal cyclicality in the food sector, I would say ADM could return at least $15 billion to shareholders. That implies a 6.5% dividend and buyback yield. 

Also, if profits increase 50%, we could estimate the stock price to increase accordingly. So, in 10 years the stock price will probably reach $60 at some point. This adds another 4.1% yearly yield and makes ADM a probably double digit investment over the long term. 

If food prices increase significantly, processing margins improve, there could be exuberant periods like it was the case in 2007, 2014 and 2018.

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The total shareholders equity is $18 billion on a $23 billion market cap giving some margin of safety, but the accumulated depreciation is $15 billion. We could assume that some things can still be used even if the accounting value is zero. The replacing value could be much higher than the $10 billion carried on the balance sheet. 

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Source: ADM Morningstar

There is also the 24.9% stake in Wilmar, a $15 billion company traded in Singapore. The value there is $3.75 billion. 

A few notes from the last conference call

The plan is to save $1 billion from efficiency improvements and digitalization. I remember when I worked for Dow Chemical, there were all these little projects and I can tell you those improved small efficiencies cumulate over time. I see Dow did manage to improve margins over the last decade, the plan is that ADM could save $1 billion.

They expect higher interest payments as they are investing now for the long term, something Bunge can’t do as it has to deal with its issues which makes it another advantage for ADM.

In 2019 they will complete the acquisition of a French animal feed business, Neovia for $1.8 billion in cash. Neovia’s target was to reach $230 million of EBITDA by 2025, perhaps they will reach it sooner now.

ADM is a growth story with more than $7 billion in growth investments over the last five years including key investment like WILD for Taste ($3 billion), Biopolis for Health & Wellness, Neovia for Animal Nutrition, Algar in South America and Chamtor in Western Europe as well as other bolt-on additions and organic investments

My personal opinion

I target an investing business return of 15%. ADM’s average earnings and cash flows point to a 10% investing return so I have to be patient and put this on the watch list. You never know what can happen, but around $30, this might be a very interesting investment. For now, it looks like a good one. 

Also, as ADM’s CEO said, low interest rates allow for high investments that leads to high competition and food oversupply, consequently leading to low margins for processors. ADM is doing fine in this environment, if the environment changes over the next 10 years, ADM might do even better so something to keep in mind. We have been having 5 years now of bumper crops thanks to good weather globally. 

On $3.4 billion in operating profits, $1 billion in capex and about $350 million in interest expense I get to cash flows of around $2 billion. On a $23 billion market cap, that is a 9% return. Given the possible future growth of 4% per year as demand for food grows, I would look at this and compare to my other holdings at 12%. So, ADM’s market cap should be around $16.5 billion for me. That is another 30% down to $30 for the stock price. It is highly unlikely that it ever gets that low, but you never know. Let’s put this on the watch list. If you are happy with the exposure to food, like 10% per year, ADM looks like a stable and shareholder rewarding option. 

Less aggressive investors could wait for opportunities below $40 but anything below $45 seems like a good buy for 98% of investors. 

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Source: ADM investor presentation

Earnings per share are $3.19, we can assume growth of 4% over the long term and a terminal value at a PE ratio of 12.

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If the stock price drops to $30, we would have a 7% return from the stock which would bring this to 11%. 

So, cash flow return is 9%, stock plus dividend return around 7%. Thus, in line almost.

I am analysing the food sector and I must say, ADM looks better than Bunge, also better than Ingredion as it offers more stability thanks to scale. 

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Ingredion stock analysis – 10% yield

Summary – Ingredion

The operating cash flow yield is 11%, the company expects to grow earnings at 8% per year over the next 4 years, the PE ratio is just 13 for such a growth story, the cash flows are strong, it is a defensive stock and the returns might be substantial for investors over the next few years.

The company operates in two segments; one is a commoditized, low margin starch and sweetener production while the other is specialty ingredients that bring high margins and growth. It is important to keep the two separated when analysing the company as the market might miss the big picture.

Contents

Summary – Ingredion

Introduction – Lamb Weston Holdings Example

Ingredion Business Overview

INGR’s potential business growth

Current situation with Ingredion

Investment outlook

Introduction – Lamb Weston Holdings Example

When it comes to food stocks, if you can find a company that will grow thanks to more food consumption and won’t be hit by volatile food prices, you might have a winner. An example is Lamb Weston Holdings, Inc. (NYSE: LW) that is in the business of potatoes, mostly frozen fries.

LW is a ConAgra foods spin-off that did extremely well. Since the spin-off in 2016, the stock is up 112%.

1 LW stock price

Source: CNN Money – LW stock price

What did they do? Well, they invested in growth, had a nice return on capital, expanded margins and consequently earnings. Revenues were up 20% over the last 3 years, earnings 50% as there was margin expansion and the dividend increased too.

2 LW fundamentals

Source: LW Stock fundamentals – Morningstar

What they did is, acquired smaller players that allow for scale and expanded their own facilities. So, the above is something to look for when looking at such growth, niche food stocks.

Just an ending comment on LW, potato prices are increasing and 2019 earnings are already expected to be lower so a PE ratio above 22 is a bit risky for me and what is a bit expensive is a free cash flow yield of just 3%. I prefer higher yields if possible, or less growth risk so I am not going to dig deeper into LW, but it is a good example of what to look for. At the spin-off date, the stock was at $30, with current earnings at $3.21, the forward PE ratio was below 10, implying a double-digit return. A company that might do the same is Ingredion (NYSE: INGR), let’s see.

Ingredion Business Overview

INGR is an ingredients company. They produce starch and sweeteners that are commoditized products which make 70% of revenue but less than 50% of profits and specialty ingredients that include flavours, colours and other stuff that goes into processed foods to make it look better and taste better. The specialty section has higher margins as it often includes own formulas. It makes 31% of revenues, up from 20% in 2010 and more than 50% of the profits.

3 Ingredion business

Source: Ingredion

Although we all know of the unhealhiness of processed foods, the trends are clear, people want better, faster and more convenient food. This leads to more and more demand for processed foods, artificial flavours, starch filled foods with sweetener that the market for INGR is there and is growing. I personally think the whole sector, that actually caters to the American diet, is worse than tobacco for people’s health so I don’t think I’ll invest in this, but if you need money for a heart bypass in the future due to your bad diet habits, you might as well make money on INGR.

I’ll just show one example of what is going on in the environment and then I’ll go back to business and investment analysis. So, a company wanted to reduce costs with its spreadable cheese so they replaced the milk fat, i.e. cheese with starch. So, people will think they eat something related to cheese while in fact it will be starch.

5 ingredion example

Source: Ingredion

Unfortunately, given how prepared and processed food aisles are just growing and growing, the market for INGR will probably grow and grow, especially in emerging markets. As economic power grows, cooking is something mostly watched on TV and seldomly done in the kitchen.

INGR’s potential business growth

The company expects to grow sales mostly through their specialty segment. The other part of the business, currently making 71% of sales is commoditized, sweeteners for example, that has lower margins. Therefore, the focus is on specialty ingredients that lead to higher margins.

6 business growth

Source: Ingredion

Even though the growth in sales is expected to be small, margins and earnings should expand by high single digits per year.

7 earnings expansion

Source: Ingredion

High single digit earnings expansion over 4 years, on a PE ratio of 13 could be very significant. Their net debt to EBITDA of 1.7, compared to LW’s 4, allows for more room for growth through acquisitions, that are often a good thing in a growing market.

8 acqusitions

Source: Ingredion

If they reach their target return on capital employed of 10%, investor should expect similar returns. Plus, there is always the possibility that somebody bigger buys them. As we have mentioned in the food sector analysis, mergers and acquisitions are common in the sector.

9 target roce

Source: Ingredion

Current situation with Ingredion

Things haven’t been really that great with INGR lately. The stock is down more than 30% over the last year. The reason for the decline is weakness in North America on lower sweetener prices and a lower than expected guidance, also because of lower commodity prices.

10ingredion stock price

Source: CNN Money

However, the specialty ingredients part continues to grow and the company has been delivering on the ROIC above 10% for the last years, so we can expect it to continue to do so and even improve margins.

On the shorter-term noise, there are issues in Mexico related to retaliation for US corn sweeteners, the situation in Argentina is unclear, margins are expected to decline in some segments but those look like normal business issues.

If they could do an acquisition like the National Starch one, they did in 2010, where their earnings quickly jumped from $3 to $5 per share, that would be great but perhaps current market circumstances prevent them from doing that as even Buffett says valuations are sky high for acquisitions. Since the 2019 acquisitions they have kept debt levels steady between $1.6 and $2 billion.

Investment outlook

Estimated EPS for 2019 is between $6.8 and $7.5 so if I take $7, that is still just a PE ratio of 13 for a company that expects to grow earnings by 8% over the next few years. If they deliver on their promises, we could see earnings per share of around $10 in 2022, and depending on the valuation and future expectations, a price between $120 and $170. If I take an average target price of $150 in 2022, 4 years from now, that leads to a 13% yearly return plus a 2.7% dividend and some share repurchases. In 2018 they have repurchased $607 million of stocks which leads to a 10% buyback yield, not bad.

Cash from operations in 2018 was $703 million, that gives a cash flow yield of 11% where capital expenditures of $349 million are focused on production expansions across the globe.

Food, and especially INGR’s starches and specialty ingredients shouldn’t be much affected by a recession, so we can call it a defensive stock. If their specialty segment manages to take over, turn this into a growth stock and not a stagnating stock due to commoditized products, things might get interesting again as temporary price pressures weaken.

If you want a food stock to follow, this might be it. INGR looks like a stable defensive business with strong cash flows, a good management and a focus on rewarding shareholders.

I am personally not that happy with the healthy side of what they do as I don’t consider sweeteners and starch much of a meal, but you see how it fits your portfolio.

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Food Stocks Sector Analysis And Investment Strategy

Do food stocks offer a margin of safety?

Before discussing food stocks as investing opportunities, let me just tell you why I am researching the sector at the moment (March 2019).

I like to invest in sectors that offer businesses with a margin of safety. This means that:

  • there is a tailwind because of what is going on in the world (more people);
  • businesses are already profitable and established (dividends and positive earnings);
  • what will happen is relatively predictable (you are going to eat tomorrow);
  • there are moats with high barriers to entry (logistics, scale, legacy etc.).

On the other hand, you have also very interesting sectors like Software as a service that are bound to grow, but I have no idea which provider will be a winner and whether it has a moat strong enough to insure long term profitability. If we look at the price to sales ratios of such tech stocks, we can see that there is a long way to go before those become profitable.

1 software as a service

Source: Justin Swierczek

The main difference between the two investing approaches is the approach to risk. With a margin of safety, you try to limit your downside but you also limit your upside on a specific stock. However, you are not necessarily limiting your total portfolio return. Buying stocks with price to sales above 10, implies a big potential for a total loss while buying food stocks limits the downside in many cases. Therefore, I am researching the food sector with the hope that I find something interesting to follow and maybe buy.

Food stocks – sector overview

I always like to go through long lists when researching a sector. Looking at each individual company gives me a good comprehension of what is going on in the sector.

2 list

Just from a quick look at some food stocks traded on the NYSE shown in the above list, I have concluded the following:

  • There is a lot consolidation where 6 out of 30 businesses in the above list have been taken over in the last few years. Consolidation means two things, a young market or an aging market. In this case, it is the latter where companies like Campbell Soup, Kraft Heinz, Tootsie Roll are finding it difficult grow. This forces them into expensive acquisitions that are usually a poor allocation of capital.
  • The second thing I found is that brand strength is declining and people look for new, different things. This leads to declining sales and many value traps. One example that I discussed before the actual stock decline, is Kraft Heinz.
  • It is not easy to find a business that is really getting traction within the new trends, as those change quickly.

Investing in the food sector

So, what are the tailwinds in the food sector?

  • The decreasing availability of land;
  • An anticipated increase in commodity prices over the long term due to finite resources and a growing, increasingly wealthy, global population;
  • The shift towards meat based diets, increasing the need for grain based feeds;
  • The creation of markets in farm-related carbon credits and water rights;
  • The increasing levels of investment by land-poor and food-deficient countries, attempting to protect food supplies;
  • The increasing value of farmland.

I don’t know why, but I am not fully convinced about the above tailwinds. I look at food prices, and see them mostly go down.

3 food prices

Source: FAO

The keys here are technology and investments. Each country subsidizes food production, which leads to heavy investments and overproduction. Further, improvements in technology, GMO etc. leads to more production that leads to lower prices, especially if there is nice global weather as we have had the last few years.

So, again value investing comes in handy here. You have to look for an investment where, you win big if food prices increase, but you still win if food prices stay low for the next 10 years.

Also, something tricky when it comes to food prices is ethanol and biodiesel. Politicians can simply say we will have to use other forms of energy, or oil prices can stay low, and a big part of demand for food would vanish.

On the other hand, there are many different trends in the food industry that we cannot put them all under one hat and call them food. There are organics, ingredients, flavours, spices, processed foods, private labels etc.

Bunge Stock Analysis

BG is a food trader and processor, grains, soy, corn with some other adjacent businesses.

Many are waiting for a stock market crash to buy things on the cheap. Well, you have one here.

4 bg stockprice

Source: BG Stock Price 5-year chart

The business is 200 years old and has been constantly rewarding investors. Over the last 10 years, 50% of the current market capitalization has been returned to investors.

4 bg

Source: Bunge IR

They business model is focused on increased volumes in food trade and processing.

5 global trade

Source: Bunge IR

We have seen volatile food prices  in the past, consequently BG’s cash flows have also been volatile.

6 bunge dividend

Source: BG’s cash flow statement – Morningstar

On top of everything, there have been rumors that Glencore or Archer Daniels will acquire BG. As these things take time, perhaps it will push the stock price up in the short term but I still have to research it in depth and compare to other opportunities like the already mentioned ADM, Wilmar and some others food businesses traded around the world.

Conclusion

To conclude on investing is food, it all boils down, like in most cases, to the specific business, the quality of the management, the moat, the cash flows, the growth, risk and of course, the price you pay. So, there is no point in discussing what will happen, will we eat more of this or that, the focus has to be on the businesses and I am going to analyse a few businesses for you, to give you an indication of what can be found and what are the dangers.

BG is a completely different investment now at $50, then it was at $90. So, let’s continue looking at businesses and focus less on things we cannot know and forecast.

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Porsche SE is Undervalued – Volkswagen Stock Analysis

In the last few weeks I have received probably more than 5 tips from various sources to look into Porsche SE, because it is extremely undervalued and there is a lot of potential for the stock over the next few years. I’ve read a few hundred pages of reports and this article summarizes my conclusion.

Content:

Porsche SE ownership of Volkswagen and holding discount

Volkswagen stock analysis

Undervaluation – relative and absolute

Personal opinion and conclusion

What is the deal?

Porsche SE

Porsche SE (PAH3) is a company holding Porsche’s family stake into Volkswagen (VOW3). In 2007, Porsche tried to take over VOW, the didn’t make it and VOW took them over. As part of the deal the Porsche family got shares in VOW. The following is the holding structure:

1 porsche

Source: Porsche

It is important to note that the Porsche-Piëch family has all of the voting shares so you can only buy preference shares. (Also traded as ADRs on NYSE)

VOW3 – 501 million shares – 19 February 2019 price is €141.6 for a market cap. of €71 billion.

PAH3 – 306 million shares – 19 February 2019 price is €54.62 for a market cap of €16.7 billion.

PAH3 owns 30.8% of the subscribed capital of VOW3, thus €21.8 billion.

The discount is sometimes bigger and sometimes smaller as the stocks don’t trade in sync.

2 comparison

Source: Bloomberg

In any case, buying PAH gives you a 24% discount on VOW at the moment. The key is to look at whether VOW is worth buying in the long term and one can always debate about the holding discounts.

VOW stock analysis

VOW, like any other car company is a cyclical and you have to put it into that bin or folder. Cyclicals do very well when the economy is doing good and terribly when the economy is slowing down as companies buy less cars etc. However, you can only postpone a purchase for a year or two, sometimes a bit longer, but then buyers usually rush back to replacing their old cars with new ones.

Can we predict the cycle? Impossible to do accurately, especially with all the central bank interventions. So, what I prefer doing is simply estimate a recession every 5 years, see how an average one would hit the company, see how the company is doing when things are fine, like those have been in 2018, and get to average earnings that we can use to calculate intrinsic value.

In my book, Modern Value Investing, I analysed Daimler as an example, when writing the stock price was €70, my fair value was closer to €40 and fortunately for my book sales, the stock is closing in on the second price.

3 daimpler

Source: Bloomberg

As there are fears of a recession, the stock falls, when the sentiment is more upbeat, the stock is up. Therefore, one has to buy these stocks when there is blood on the streets. However, before buying, one must know what would be a good business price to pay for a decent long-term business/earnings return. Let’s see.

VOW group hopes to increase their return on sales by 1.5 percentage points by 2025. Given sales are €230 billion, it would not be a bad thing.

4 return on sales

Source: VOW

But, just to stay conservative, let’s say they don’t improve there. On the cash flow, they have their benchmark at €10 billion, a level they can achieve and have been achieving.

5 cash flow

Source: VOW

So, in a bad year, cash flows will probably be €0 to €3 billion, in a good year it will be €10 to €12 billion and 8 billion in an average year. In a cycle, we will have two good years, two so-so and one bad. I would say their net cash flows should be around €8 billion per year over the next 5 to 10 years.

The industry is highly competitive so, this is what one should expect. €8 billion on a €70 billion market cap implies a yield of 11%, not bad. I have to see what is the story around the €8 billion in cash flows. In the 5 year strategy plan conference webcast, the finance board member discusses how they expect to reach the 30% earnings dividend pay-out in 2020 and keep that for longer.

6 earnings

Source: VOW

So, 30% of €25 is €8.3 that on a €141 stock price, would imply a dividend of 5.8%. The positive scenario would imply a €10 dividend that is still just 7% of it.

The 7% dividend yield from VOW would be a 9.1% dividend from Porsche. So, this doesn’t come even close to my required 15% return but I’ll give you another perspective.

The market’s perspective on VOW

Remember all the brands VOW has?

7 brands

Audi (NSU) is traded on a stock exchange with a market cap of €33 billion and VOW owns 99.64%.

VOW also plans to IPO Traton, the truck/transportation division, in April for €6 billion for 25% that would value the company at €24 billion. Let’s say €20 billion. Just Audi and Traton are already at a €53 billion value.

8 traton

Source: Traton

Then we have the car branks and makers; Volkswagen, Skoda and Seat, that should also be worth at least €30, €5 and €5 billion respectively. Thus, we are at €93 billion in total. And, not to forget, Porsche AG, the car maker, not the holding company.

Ferrari N.V. that spun out of Fiat Chrysler a few years back, has operating cash flows of €400 million and a market capitalization of €20 billion.

9 ferrrari

Source: Ferrari

In 2018, Porsche AG had operating cash flows of €4 billion that would leave at least €2 billion in cash flows. Give it a Ferrari valuation and you are at €100 billion, but let’s put is at just €25 billion.

There is then the financial services, another €2.5 billion in operating cash flows that we can set a value of €10 billion on.

Lamborgini, Bugatti, Bentley etc must be worth something too. When