production to exceed 100,000 oz. per year with Holt growing and the Taylor mine likely also contributing. St Andrew should deliver respectable cash earnings in 2014 and much more attractive figures next year—about $25 million. With a market cap, net of $20 million of cash, of only $88 million, the market’s appraisal appears too low.
Lower gold prices could diminish earnings but gold prices, already below the global marginal cost of production, appear unsustainably low. The net asset value of the company, even at $1300 gold, is more than twice the share price.
Dynacor reported another strong quarter of earnings. Though the quarter still had some impactfrom the Peruvian government’s crackdown on illegitimate miners (most movement of gold in the country was essentially halted for a short time), which did not include Dynacor, the company should be the recipient of a lift in its business as noncompliant competitors fall away. Trading at about 6x earnings estimates, the price is still much too low.
Final approval for its larger mill has taken longer than expected given the government’s preoccupation enforcing its rules. However, the approval is expected in the next 3 months and construction should be completed about 9 months thereafter allowing earnings power to climb to over $0.35 per share annually. At just 10x earnings, this could more than double the share price based on its milling operations alone, ignoring the value from Dynacor’s own exploration properties where the company should have a NI 43-101 report later this year which could show an initial resource in excess of 1 million ounces. As long as results continue positively, the company’s own production could begin in about 3 years.
Our top holdings in our All Cap portfolios include large cap positions China Unicom, Apple, CST Brands and Weatherford International, which are all discussed below in our Global Insightportfolio review.
Our All Cap Portfolios – Portfolio Changes
In the last few months we sold Guess, Staples, Aeropostale and Dean Foods as they declined and breached TRAC™ floors.
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We recently added Standard Chartered, Juniper Networks, Volkswagen, Whole Foods, Triumph Group and Las Vegas Sands (also summarized in our Global Insight portfolio review below).
Global Insight (Large Cap) Portfolios – Key Holdings
Through July, our Global Insight Long/Short Model (our entirely large cap model) is up 11.1% (USD) and 13.9% (CAD) annualized since inception June 1, 2012, net of all fees. A complete description of the Global Insight Model is available on our website.
Our target for our larger-cap positions is more than a 20% return per year over a 2-year period, though many may rise toward our FMVs sooner should the market react to their undervaluations sooner. Or, some may be eliminated sooner if they decline and breach TRAC™ floors.
China Unicom, one of 3 dominant competitors in the Chinese mobile telecom market, recentlyreported a quarter that beat estimates with wireless service sales up 12% and adjusted net profit higher by 62% from the previous year. The company continues to add subscribers, 18 million added YTD bringing its total to about 141 million. Positive industry tailwinds have developed too. The rumored telecom joint venture is moving forward which should lower capital spending for the 3 key operators. Additionally, the largest operator, China Mobile, recently reduced its cellphone subsidies which increased our confidence in near-term rational pricing. China Unicom remains inexpensive even when we apply conservative assumptions to our FMV calculation—and, even assuming minimal growth past the next 36 months, we continue to arrive at a US$22 valuation today.
Newfield Exploration, an independent oil and gas company headquartered in Texas, hassuccessfully created significant shareholder value over the past year by monetizing its international assets and focusing on its domestic, unconventional resource base. Although the company has yet to complete the sale of its Chinese assets, the final piece of the international restructuring, we expect this transaction to close shortly. Recent results in the U.S. have been so impressive that 2014 production guidance and its capital budget was raised, with oil and liquids production now expected to grow 30% year over year. Based on solid drilling results in the Anadarko Basin, Newfield added 25,000 net acres in the area and now owns interests in more than 250,000 net acres in this unconventional but developing basin. We continue to expect the pattern of value creation to continue in the near term as the company’s new resource plays are booked into reserves by year end.
Weatherford International, one of the largest U.S. domestic and international oil and gas servicescompanies, has continued to deliver on its promise of divesting underperforming or non-core assets despite the recent global turmoil. Importantly, the company closed its sale of its Russian and Venezuelan land rigs to Rosneft for approximately $500 million in cash. Further, the recent release of Weatherford’s second quarter results demonstrated the improvement in profitability that the market has been waiting for. Operating margin expanded sequentially driven by an improvement in the Eastern Hemisphere operations and a major headcount reduction. Management still has some room to squeeze incremental profits from the business. The combination of margin recovery and debt reduction should lead to multiple-expansion back to historic levels. Based on current earnings expectations, we expect solid capital appreciation through the next year to our FMV in the upper $20s.
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We have bumped up our Apple FMV estimate to $110 per share ($770 on a pre-split basis). Our Apple model has always been conservative and assumes harsh average selling price (ASP) declines and falling gross margins going forward. We believe such harsh assumptions are appropriate given that the smartphone industry is undergoing constant change with intense ASP cuts and a potential shift in the balance of power back to carriers. Revolutionary products—which CEO Tim Cook has said are on the way—could raise our FMV estimate even further. Though as the iPhone 6 arrives with accompanying hype and as the share price closes in on our FMV estimate we may cull the position shortly.
EMC’s share price recently spiked after hedge fund Elliot Management Corp. announced a$1 billion stake. Elliot has a history of targeting underperforming technology firms that are ripe for cost reduction programs, spin-offs, and/or stock buy-backs. In EMC’s case, they want EMC to spin out its 80% stake in VMware. With EMC trading at approximately $30, we are contemplating exiting. We believe EMC could be worth $35 in a take-out by a tech giant such as Oracle. With limited upside to our optimistic-case scenario, we may swap EMC for a more compelling opportunity.
As we alluded to in past commentary, with TRW Automotive Holdings trading well below its peers based on several financial metrics, despite having an industry-leading growth rate, strategic buyers should have been sharpening their pencils. Remember that the company’s focus on safety products, including braking and steering, airbags and seatbelts and electronic control units such as crash and occupant weight sensors is high-tech in nature, proprietary and covered by numerous patents. Our thoughts and suspicions were confirmed recently, when the company announced that it had received a preliminary, non-binding proposal by ZF Friedrichshafen, a German automotive supplier, to acquire TRW. Initial reports pegged the value of the bid in the $11 to $12 billion range and potentially as high as $13 billion. These figures worked out to approximately $105 to $110 per share, with speculation that discussions were in the $110 to $115 per share range. Management has engaged Goldman, Sachs as its financial advisor and we anticipate hearing further details in September. However, with the shares currently trading around $100, we are carefully weighing the opportunity cost of continuing to hold our position given various other investment options.
Leading gas station and convenience store operator CST Brands reported a dull quarter recently. Fuel margins due to higher inputs costs were blamed. We continue to take a longer term view on CST and are cognizant of the lagged effect of passing along higher oil prices. Much more important, our thesis was strengthened with the newly signed Master Limited Partnership. Going forward CST will sell its newly opened gas station convenience stores to Lehigh Gas, which will supply them with fuel and lease the stores back to CST who will operate the retail business. Cash from the sales of stores will be used to build new stores. To quote the CEO, “We build it, sell it to them, get cash, build it again.” This deal provides CST Brands with lower cost capital to help build out its geographic footprint. Our FMV, including the MLP deal, is $40.
Electronics retailer Best Buy’s shares fell nearly in half in the early part of 2014. With the recent results ahead of expectations and the share price undervalued, given our FMV estimate of nearly $35, we initiated a position. We have been impressed by the company’s market share gains, cost savings, cultural changes, price matching and online offering. Simply put, we don’t believe the business is going away anytime soon even though its current valuation assumes Best Buy will follow the demise of Circuit City and soon to be restructured RadioShack. The company expects
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slightly negative same-store sales in the coming quarters, in-line with the industry, but that its cost cutting efforts will offset weaker sales and pricing matching costs.
Baker Hughes, like Weatherford—one of the “Big-Four” U.S. domestic and international oil andgas services companies is benefiting from domestic oil and liquids production growth and a global demand recovery for its equipment and services. Second quarter results included 8% revenue growth and operating profits up 15% sequentially while the company repurchased over $200 million of its outstanding shares. Given improving utilization rates in North America and the uptake of products and services developed for unconventional shale basins in new regions such as the Middle East, Argentina, North Africa, Russia and China, we believe that the outlook is very positive. Baker Hughes sees a lift in international rig counts and North American drilling providing a boost to its own business as the provider of innovative technologies.
While the oil and gas services sector is notoriously cyclical and the share prices can be quite volatile, current earnings estimates for Baker Hughes and a more appropriate valuation justify capital appreciation toward our $87 FMV estimate.
Global Insight (Large Cap) Portfolios – Portfolio Changes
In the last few months a number of positions were sold as they rose to our FMV estimates or inflected down from TRAC™ ceilings, including: Meggitt, Freeport-McMoran, Asahi Kasei, Occidental Petroleum, Xerox, First Quantum Minerals, Apache, Cheung Kong and Intel.
A few fell below TRAC™ floors and were sold to avoid further potential declines from those levels: Guess, Staples, Aeropostale and Dean Foods.
In the period, new additions—all at floors and at least 20% below our FMV estimates—include the companies detailed below.
Thanks to previously unforeseen competitive threats, Whole Foods Market common shares reached a material discount to our $46 FMV. Rarely are we afforded the opportunity to purchase shares of a high quality retailer with 10% square footage growth and industry high same-store sales near its “no- growth” value. Admittedly, the shares still screen expensively on a price-earnings basis but the company’s growth capital spending and material new store opening expenses mask the cash earnings power of this industry leader. We’re confident Whole Foods will continue to effectively compete versus traditional grocers thanks to management’s new initiatives which include a material remodel strategy for older stores, further price investments to drive value at the store level, a new national marketing campaign and a new home delivery and loyalty program.
With Russia-Ukraine tensions driving the price of WTI crude oil above $107 per barrel and the fear that the U.S. government was about to allow the export of unrefined crude oil (which would have compressed the WTI-Brent spread), expectations for the refinery sector took a hit. As profit expectations declined, shares of the U.S.-based refiners fell in concert. However, as crude oil prices peaked and began to decline, we took the opportunity to sell some our fairly valued oil-weighted E&P holdings and replaced them with two refiners, Marathon Petroleum and Valero Energy.
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Marathon Petroleum is the fourth largest refiner in the U.S. Midwest with refining, marketing andtransportation operations spread across the Midwest, Southeast and Gulf Coast regions of the U.S. The company owns seven refineries and an extensive terminal and transportation system that supplies its wholesale and retail operations. Marathon acquired Hess Retail, which included over 1,200 company-operated locations, a transport fleet, pipeline capacity and undeveloped real estate for nearly $3 billion. The acquisition was consistent with the company’s strategy of growing its higher-valued and more-stable cash flow businesses and created the largest company-owned and operated convenience store chain in the U.S. (by revenue), with operations in 23 States. With the shares down over 20% from recent highs and trading at only 8x expected earnings we believe that the market has incorrectly priced the future earnings potential of the company’s retail division. Our FMV estimate is about $107.
The other selection from the refinery space (although not the first time we’ve owned this particular name) is Valero Energy. Valero is the world’s largest independent refiner with 16 geographically diversified refineries (2.9 billion bpd throughput capacity), 11 ethanol plants (1.3 billion gallons per year total capacity) and more than 7,400 retail outlets branded under the Valero, Shamrock, Ultramar, Texaco and a few other
