Earnings Digested 2Q14: Best Buy

I have written about Best Buy before: Best Buy: Why This Is One Of The Best Value Plays Around
I f you’ve read the article, you will come to the conclusion that I am bullish on the stock for buy and hold purposes. Therefore, I’ve been monitoring the company’s results, so let us see how the company fared in the 2nd quarter.
Sales dropped 4% to $8.9 million, while profits also shrank to $146 million. However, the diluted earnings per share for the 1st half of the year were $1.73, up from $0.54 a year ago.
Best Buy’s CEO argued that the market environment is not helping the company with soft demand for electronic products. On the other hand, the fact that the company is on track to deliver the $1 Billion in savings, is a promising sign that a recovery in demand for tech products will significantly add to the bottom line.
In my opinion, the 2Q14 results, sustain my view that the company is on track to normalize its earnings. We shouldn’t expect explosive growth, but an improvement in profits is likely.

Table 1 – Normalized earnings estimated

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Best Buy is one of my favorite companies in 2014. I first wrote about this company in May. At the time the company was trading around $26, it has climbed around 20% since that time, beating the S&P500 by 14.5%

Graph 1 – Best Buy vs S&P500

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Conclusion: The company is on track with its recovery. Although, the results are not brilliant, the competitive environment is also far from good. On the other hand, the stock had a huge depreciation and an improvement in the company’s markets will, most likely, bring better results and further stock appreciation.

Peugeot: The Making Of A Turnaround

Peugeot (PSA) is going through a tough transition. The company is facing an European declining market and its heavy dependence on this market has been a drag on the company profits. This way, the company decided to revamp its current management team and brought the Portuguese Carlos Tavares (ex-COO at Renault) to turnaround the company. 

The first results appeared on the Q2 earnings presentation, where the company posted some interesting improvements. I have recently wrote an article about PSA, you can read it here.

Ford: Where is the upside?

In my most recent article for Seeking Alpha, I discuss the Lean production system approach adopted by Ford, the future income tax rate and the current valuation levels:

Summary

  • Ford has partially executed a successful turnaround based on lean production principles.

  • The operating business has improved a lot and the current shareholder has an increased margin of safety.

  • However, the current valuations do not indicate much upside in the most likely scenario.

You can read the whole article in Seeking alpha.

Why is Santander poised for growth?

Currently, Santander (NYSE:SAN) has been perceived as another Southern European bank. However, Santander is the biggest Euro zone bank, in terms of market capitalization, with presence in several high profile markets like: UK, USA, Brazil, Mexico, Germany, among others.

Graph 1 – Santander Profit Distribution (Source: Santander strategy presentation)

Looking to the Graph 1, we can see that the company’s profits are not dependent on a single geography. This, probably, helps to explain why this Spanish bank did not have any quarterly loss since 2007 (Source:Santander strategy presentation). On the other hand, the stable earnings base has helped the bank achieving a total capital ratio around 12.1%, which is well above the 8% minimum required.

Strong liquidity position helps business

With a stable and diversified earnings source and a strong capital position, Santander has been mostly focused in streamlining its current operations while making some acquisitions, taking the opportunity to close interesting deals. One of those deals, the acquisition of a 470 million stake in Bank of Shanghai (Source: Financial Times), perhaps signals an incursion into the Asian banking market. While other banks in trouble have been mostly selling good assets in order to boost capital ratios, Santander has been able to take an opportunistic approach to the current environment.

The opportunistic banking deals have been in Santander’s DNA for a long time. In 1993, Santander bought a significant position in the US bank First Union (Source: High Beam). In 1997, Santander sold the position at a hefty profit, just in time to buy the Brazilian Bank Banespa in the beginning of the millennium (source: New York Times). Needless to say, Brazil represented 20% of Santander’s profits in the 2013 exercise.

Since 2008, Santander has been on a spree of acquisitions. The bank took advantage of the opportunity created by the financial crisis, to buy the totality of the Sovereign Bank (Source: Bloomberg). From 2010 to 2012, Santander bought two Polish banks, which together are worth around 10% of the market share in deposits (Source: Bloomberg). As we can see in Graph 1, the US and Poland, already represent 15% of the Santander’s profits.

Building an asset base during fire sales must be good for business

Most banks were caught off guard during the 2008 crisis. The impact of the crisis was amplified by strict regulations in terms of capital levels. This meant that many banks had to sell some of their best assets in order to be able to have asset sales gains that generated positive impact on capital levels. The problem with this approach is that it resolves the capital problem in short term, but reduces the asset base quality, which means lower profitability in the long run.

Santander, on the other hand, wasn’t caught off guard. The bank always relied mostly on traditional banking and wasn’t relying too much on leverage. This way, when the storm came, Santander had the flexibility to adapt to new capital levels demands while keeping a liquidity slack to take advantage from circumstances. I am guessing that in the following years, the bank’s asset base will be more profitable than in the past.

Angles to cover

No investment is ever perfect, there are always some risks that are hard to quantify. In the case of Santander, there’s the huge influence that the Botín family still maintains in the bank. On the other hand, Emilio Botín, 79 years old, has been held as the main responsible for the huge growth that the bank achieved during the last 3 decades. Clearly, the succession plans will be a major concern, for the bank, in the following years.

Conclusion

Santander has been able to meet capital levels while maintaining the liquidity to address interesting opportunities. I believe that the deals that the bank made recently will contribute positively for a stronger balance sheet than it had before the sovereign debt crisis. I think this will be evident once the Spanish operations normalize.

12 Rules that make great CEOs

1. Experts are clueless;
2. Clients can’t tell you what they want;
3. True innovation is on the next curb;
4. Biggest challenges beget the best work;
5. Design counts;
6. Use big graphics and big fonts;
7. Changing your mind is a sign of intelligence;
8. Value not equal to price;
9. “A” players hire “A+” players;
10. Real CEO’s demo;
11. Real entrepreneur ship;
12. Marketing = unique value.

Top Picks I

I will now initiate a stock picks postage in the blog. For instance the Top Picks I are my current selection of stocks. In the future, I may post a Top Picks II, which will be an update to the Top Picks I. In each post, I may also add some stocks that I researched but found unattractive.

The categories will be very simple: Overweight, Equal-weight, Underweight, Sell and Joker.

Overweight – I feel very comfortable about this stock, I am interested in having a higher share of my portfolio invested in this stock, when compared to my other holdings.

Equalweight – I am comfortable with this holding, but I do not wish to have more than the average position in this stock.

Underweight – I am considering reducing my position in this stock.

Sell – I intend to sell all my holdings on this stock (or not buy any).

Joker – This stock is currently under research, some future developments might turn it into a buy. Keep it under watch.

Ok, so here are the Top Picks:

1- Santander Bank (SAN) – Overweight (You can find research about this stock here and here).

2 – Bank of America (BAC) – Equalweight (You can find research about this stock here).

3- Intuitive Surgical (ISRG) – Joker  (You can find research about this stock here).

4 – Peugeot (UG)- Joker  (You can find research about this stock here).

5 – Corning (GLW) – Underweight (You can find research about this stock here).

6 – Best Buy (BBY) – Equalweight (You can find research about this stock here).

Commentary: Intuitive Surgical is going through a storm. My view about this stock is long term positive, but in the short term I see it as really expensive. Further significant price drops, pushing the stock below the $300, might bring a good entry point.

Peugeot is going through a capital raise, I advise waiting for the end of the month, when I believe the operation will be over and the full picture will be clear.

Disclaimer: These are my personal picks, these are not buy or sell recommendations.

The Investor’s Chronicles: Shaping Up An Investment Philosophy Part II

Part 2 – Where do we go now?

1-Understand the business model

My view is that the success in stock investing will always be dependent on the success of the underlying business. So first of all an investor must become an expert in understanding business models. Only if you have a deep comprehension of the business model can you go after the evidence that supports the performance of a given business unit. If you want to know more about business models you can find valuable information in the book Business Model Generation.

2-Avoid commoditized product portfolios

As a general rule you should avoid companies whose products or services are mostly commoditized (exception made for regulated activities). I believe you can do this by thoroughly analyzing the company’s product portfolio and compare it to the main competitors’ portfolios. If you identify a clear driver (excluding the price), that would make a customer buy the company’s product instead of the competitors’ product, then you have a non-commoditized product.

3- Evaluate the company’s product innovation skills

However, it is not sufficient to have a good business model in the present, it is also necessary to have it in the future and to do so we need future products. The key point is product innovation. This is one of the hardest areas to evaluate since we are dealing with qualitative information. This is critical, since the future of the company depends a lot on keeping the innovation stream alive and healthy.

There are several sources that can reveal a little about the current state of the company’s innovation skills (a business case study about a company, an interview with the CIO an article in a specialty magazine). However, this will always need some double checks. A good thing to do is the check the recent track record in terms of new products. Then, check who was responsible for them and confirm if this person is still in the company leading new projects. These are simple steps that, in my opinion, can support or refute your rationale.

4-Evaluate the production skills of the target company

The improvement in process efficiency is the next critical factor. The company’s industrial plants should be organized in a way that allows them to continuously search for areas where waste is generated, new ways of organizing production that increases efficiency, and new technologies of production that decreases the production time and increases the quality of the output.

Toyota was the most notable company in assimilating this view, with its famous Toyota Production System (TPS) or “Lean Production” practice.

Most of all, we need to be sure that the company has a widespread culture of continuous search for improvement. All the workers must be part of the effort to reduce waste, through the increase of standardized processes and reduction of overburden activities and processes. This will be reflected in some performance indicators such as the gross margin. Also, in Industrial companies the production is at the center of the company’s attention, we must ensure that the management is competent in terms of production management, but also be sure that the company is not getting “production oriented,” thus forgetting about developing new products at the expense of the current ones. Companies that get production oriented, seeking economies of scale, usually get sucked in a spiral of price reductions which ends-up destroying margins (Marketing Myopia Theodore Levitt). The constant introduction of new, differentiable, products is the solution to this trap. By developing products that the competition does not have yet, the company is able to maintain premium prices, thus sustaining or even improving margins.

A good way to verify the production skills is to check some performance indicators like the gross margin or inventory turnover.

5-Think out-of the-box when looking for information

Today, we can find most of this information in the internet. Frequently, I note that investors:

- follow the Graham’s tradition of religiously reading the annual reports;

- accompany blogs with gossip about a given industry or company;

- accompany patent registrations and speculate about it;

- speculate about the line of products soon to be introduced by a given company.

Although, I see benefits from any of the previous sources, I think that to be successful we will need to validate some facts, which is not possible if we do not extend our research sources. The internet allows us to explore sources like employees’ reviews, business case studies from reputable academics, executives’ interviews, executives’ biographies, scientific papers concerning new technologies. We have a wide-range pool of intelligence at our disposal.

One example of an unorthodox approach: when I want to understand how a given company’s employees feel about their company, I just go to a job review website (the ones directed for people looking for a new job) and read the comments about that company, sometimes it is really enlightening.

Thank you for reading this article.