Investment Activity Review - April 2016

The Canadian dollar continued to surge during April, rising close 80 cents per US$ at one point. The rise had me motivated to take advantage of the additional purchasing power to do some cross-border shopping.

Opened Position in Vanguard Emerging Market ETF (Ticker: VEE)

Emerging market assets have had a really hard time in the last few years.  If you broke down emerging market economies into their marketing friendly BRICS, you would not find too many happy stories. Brazil is imploding as a result of corruption scandals. Russia has its own corruption cult of personality thing going. India has actually been quite tame, and likely holds the most potential. China has been having its own growing pains dealing with the whole slowing economy concept.  Finally South Africa has been an all of the above.  These levels of malaise have been committed under a backdrop of capital investment seeping out of these and other emerging markets as a result of a surging US$, and the prospect of higher interest rates in the US sucking capital out.

This was the dynamic. The reality is that it appears interest rates in the US or anywhere for that matter are not going up anytime soon. This continuous struggle for yield may take investors back to the emerging markets at some point. Again I have no idea when this will play into pushing emerging market stocks up. In the meantime, Emerging market stocks have been taking a beating.  Right now they are out of favour and that has perked up my interest. The reality is that emerging market economies are still generating healthy levels of GDP. It may not be in the double-digits like many years ago, yet they are growing meaningfully (Brazil, Russia not withstanding).  I thought it would be a good time to establish a small position in this via an ETF. The Vanguard product comes in with a minimal 0.25% Management Expense Ratio (MER) so I thought that would fit the bill as I really don’t have the time to do some deep dives into individual companies so I’m willing to sacrifice some return for exposure.

 

Added to position in Potash Corporate of Saskatchewan (Ticker: POT)

The stock dropped below $22 so I decided to buy more stock to lower my average cost down to $23.78. There have been more rumblings of another dividend cut and that may have put more pressure on the stock. The fundamentals are still weak in terms of potash prices, however I think over the long term, demand will drive the markets and POT is a best of breed company that has so far shown they can still make a tangible profit in a depressed market. Eventually things will turn back to the mean and the stock will come back. The question is how much pain do I have to endure to get there?

Sold position in Las Vegas Sands (Ticker: LVS) for 8.5 percent gain

This was an unexpected one. I’m still pretty high on the premise of casinos and their cash cow qualities. What changed though was in my eyes a negative game changer moment. It was revealed that LVS paid a fine $9 million to end an SEC probe into its business practices in Macau. If a business practices involve keeping 2 sets of books even if it is for a one-off payment for a consultant, what other segments of the business is adopting similar practices? I don’t want to stick around to find out.  The fine is the standard hush money that businesses pay as the cost of doing business which at some level I’d agree with.

The 8.5 percent factors in a nice bump in the currency. Add in the 5.7 percent dividend and the investment has yielded me closer to 14%. Backing out currency, the stock was up about 6 percent on an apples to apples basis. Not the ideal return I’m seeking with my investments, however, when I see a situation that could potentially challenge the credibility of a company’s financial reporting, I draw the line. I’d rather sell first and let the dust settle and maybe I would consider coming back in.

Sold partial position in Gold ETF (Ticker: CGL)

After I sold the LVS position, I decided to reduce my pseudo/quasi hedge position on my US$ assets by selling some of the Gold ETF.  It didn’t make sense now to hold that much in gold.  As I mentioned, my intentions in using the CGL was not for speculating on gold prices.

 

Opened Position In Whole Foods (Ticker: WFM)

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If you have been a regular reader of this blog, you’ll know that I’m always on the lookout for companies that have demonstrated they can create tangible economic profit, but have been shunned by the Smart Money People. The reason being if these types of stocks are out of favour, it could mark a great entry point into the stock, assuming all the fundamentals are intact. One company that has been on my radar for awhile has been Whole Foods. I did a size-up using my 8 Questions and here’s what I came up with.

Question 1: What Do They Sell?

Whole Foods is a leading retailer of natural and organic foods in North America. The company seeks out the finest natural and organic foods available and maintains the strictest quality standards in the industry.

Per Reuters: “…The Company has one operating segment, natural and organic foods supermarkets. As of September 29, 2013, Whole Foods Market operated 362 stores in the United States, Canada, and the United Kingdom. The Company’s offices are supported by its headquarters, regional offices, distribution centers, bakehouse facilities, commissary kitchens, seafood-processing facilities, meat and produce procurement centers, and a specialty coffee and tea procurement and roasting operation. The Company’s product selection includes grocery, meat, seafood, bakery, prepared foods and catering, coffee, tea, beer, wine, cheese, nutritional supplements, vitamins, body care, and lifestyle products including books, pet products, and household products. The Company’s 365 and 365 Organic Everyday Day Value brands account for approximately half of its brand items.”

When one thinks of premium, high quality, and some cases overpriced food, WFM is top of mind. Their basic value proposition is not to sell just food, but the experience of celebrating amazing, healthy, top shelf food. It’s a luxury food company that tries to offer the high quality, exclusivity factor. The stores are very inviting and a great deal of effort is put into educating customers on the origins and values of the foods they sell and to make the experience with food more personal. The staff is very customer focused and bring a general positive energy to environment.

Question 2: Who do they compete with?

The simple answer is they compete with other large grocery chains such as Safeway, Kroger, and Loblaw in Canada. They also compete with other big box retailers such as Walmart, Target and Costco who are upping their food quality. They also compete with other grocers that specialize in organic food such as Trader Joe’s. At one point, WFM was the dominant vendor of organic foods, but their competitors have been stepping up their game and offering a base product mix. WFM has been losing market share in organics in recent years.

Question 3: Who Do They Sell To?

Traditionally they have catered to the higher income, professional, gourmet, foodie type of demographic, however they are branching out to other segments, namely the millennial segment via their new 365 stores which offer lower price points but fewer selection.

Question 4: Will They Buy It Over and Over Again?

When I work with people helping them to identify companies and stocks to start researching, I get them to think about products, resources, and commodities that are essential to our day-to-day survival. Food is one of those core pillars. We need to eat to survive every day.  It’s non-negotiable. Because of this we gravitate to places that meet this need. In terms of WFM, it has build a highly loyal clientele that commits to shopping there as a routine. When a new location opens up, it creates a buzz, much like an Apple store does.

Question 5: Do They Make Any Money?

Source: Valuentum Securities

Source: Valuentum Securities

WFM has generated consistent positive economic profit over the past several years, despite increasing levels of competition that have whittled away at their market share. Returns on Invested Capital have tracked between 25 and 27 percent which is amazing for what is traditionally a lower margin, lower return sector. With a cost of capital tracking in the 10-11 percent range, the company is generating a very healthy level of tangible wealth. This makes me want to go further.

Question 6: What do they own and whom do they owe it to?

The company has a pretty rock solid balance sheet with hardly any debt. As a result, many have cited WFM as an ideal buy-out target for private equity. The quality of the company’s assets is pretty strong with very little in the way of intangible/goodwill type of assets. It’s pretty flush with cash, with about 12 billion in the bank. The company has made a conscious decision to grow its portfolio of stores slowly in order to keep its brand and value proposition solid.

Question 7: How risky is the business?

The company is financially strong enough that it is unlikely to go out of business anytime soon. Suffice to say it faces the traditional headwinds the grocery distribution market faces (margin pressure, new entrants, discounting, and a demographic that could walk away if their prices are not competitive enough). Management doesn’t seem to be intimidated and has fostered a culture where it is encouraged to push the envelope on trying new things. The 365 store is one example. It is also a very big wild card as if it doesn’t work out, the market may punish the stock pretty hard. If it does work out, then it risks cannibalizing it’s higher margin flagship stores. The lines are being drawn.

Question 8: Is the stock cheap?

Source: Valuentum Securities

Source: Valuentum Securities

On a relative basis the WFM multiple is higher than its competitors tracking at around 18 times forward earnings versus the median P/E of 16.6. This despite the stock falling almost 40 percent in the last 12 months.  From a discounted cash flow perspective the valuation comes in at about $35 to $44 which is higher than its current price of $29.60. It appears that there’s at least 20 percent return that can be found over time.

Assessment

WFM is love it or hate it company. People who love shopping there, are extremely loyal to the brand. Others have a disdain because of their higher prices and affordability factor. Once a darling of the Smart Money People,  Wall Street doesn’t like the company because it is not generating the crazy growth like it used to. For me it’s about cash. It appears to be making a lot of tangible profit despite the competitive pressures. The 365 store model is really going to tell the tale of how this company will shake out. At its core, WFM is a luxury brand. The exclusivity and quality elements are what draw people to the stores. If the 365 store concept dilutes the brand, the company could be in trouble. On the other hand great companies have an uncanny ability to embrace the transition and come out stronger. Apple is a good example with their iPod-iPhone cannibalization. The edge they may have is that they have a management team that is ready to push the envelope and appears to have a more long-term focus on developing the business. I think they have a pretty good shot of pulling it off. Other grocers have established multi-channel stores that cater to various demographics (Loblaw in Canada is a good example). I don’t’ see why WFM can’t do the same.

I’ve been watching the stock for about 6 months and have had it on my List. I have been waiting for an opportunity to start buying in if it went below $30. Sure enough it did and it also helped that the CDN$ went down from $1.47/US$ to $1.26/US$, offering up another 15 percent discount. So I used that to open a small position with a plan to add more as times goes on. I bought in at US$29.62.

Update:

Since I wrote this piece, the stock has taken a tick up, crossing back near the $31 range.