Investment Activity Review - December 2014

December is usually a slow month for making any investment decisions. As the Christmas period emerges, trading volumes will ease off and with many events and gatherings around, it usually isn’t a great time to be thinking about stocks. This year though was a bit different in that I was ending the year with several stocks generating returns that had crossed my personal sell threshold of 20 percent. I had a few decisions to make. I also wasn’t planning to add any new positions to my portfolios but some recent market events, forced me to crunch some numbers to see if opportunities were indeed presenting themselves.

ADDED to Position in Las Vegas Sands (LVS)

The news from Macau continues to be negative with gambling revenues continuing to fall as a result of the Chinese Government’s continued crackdown on corruption. Displays of in-your-face spending and money throwing are more subdued now and it has impacted gambling stocks across the board. The company is still profitable and its balance sheet is still pretty solid. At some point the pendulum will swing the other way and the high-margin gambler will return. Because of this, I decided to take advantage of the recent price drops to add more to the position to reduce my average cost base. The stock got into the low $50’s so decided to buy some more.

SOLD position in Church & Dwight (CHD) for 26.4% gain

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The maker of Arm and Hammer and other cleaning products had a pretty nice year. I bought this stock for my son’s RESP at the $66 level as a long-term holding, but with the fast run-up in price to over $80 and the fact it had crossed my 20 percent sell threshold, I decided to take advantage of the pop and bank the profit instead. It’s a very solid company and I would not hesitate to buy back in, if the stock were to get thrown out in a market correction.

SOLD position in Costco (COST) for 31.6% gain

Another company I bought for my son’s RESP (he had a good year. Taking out the government grant, his portfolio was up 12.3 percent). Another high quality company that cranks out wealth and cash like nobody’s business. I bought in at $112 and sold it at $143. The stock was languishing for most of the year, but in the last few months it seemed to have caught a nice draft. Same thoughts hold here  in terms of my willingness to buy back if the stock should drop meaningfully with no fundamental changes in the company.

SOLD position in Whole Foods (WFM) for 20.8% gain

Whole Foods was slammed throughout 2014 by analysts saying the entry of other grocery players would eat into the company’s margins. They seemed to have forgotten one thing. Whole Foods is the industry leader in premium grocery distribution. Nobody has the core competencies and a better understanding of the foodie segment than Whole Foods. Management owned up to the fact they needed to be more aggressive in pricing and they stepped up. My average cost was around $41 and I sold the stock in the $49 level. Again I decided I was more than happy to bank a 20% return on the investment.

OPENED Position in Imperial Oil (IMO)

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Since the summer the price of oil has been going down. As of this writing it was down more than 45 percent. What has been interesting is that stock prices had not followed suit very much. In November and December that started to slightly change. During this period, we saw many “experts” weigh in on the downturn saying the correction was a short-term play and expected prices to go back up to the $90-100 range. As usual I framed my decision based on the 8 questions I always ask about a company and their stock. Below are some numbers pulled from the StockPointer investment research service that specializes in EVA analysis. 

 QUESTION 1: What do they sell?

(From Reuters) Imperial Oil Limited (Imperial) is an integrated oil company and a subsidiary of Exxon Mobil. The Company is engaged in the exploration for, and production and sale of, crude oil and natural gas. In Canada, it is a producer of crude oil and natural gas, a petroleum refiner and a marketer of petroleum products. The Company is also a producer of petrochemicals. The Company’s operates in three segments: Upstream, Downstream and Chemical. Upstream operations include the exploration for, and production of, conventional crude oil, natural gas, synthetic oil and bitumen. Downstream operations consist of the transportation and refining of crude oil, blending of refined products, and the distribution and marketing of those products. Chemical operations consist of the manufacturing and marketing of various petrochemicals. The Company owns and operates four refineries.

QUESTION 2: Who do they compete with?

The big players Imperial competes with in Canada include Suncor, Canadian Natural Resources, Husky Energy and Cenovous. The company has strong relationships with Exxon Mobil in the US, which just happens to be the largest company on the planet.

QUESTION 3: Who buys their products and services?

As an integrated oil company, Imperial owns all aspects of the energy supply chain and as a result, they sell to a cross section of industries from industrial companies to consumers in their retail locations.

QUESTION 4: Will people buy it over and over again?

Oil is one of those core commodities that will always be needed to keep the economy chugging along, although that level of demand as we see these days can fluctuate.

QUESTION 5: Do they make money?

In the past 3 years, Imperial Oil has been generating returns on invested capital (13-18%) that are greater than their cost of capital  (7-9%) so they have been making tangible Economic Profit for its shareholders.

Courtesy: StockPointer

Courtesy: StockPointer

QUESTION 6: What do they own and who do they own money to?

The company has very strong balance sheet which is impressive for an industry that is very capital intensive. Their debt ratio has fluctuated between 23-35% which is much lower than its competitors.

QUESTION 7: How risky is their business?

We’re finding out just how risky oil companies are with the big price drop.  Every Smart Money soothsayer out there was calling for oil prices to stay in the triple-digits. Heck one economist quit his job to go tell everyone what the world would look like with $150 oil. The good news is these companies have a very strong track record in managing oil price swings. I remember crunching numbers on these companies in the late 90’s when oil was trading at $10/barrel and they still were able to create tangible wealth. Oil companies have historically been excellent managers of scarce capital. They have no problem ratcheting back operations with the market fundamentals are not in their favour.

Courtesy: StockPointer

Courtesy: StockPointer

QUESTION 8: Is the stock cheap?

On a discounted cash flow basis, the stock has an intrinsic value in the mid-$60’s, implying there is about a 30 percent upside in the stock. Granted with oil prices falling, it wouldn’t be surprising to see valuations fall also. Despite the 46 percent drop in oil prices, the stock has fallen marginally about 4 percent in the past 3 months. So far the stock seems to have held its own despite the negative fundamentals and future expectations that oil prices are not done with their decscent.

Conclusion.

I’ve always held a belief that you need to have some high quality oil companies in a portfolio because of the fact that oil companies have a very acute understanding of managing scarce capital. In the late 90’s when everyone was buying Pets.com and Nortel, I was buying Precision Drilling and Encana and it worked out well. Although we’re no where near those days, the  sentiment on oil stocks has changed dramatically and it has flagged me to start looking at opportunities to get some more exposure at a good entry point. It appears Imperial Oil is one company that has a capability to create wealth in a weak market and so I decided to open a small position. It has a relatively clean balance sheet and is diversified into a number of areas in the supply chain so it can withstand the shocks better than other companies.  I have no idea where oil prices are going. Intuitively if the US$ stays at these levels or rises further and if economic growth continues to be tepid globally, the conditions for further price falls are there. If oil prices continue to fall, I would then look to average down the position by buying more stock. At some point economic growth will gain traction and prices will head back up. Again I have no idea when, but I’m willing to wait.  Like everything I own, I have built in exit points when losses exceed 20 percent to limit the downside.