GROW’s AUM held steady during the first half of the year due to the strong performance of resource related (commodity) stocks. Most asset managers, other than Diamond Hill (ndq: DHIL) have seen AUM fall in 2008. If AUM has held up, why am I so negative? The reason is that GROW has typically earned a large amount of its earnings in the June quarter ( the company’s 4th quarter) from incentive fees related to its management of funds for Endeavour Financial (Cdn: EDV), which will likely not happen this year due to poor performance. Whereas in last year’s fourth quarter GROW earned 42 cents per share, they will likely only earn about 17 cents in this year’s fourth quarter. The difference is due to the lack of incentive fees.
With the stock at $14 and current trailing earnings of $0.88 it may appear attractive to some at first glance. After the June quarter report, trailing earnings will fall to about 62 cents, which will put GROW at a significant premium to most asset mangers in terms of P/E valuation (22 times). Another metric I use is market capitalization to AUM, which is above 4% for GROW, and that is too high for an asset manager that doesn’t manage all of its funds in house (GROW’s emerging market funds are sub-advised by Charlemagne Capital (AIM: CCAP).
To make matters worse, resource related stocks have had a rough time since the start of July. Based on fund performance alone, which ignores inflows and redemptions, GROW’s AUM has declined by about 900 million since June 30. Thus GROW is still a SELL in my book.
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Liquidation Value
Not that I think they would liquidate the company by selling off all the vessels, it is helpful to know what the ships would be worth on the market. Based on their purchase prices and recent sales that I have seen, I value their eleven vessels at just over $800 million. If I add back cash of $40 million and subtract debt of 213 million it leaves a residual value of about $628 million, or about $12.75 per share. They have agreed to buy two additional vessels, which I will assume are at market prices. So under this scenario, buying at $10 gives me a decent margin of safety.
Operating Value
Dry bulk shippers have only traded in U.S. markets for a few years. Share prices have been quite volatile, which is understandable because shipping rates have fluctuated widely. One can easily see this by looking at the BDI shipping index available at Bloomberg.com. The index started 2007 around 4,400. It peaked at just over 11,000 in November of 2007. By January of 2008 it had fallen under 5,700, only to rebound to above 11,000 in May and June. It has since fallen again, and is currently at 8,280.
The reason for the volatility is usually attributed to general economic conditions, and issues related to China slowing imports during price negotiations and possibly during the Olympics. I will admit I have no idea which direction the index will go in the short or long run. Thee are just too many factors to predict accurately. What I do know is that the general economic conditions will eventually change. Since Star Bulk has mostly fixed charters, I have time to wait.
Star Bulk currently pays a 35 cent quarterly dividend, for a yield of 14%. I estimate cash flow at $0.50 per share in Q2, and climbing to over $0.70 per quarter in Q4 as two new vessels are delivered. So the dividend is well covered. Starting in the summer of 2009, cash flow will depend on what rates they get as some of their existing charters near expiration. Since most of their charters are at below market rates it is unlikely that they will be lower, but you never know.
I try to be conservative in my future assumptions. Dryships has a nice chart that shows current charter rates for dry bulk ships for various terms of six months to five years. This allows me to calculate what future predicted rates are for future years. For example, for Capesize vessels, it results in year one rates of $170,000 per day; year two of $100,000 per day; year three of $75,000 per day, and years four and five at $40,000 per day. This gives me a figure to use for future years once the current charters expire. In theory, Star Bulk could charter those future years now.
Using those figures still results in solid cash flow in excess of the dividend until about the fourth year out when rates are much lower. Does this mean there is long-term risk? Probably, but the overall risk is reduced by the cash flow between now and then. Projected free cash flow (net income plus depreciation) between Q2 2008 and Q2 2011 is just over $8.50 per share. That is nearly equal to today’s purchase price of $10.
So I’m adding to my position at these prices, with a current sell target of $13 to $15 per share. If prices fall further I may also buy their warrants (SBLKW) which give holders the right to buy at $8 per share before December 2009, but do not participate in any dividends.
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Since my model did not assume a high growth rate in assets the closing of the fund does not impact my projections. My model only assumes about $250 million in new assets per quarter. Based on the size of the firm ($5.5 billion as of the end of May), approximately half of the growth should be from fund performance (assuming average annual returns of 9%), thus the model only assumes about $40 million in new assets per month.
So far today, Diamond Hill has dropped by more than $4 per share, ot $88. We would use any further weakness in the stock to add to our position.
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I am no technology genius, but Microsoft (MSFT) looks attractive at its current price. At $27.50 per share it trades at less than 13 times analysts estimates for 2009. Granted they could screw that up by overpaying for Yahoo! or some other company, but I am willing to trust that management will make wise decisions. My preference is for Microsoft to continue to use the cash it generates to repurchase its shares.
I won't get rich with these holdings but they should outperform cash until I find additional small cap names to invest in. ]]>
Swift does not have any hedges in place, thus it will capture all the benefits of the current rise in oil and gas prices. I estimate cash flow at over $15 per share for 2008, EPS of $7.85 per share, based on oil trending down to $90 by year end, and natural gas dipping to $8 per mcf in the summer before rebounding to $10 at the end of the year. (Those are not my actual predictions of what will happen, I just try to be somewhat conservative to keep a margin of error/safety.)
PV-10 was $85 per share as of December 2007 based on prices of about $93 per bbl and $6 per mcf for oil and gas, respectively. Oil reserves are 10 times last years’ production levels, while gas reserves are at 17 times. In other words at current levels they have 10 years worth of oil and 17 years worth of gas, which is very good. Production is stable.
Wall Street has slowly been increasing estimates for the company, but is still far behind in my opinion. The street has Q2 at $1.83 and the year at $7.36. I see Q2 at $2.35 and the year at $7.85 based on my oil prices falling to $90 by year end. If oil pulls back to $110 per bbl and stabilizes then 2008 EPS should be about $8.65 per share.
At $58 per share it is just over 7 times my estimate of earnings. If oil prices rise I should do very well since they are not hedged. If oil falls a bit, the low valuation should still result in a modest profit. If oil falls precipitously? Well I probably will lose a bit. Hopefully, I will see it coming and sell, if not at least I will quit complaining when I fill up the car with gas.
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2008 has started off exceptionally well. AUM has grown from $4.4 billion $5.5 billion as of May 31. That is 25% growth in just five months. The stock has risen to $90 per share. Obviously future AUM growth is difficult to predict, since it is related to specific fund performance and general market conditions, as well as Diamond Hill's marketing efforts.
I model out various growth rates to come up with the what is most likely and what are worst and best case scenarios. Due to the unforseen market correction that began last summer, my original eanings projection should be extended out another year. Based on the conservative assumption of AUM gorwth of $250 million per quarter, it looks DHIL would earn $5.00 to $5.50 per share in 2008; $7.00 per share in 2009; and near $8.50 per share in 2010. That should result in the stock price climbing to near $150 in 2009 and $175 to $200 in 2010 (about 20 times earnings). If AUM grows faster, the shares could reach those price targets even sooner.
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Allegiant has a $500 million market cap, so it is relatively small but has enough liquidity for the small investors to get in and out, but not enough for the big Wall Street firms to care about. It is covered by four analysts, which is important. It means that any earnings surprises will likely result in immediate stock price movement. Additionally, the company provides enough information that earnings are somewhat predictable. This is a key point. I am not a guesser, I want a high probability of being right.
Allegiant reports monthly statistics on everything from fuel costs, number of departures, average fare, load factors, etc. All I need to do is create a spreadsheet model to predict what the end result will be and compare it to analyst expectations.
Model creation typically is a two hour process for me. I usually enter in results form the last two years and look for what costs are fixed and what are variable, and what are the drivers of additional cost. For example, with depreciation, I can look at past cost versus number of planes in operation and estimate current and future costs based off that. For fuel costs, which are very significant for an airline, Allegiant provides most of what I need. Allegiant releases their monthly average price per gallon so all I needed to figure out was how much fuel they used. By comparing the number of available seat miles in the current quarter to prior quarters, I am able to approximate change in miles flown, since their stage length (average flight distance) had not changed much.
For Allegiant it resulted in earnings per share beating the market handily. I looked at the stock price and found it reasonable at about $20. My estimates put earnings for the March quarter at around 45 cents versus analysts 34 cents.
The end result
I purchased shares in my Marketocracy portfolio for $20.13 on April 25. Earnings were released on Monday April 28. Allegiant earned 47 cents per share, well over the 34 cent estimate. The stock climbed from $20 to about $28. On April 30, 2007, I sold all my shares at $27.29, for a nice short-term profit.
Some may ask, "Why sell if they beat earnings so easily?" The main reason was that when I put the higher projected fuel cost estimates into my model it revealed that the June quarter will be tough for the company. So I decided to take the profits. The stock will stay on my watch list because it will benefit greatly from any drop in oil prices should that occur.
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The asset management industry is one of my favorites to invest in because the industry has attractive characteristics: high profit margins, little need for capital investment, and solid sales growth.
A favorite asset manager of mine over the last two years has been Diamond Hill Investment Group, Inc. (nasdaq: DHIL). It has grown rapidly and its share price increase reflects it. But when I look at the company, it still appears that the market is pricing DHIL as if its growth will stop. Based on past performance and current trends, I think that scenario is very unlikely. In fact, I think the shares can double in the next two years.
Diamond Hill manages mutual funds, separate accounts and two hedge funds. Management follows a value-based investment philosophy - they invest in good companies when prices are at a bargain to their assessment of intrinsic value of the business. What is most impressive is the firm’s growth. Assets under management (AUM) were $107 million at the end of 2002, $250 million at the end of 2003, $515 million at the end of 2004, $1.5 billion at the end of 2005, and $3.7 billion at the end of 2006. That’s four straight years of over 100% growth!
A number of factors have led to Diamond Hill’s tremendous asset growth but the primary factor has been the performance of its funds. The Small Cap fund (closed to new investors) and Long-Short fund have five star Morningstar ratings, while the Large Cap, Financial Long-Short, and Strategic Income funds have four star ratings. In 2006 DHIL introduced two new funds, a Small-Mid Cap fund and a Select fund, which is based on the best ideas from the Small Cap and Large Cap funds.
I believe the market is not pricing in any future growth for the company, which I think is a very unlikely scenario given its historical performance. If growth stopped and AUM leveled off at the current $3.7 billion I estimate the company would have 2006 earnings of $4 per share. Based on the average industry multiple of 20 times earnings that would support a share price of about $80, close to the end of 2006 market price. This gives us some downside protection.
While I can’t precisely estimate future asset growth, continued AUM growth is likely. If asset growth were to continue at just half of its 2006 average of $180 million per month for the next two years, I estimate annual earnings would be $7 per basic share in 2008. At the industry multiple of 20 times earnings, DHIL would be priced at $140.
If DHIL can maintain their 2006 rate of growth in 2007 and 2008, it could see earnings reach $8 to $10 per basic share. At the normal industry multiple of 20 times earnings, that would result in a stock price of $160 to $200 per share. Based on its historical growth rate, I think Diamond Hill should trade at a premium to the industry average. If I use a PE ratio of 25 to 30 due to its superior growth rate, the above scenario would result in price range of $200 to $300 per share by the end of 2008.
Diamond Hill fits the kind of stock I look for. I want to invest in good industries that are not capital intensive, that have upside potential without all the downside risk. It looks to me like a stock that can double in two years.
Note: Mr. Eriksen is a registered Investment Advisor. Both Mr. Eriksen, and funds he manages, have a position in Diamond Hill.
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