FairFax Financial Spots a Deal

Fairfax spots a deal - The Globe and Mail

After months of issuing preferred shares and debentures, the insurance giant Fairfax Financial Holdings Limited is initiating one of the largest share buybacks of it's history. At yesterday's closing price, it would be valued at over $600 million. Over the next 12 months, the company will buy close to 1.6 million shares, almost 10% of the current float. This means that the average daily volume of the company will be greatly influenced by the actions of the company.

The company's Chairman and CEO, Vivan Prem Watsa, has developed a reputation of value investor over the past 20 years. Having the company dedicate more than half a billion dollars to buying it's own shares instead of increase it's current investments is a clear sign that the FFH is currently trading under or close to it's book value. This is an hypothesis that will be confirmed on the next quarterly filing of the holding company. Note also that this move will greatly increase the seize of the CEO's control stake in the company, which is already pretty close to 50%.

However, before buying the stock, one should consider taking this news with care, as the final amount of the operation is not yet known. Some companies will issue such statements to stimulate a downbeat stock price. Fairfax is up a mere 2% for the year, this is therefore another possibility. If the transaction is completely filled, the remaining shareholders will be greatly rewarded as the company will showcase higher EPS.

This might not be a good time to buy the company's stock, but for those who already own it, it is definitely a great idea to hold on to it.

Full disclosure: Long FFH.TO

Ridley Inc. Reports Preliminary Results for Fiscal 2010 Fourth Quarter

Ridley Inc. (RCL.TO) Reports Preliminary Results for Fiscal 2010 Fourth Quarter

As stated in that MarletWatch article, the 4Q results of Ridley showcase improved operational performance for the company.

As they state it in their quarterly report, their loss has been narrowed compared to a year ago. This is good sing for a company on it's way to profitability.

Let's remind that Ridley Inc., the former subsidiary of it's Australian parent company, was sold to Fairfax Financial Holdings Limited in 2008. since then, the stock of the company has been pretty illiquid because of the large block owned by the Canadian insurer.

Their short term results have been altered by the critical conditions present in the current financial environment. Exempt from them, the company is on track for great success for their shareholders.

Depending on right assumptions, the company should yield great returns, since the parent company, Fairfax Financial Holdings Limited, should proceed to a complete buyout of the roughly 20 millions shares of that company that are still publicly traded on the Toronto Stock Exchance under the symbol RCL.TO.

Untill then, I will keep acquiring more stock in this interesting value play.

Full disclosure: Long RCL.TO

Institutional Investors and Stock Prices

In their quest to generate impressive returns to their clients, institutional investors shape the financial world. An average investor will tend to get heavily influenced by their investment choices.


Institutions generally tend to be banks, insurance companies, pension funds, mutual funds, investment trusts, unit trusts or hedge funds. They are very meaningful invertors because of the sheer size of assets that they manage.


Any individual wandering in the financial arena should consider getting more acquainted with those entities. If you are playing in the small capitalization and mid capitalization field, you should know that some of those investors shun companies that expose their stock prices to levels that they deem too low. In fact, some if those institutional investors establish minimum buying prices; in order to avoid the frequent price manipulation that incurs from companies have a too low stock price.


For most of those investors the minimum price will be set at 5$. This will explain why some companies experience huge gain in their stock price as soon as it hits that minimum price. A good example is DryShips over the past two years. However, some funds will go as low as 1$ per share.


Mass market movements are often the consequence of actions by those investors. If we take that market plunge of September 2008, one of the conclusions implies a chain reaction in the financial market.


Like any companiy, institutional investors have balance sheets and obligations towards their lenders and must maintain some capitalization levels in order to stay solvent. When news about a financial crisis were gaining grounds, many individual investors, who had their money managed by mutual funds, pension funds or companies, began redeeming their investment, thus causing a lot of stress on the cash position of those companies. Those institutional investors were forced to sell promising positions to fulfill their cash balances that were dwindling because of redemptions from clients or investors.


The investing world is a challenging one for value investors. Even if you get the right assumptions about the value of a company, institutional investors can dramatically affect your results because of their specific needs.

Agruim Inc (AGU): An Undervalued Fertilizer Company (Part 4)

This is the fourth part of a series of posts relating to a thorough analysis of Agrium and what led to conclude that it was a company worth your attention for a further analysis. Part one can be found here.


Agrium Inc is a Canadian retailer and manufacturer of agricultural chemicals. Its main products are fertilizer and crop protection products. Although the company operates globally, the bulk of its operations are in the US and Canada. This, however, is bound to change due to Agrium’s recent acquisition of CMF and an increasing focus on foreign markets. After evaluating Agrium Inc from different perspectives, we have come to the following conclusions:


Economic analysis: global supply and demand for crops, as well as economic conditions determine crop prices which in turn determine fertilizer prices. Crop prices, although negatively affected by the financial crisis, have been rising due to the expansion of the Asian middle-class, and the recent focus on biofuels. The world population is growing and every year there are an extra 80 million people to feed. Thus, we foresee an increase in the demand for fertilizer and also in fertilizer price.


Industry analysis: the industry as a whole was negatively affected as a whole, but things are expected to return to normal in the short to medium term with moderate growth for the sector thereafter.


Company analysis: the firm has an aggressive acquisition strategy, has shown robust growth, and has a strong management team in place.


Financial analysis: We were not able to calculate intrinsic value because ROE growth is too high! The average annual return for an investor who bought in 1995 and is still holding the stock is 13.5%. This return is higher than the expected return required by CAPM. We therefore conclude that, assuming that this growth rate is sustainable, investing in Agrium stock yields a higher expected return than that warranted by its risk. In addition, the company’s P/E ratio is lower than it’s peers, leading us to belive that it is undervalued. The stock is also currently in an uptrend: a bullish sign.


Based on all of the above information, our conclusion is that shares of Agrium Inc. are underpriced and should be bought.

Agruim Inc (AGU): An Undervalued Fertilizer Company (Part 3)

This is the third part of a series of posts relating to a thorough analysis of Agrium and what led to conclude that it was a company worth your attention for a further analysis. Part one can be found here.

Dupont Model analysis

Net profit margin:
Between 2007 and 2008, the net profit margin went from 8.37% to 13.18%, a significant increase of almost 5%. In 2008, the industry had an average profit margin of 5.19%. This increase in profit margin is mainly due to savings in general and administrative expenses, depreciation expenses and other non-operating income. (Annual report 2008)

Asset turnover:
The asset turnover increased from 1.16 to 1.28 between 2007 and 2008. Each dollar invested in the asset generates 1.28$ of sales. The industry’s ratio in 2008 is 1.02. Hence, Agrium’s asset was used efficiently.

Financial leverage (Asset/Equity):
2007-2008: It went from 1.89 to 2.39 meaning the company incurred more debt. This is due to the acquisition of CMF.

2008
EBIT/Assets: 0.2
Interest/Liabilities: 0.018
Positive leverage, it’s a favourable debt, so when asset on equity increases ROE increases

Profitability

Both EBITDA Margin and Gross margin increased from 2007 to 2008 and both are above the industry level thanks to the growth in sales.

ROA (net profit margin x asset turnover):
Almost doubled from 9.69 (2007) to 16.84 (2008) because of net profit growth.

Liquidity Management

Current Ratio:
Between 2007 and 2008, Agrium’s ratio decreased from 2.83 to 1.82, while the industry average raised from 2.26 to 2.94.

Quick ratio:
2007 and 2008 the ratio decreased from 1.84 to 0.57 and a constant 1.3 for the industry.

The company may have some liquidity problems after the new acquisitions. To begin with, the company’s ratio is lower than the one of industry. The difference between the current ratio and the quick ratio demonstrates that the company holds to many inventories which are often less liquid. As a result, Agrium may face short term reimbursement challenges.

Debt Management

Interest Coverage:
2008: 18.91 ≥ 1, therefore Agrium is able to pay the interest.

Total Debt to Equity:
An increase from 0.25 (2007) to 0.39 (2008) with an almost constant industry ratio of 0.29
This is due to the new issued long term debt. As we observe an raise in the LT Debt to Equity ratio from 0.25 to 0.39.

Asset Management/productivity

Receivable turnover:
Still below the industry because of high accounts receivable

Inventory turnover:
Diminished from 6.17 (2007) to 4.99 (2008), and it’s still below the industry’s ratio (7.6). The reason of the low inventory turnover ratio is because of the high amount of inventories.

Property Plant & Equip Turnover:
Both ratio in 2007 (3.39) and in 2008 (5.24) are higher than the ones of industry. This represents 1$ of capital assets generates 5.24$ of sales.

Cash & Equivalents Turnover:
In 2007, 6.39, lower than the industry (14.78)
In 2008, 13.04, got better, but still lower than the industry (16.15)
This shows possible liquidity problem.

Quality of managers

Evaluating management quality objectively is quite a difficult task. If we compare the performance of Agrium to its peers, we can see that Agrium is much more efficient. Given Agrium’s stellar performance, we assume that management must be doing something right. In addition, we watched Agrium’s conference call and we found that they left a good first impression. They seemed like diligent and competent people. It is also worth noting that Agrium’s CEO, Mike Wilson, was honoured as business person of the year by Calgary Inc magazine for his various accomplishments that made Agrium a “strong, vibrant international corporation.” Last year, Agrium’s CFO, Bruce Waterman, was nominated Canada’s CFO of the year by PricewaterhouseCoopers LLP.

Company prospects

Despite of the unprecedented bad year for fertilizer in 2008-2009 that was due to the economic downturn, Agrium is expecting strong future growth in its retail and wholesale divisions. Indeed, Agrium is poised to benefit from the strong agricultural forecast. Based on its growth strategy and value-creation throughout the supply chain, the company plans to expand wholesale operations to further optimize earnings. It has planned strategic acquisitions and other expansion/growth initiatives across the agricultural value chain: 9 acquisitions ($3.5 billion invested) and other growth initiatives (Potash expansion of 40% increase in capacity by 2013 well on its way, nitrogen production facility in Egypt on schedule, ESN expansion, etc.), in addition to its 4 acquisitions in Retail in North and South America (over $3 billion invested). As shown in the graph below, Agrium’s goal is to double earnings from stable Retail and AAT base, and significantly grow capacity across all three nutrients.

Agruim Inc (AGU): An Undervalued Fertilizer Company (Part 2)

This is the second part of a series of posts relating to a thorough analysis of Agrium and what led to conclude that it was a company worth your attention for a further analysis. Part one can be found here.

Agricultural market fundamentals remain strong

As we know, the price of fertilizer is closely related to the price of grains. The cereal harvest reached world record levels in 2008. The United States Department of Agriculture (USDA) estimates that 2,225 million metric tonnes (Mt) were harvested and that cereal inventories went up slightly. The Food and Agriculture Organization of the United Nations (FAO) and USDA estimate that the 2009 cereal crop was 1.5 to 2.0% lower than the 2008 record. Because of the recession, world grain demand will increase only modestly in 2009/10 and the world output would match demand, resulting in relatively stable inventories. Affected by the economic context, crop prices dropped in the second half of 2008 before slightly firming in the first half of 2009. Most international prices for agricultural commodities are currently relatively strong compared to pre-2008 levels.

Global Fertilizer Demand

After years of increasing demand, fertilizer use slowed in 2008. Like other commodities, the worldwide economic downturn is the primary reason for the declining fertilizer use, dropping prices and mounting inventories for the year 2008-2009. World fertilizer consumption seen as dropping 5% in 2008/09, negatively affecting the demand compared with the previous year. Nitrogen has been much less affected, as this nutrient is vital for crop yields. Nitrogen, Phosphorous and Potassium fertilizer demand is estimated to drop by 1.6, 7 and 14%, respectively. The largest contractions in volume are observed in Western and Central Europe, North America and Latin America which, coincidentally, are all of the areas in which Agrium operates.

Global Fertilizer Supply

The world fertilizer markets experienced a period of huge volatility in 2008 despite strong demand fundamentals. The global economic downturn and tight credit dampened short-term prospects for fertilizer consumption. Fertilizer market conditions worsened considerably in the fourth quarter of 2008 as sales collapsed, driven by weakening financial and economic conditions, tight credit access and, to a certain extent, loss of fertilizer demand or purchase deferral in a large number of consuming countries.

In 2008, global nitrogen production rose by a meagre 1.7% compared with 2007 while the output of phosphate fertilizers and potash declined by 7.5% and 2.8% respectively, due to a drop in exports and weak import demand. Entering 2009, the fertilizer industry was confronted with poor market conditions, marked by lack of sales and weak prospects for production and trade this year. However, stocks of soft commodities and cash crops remain low compared with historical levels. Fertilizer demand will therefore recover, although the pace of recovery is uncertain. The International Fertilizer Industry Association forecasts the balance of supply and demand for the next four years, from 2009 to 2013. For the three main nutrients, Nitrogen, Phosphorous and Potassium the supply is projected to grow at an average annual rate of 6%, 8% and 23% respectively.

Price of inputs

Here is a brief description of a few factors that have an impact on production costs. Because ocean shipping rates have been in free fall since May 2008, delivery costs have fallen. Energy prices, notably those of crude oil and natural gas, have fallen by more than half compared to their levels in mid-2008, offering some relief to nitrogen producers. However, in the medium term it appears that natural gas prices in key exporting and importing countries may increase again. The cost of sulphur has an impact on the cost of producing phosphorous.

Since Agrium and other companies in the industry operate internationally, currency valuations may affects costs of inputs and price of outputs. Indeed, as a result of the weakening of the Canadian dollar during the fourth quarter of 2008, Agrium experienced significant foreign exchange gains of $98-million.

Important variables for the industry and their business cycle sensitivity

The most important variable that affects fertilizer demand and price is commodity prices such as corn and wheat. Commodity prices affect the farmers’ revenue and thus willingness and ability to pay for fertilizer. The price of corn is currently around $4 per bushel, double its 2005 price of $2. We must note however, that in the summer of 2008 just before the financial crisis, corn peaked at a price of $7.88 per bushel. High commodity prices are an incentive for farmers to plant more, thus increasing the acres of land cultivated. In addition, higher commodity prices increase the farmers’ willingness and ability to pay for fertilizer.

Prospective Demand

With the prevailing strong agricultural market fundamentals and anticipated progressive recovery of the world economy, world fertilizer demand is seen as slightly rebounding in 2009-10 (+3.6%) to 165.4 metric tons, with growth rates of 2.6% for nitrogen, 6.1% for phosphorous and 4.1% for potassium, as it is shown in the table below. Strong recovery is anticipated in East Asia and in Western and Latin America. Consumption would further increase in South Asia and East Asia going into 2013-14. Although slower growth rates than other regions are anticipated for North America and Western Europe, these regions are still expected to expand. Slower growth in these key areas could diminish Agrium’s future performance compared to other foreign firms.

Disclosure: The author has no position in AGU but intends to initiate one in the coming weeks

Agruim Inc (AGU): An Undervalued Fertilizer Company (Part 1)

This is the first part of a series of posts relating to a thorough analysis of Agrium Inc. and what led to conclude that it was a company worth your attention for a further analysis.

Agrium Inc. was founded in 1931. It started out as a fertilizer company called Cominco Fertilizers, Ltd. Over the years, Cominco grew larger and larger and started to diversify its range of products. The company went public in 1993 and decided to change its name to Agrium Inc two years later. Its Headquarters are located in Calgary, Alberta.

Products & services

Agrium is one of the leaders in the sector of agricultural nutrients, industrial products and specialty products in the international market. The structure of the company is divided in three business segments: retail, wholesale and advanced technologies.

Agrium’s retail division supplies agricultural products and services directly to growers in North and South America. The wholesale division produces, markets and distributes the three primary nutrients for fertilizer production, which are nitrogen, phosphate and potash, directly to agricultural and industrial customers. The Advanced Technologies business segment, which rests on its production and sale of controlled-release nutrients, micronutrients as part of its specialty products and plant protection products such as pest control marketed to residential and commercial consumers.

Strategy

As a mission, the enterprise will continue to provide ingredients for growth. Although Agrium is already one of the world leaders in its field, their vision is still to become the leading supplier of agricultural chemicals in the world. Following its IPO in 1993, the company grew by making important international investments and undertaking multiple acquisitions. For instance, Agrium owns three foreign subsidiaries that are located in Belgium, China and Argentina. In addition, important investments were made in Hanfeng Evergreen Inc (China) and MISR Oil Processing Company, S.A.E. (Egypt).

Its corporate growth strategy consists of three aspects that are: to invest through the value chain, to continue to provide with the lowest cost in the wholesale segment, and to diversify internationally. With regards to different geographical market and international opportunities, China, Brazil and India are the three major emerging markets for potash exportation; South Korea, Mexico and Taiwan are some targeted markets for nitrogen. In addition, these markets express great concern about environmental issues, and thus are prepared to pay a high price for innovative products and solutions.

The firm's market position

According the Agrium’s 2008 company fact book, the company manufactures fertilizers and crop protection products based on 3 different main chemicals: nitrogen, phosphate and potash. Most of Agrium’s competitors are also produce products that contain those three elements because they are found in all fertilizers (at least one of the three and sometimes all three). Agrium is more diversified than its competitors, producing and all three elements as well as controlling distribution channels in North America, South America and Europe. Based on output in metric tonnes, Agrium comes third in nitrogen based products with 2 403 000 tonnes. That puts it right after Yara International ASA and Terra industries inc., producing 7 032 000 tonnes and 2 519 000 tonnes respectively. For phosphate based products, Agrium comes in 4th, with a production of 720 000 metric tonnes after Mosaic Co., Potash Corporation of Saskatchewan and CF Industries Inc. They produce 4 488 000 tonnes, 2 209 000 and 998 000 tonnes respectively. Finally, Agrium is recognized as a global leader in advanced technology, innovation and environmental solutions in the agricultural industry.

Disclosure: The author has no position in AGU but intends to initiate one in the coming weeks