Will it be iPods for Dinner?

Many are starting to see lots of opportunities in the US equities markets. Conventional wisdom states that a correction is a dip of no more than 10% from recent highs (for the DJIA, that’s 14,279) and that a bear market is usually more than that. Well, right now we’re down about 15%. The DJIA is about 3.7% above its 52-week low. So where does that leave us? Many traders seem very pessimistic and quite a few have capitulated, stating that the market will continue correcting. Meanwhile, economic data continues to paint a mixed picture. What should an Intelligent Investor do? Continue to focus on value. The same guiding principles hold: (1) a straightforward business preferably with a repeat purchase model, (2) a stable business, (3) decent balance sheet, (4) top notch management team, and (5) industry leadership. This is boring.

Consider Apple (AAPL). I own 4 Macs (I’m writing this using an iBook) and 6 iPods. I love their products (obviously), but their stock has dropped from about 200 down to 160. Many people were thinking it ‘had to’ rise to 300. Many of these people weren’t around in 1999 or in 1987. They refer to AAPL’s cash position–guess what: it needs cash to fund growth. The company is on a treadmill and needs the cash to continue to fund growth. If they have a disappointing “show” and fail to release the products the market expects (and let’s recall that AAPL has a history of doing this), they get crucified. It’s really high risk/reward. When, in the life cycle of the company, they no longer need the cash, they can declare a sizable dividend–which is what Microsoft did a few years back. Still, it is very hard for a company to support a mid-double digit P/E ratio for long periods of time. The market will not pay a high multiple for very long, especially if the company shows the slightest disappointment in future cashflows (earnings) due to issues with products, markets, etc. If in the midst of this the economy gets tough (recession or worse), consumers may have to choose between necessities (food, shelter, water and clothing) and discretionary purchases. Which do you think they’ll choose?

Many companies focus on relatively mundane products. Their money is just as green as the money that comes from glitzier companies. I will be highlighting a couple of these shortly. One is in the food industry and the other one specializes in high tech machining.

Risks of Investing in ABFS

The last post showcased the opportunity that exists with Arkansas Best (ABFS:NYSE). As with any investment, there are risks. Given the nature of their business (shipping via trucks), several risks come to mind:

• Capital investment: ABFS has $461M in fixed assets (net of depreciation), which works out to about $18.40/share--this is clearly not a "light" business; additionally, investment may be required track assets/deliveries (IT infrastructure) and to support the trucks (maintenance and repair)
• Repeat business: There's a lot of competition in trucking; while customers repeatedly use the trucking, they may choose from a bevy of other carriers
• Differentiation: Since trucking services are ostensibly commoditized, ABFS has to differentiate itself (products, service, price) in the marketplace to establish their brand
• Margins: Their net profit margin (3.18% is below the industry average of 6.58%)

There are plenty of other risks as well (many of these are generic in nature): rising labor costs, increasing regulatory burden, management skill and modal conversion (i.e., shippers switching to other methods of shipment such as rail).

With that being said, it appears that ABFS is quite effective in dealing with many of these risks. Even though one of its subsidiaries is in a union stronghold (Clipper Exxpress is in Woodbridge, Il), Arkansas Best seems to have done a good job of avoiding labor strife. To keep costs low and service level high, Arkansas Best has set up two subsidiaries, Data-Tronics and Fleet Net. these two subsidiaries provide 2 essential services to Arkansas Best: shipment tracking and truck breakdown/repairs. Facing the option of doing this in-house vs. outsourcing, they appear to have launched these 2 services as standalone businesses (similar to how Ford spun off Visteon). Hopefully they will meet with more success than Ford!

Differentiation appears to be along the lines of operational excellence and scale. For the most part, ABFS appears to promote from within (they recently appointed a new president of Data-Tronics, a 28 year company veteran). Nevertheless, there is a major red flag with respect to margins, which are significantly below the rest of the industry. This bears more research, as it points to differentiation on price (which requires persistent, focused efforts to maintain low costs).

Lastly, ABFS has mitigated the modal conversion risk with their Clipper Exxpress subsidiary which operates in the intermodal space (intermodal shipments are the trailers you see riding on flat railroad cars).

Overall, they appear to have a good command of their business (they've won their share of trucking awards) and a decent amount of industry credibility. The only real red flag appears to focus on their low margins, which will be explored in more detail. Nevertheless, at current valuations, there appears to be a decent bit of Margin of Safety with Arkansas Best.

ABFS: Logistics Opportunity?

One of the potential value stocks being looked at is Arkansas Best (ABFS: NYSE). The stock has been driven down recently by 2 forces: slowing economy (lower traffic growth) and rising fuel prices (higher costs). To be clear, ABFS is a holding company that operates several subsidiaries, the largest of which is probably ABF Freight System, Inc. ABFS is a trucking company and they focus on LTL (less than truckload) shipments. Increasingly, they are focusing more on regional markets (this is important given the wide use of regional distribution centers). The stock had a significant run-up on 1/14, but still looks attractive for several reasons:

• Undervalued at .8x book value with a P/E around 7.7
• The company is kicking off cash ($5.01/share cashflow)
• Business is fairly straightforward; trucking is definitely a repeat business
  
• ABFS has very little debt ($1.7M); quick ratio of 1.4

Additionally, it appears the company is pretty well run and takes its operations seriously--it had the forethought to set up an IT subsidiary (Data Tronics). This is important for several reasons: (1) ABFS can keep track on their assets (i.e., trucks), (2) ABFS can generate data on their shipments that they can use to streamline their operations, and (3) it allows shippers/consignees to track shipments which is crucial to supply chain management.

ABFS also, it has the advantage of being in a very central part of the country where there's a high availability of moderately priced labor. All this sounds good--in my next post I'll look at possible downsides to ABFS' business.

Interesting Stocks

Looking at things from a value perspective, there are several interesting stocks. This is actually a particularly tricky time since P/E’s are coming down pretty quickly and book values are increasing. The challenge is to separate the proverbial wheat from the chaff. Some criteria being considered here include: (1) a straightforward business preferably with a repeat purchase model, (2) a stable business, (3) decent balance sheet, (4) top notch management team, and (5) industry leadership. Without getting into too much arcane language on intrinsic value and obscure techniques on valuation, the goal is to use a common sense approach while being selective.

DEA Value Investing–the human side of value investing

It appears the market is hovering between sporadic good news (Dow Chemicals last week and IBM today) and constant bad news (subprime, weak dollar, inflation). Today, the market is up based on IBM’s good news. Mr. Market seems to have ignored the bad news from Sears–sales are disappointing and don’t bode well for continued consumer spending. The broad sentiment is that the economy has been propped up by consumers. About 2 years ago, the same was said about housing.

This shouldn’t matter to a value investor, but it does. Because we’re not machines, we care about the economy, our jobs, and our surroundings. While we might try to focus on balance sheet assets with underrepresented value, most of us are also worried about paying for our kids’ education, mortgages, etc.

Being comfortably away from Wall Street (almost 1,000 miles), I’m about 25% closer than Omaha, NE. With that being said, the goal is to keep a realistic perspective on things. Right now, I’m watching several interesting companies that seem to offer a reasonable value play. They’re in industries we all touch in one way or another. More on these in future posts.