Positions Revisited

I want to revisit some of my stock decisions and see what was the outcome and analyze if there is anything I should have done better. I will try to be intellectually honest with my assessments and recognize my errors. Also i want to look back and see if there are any mental traps that affected my decisions and recognize when i fall for these psychological biases.

Below is all the positions that I have talked about on this blog for over a year or so. All are businesses that I looked to own but did not or I bought and sold.

General Growth (GGPWQ): I have dismissed the value in this name when it was trading at $.35. now the stock is over $4.5 an impressive 600%+ return. Was I wrong? Off course I was. Would I do the same decision again? Probably yes. There is nothing inherently wrong in how I analysed the situation. I came to the conclusion that there is a probability of permanent loss of capital; this probability excluded the equity of GGP right away.

I honestly can live with the consequences of such decisions. I prefer to err on the side of preserving capital than take a speculative position like General Growth.

Coach (COH): I liked the business and its management but I decided I will only buy at $18 or below to give me enough margin of safety. Coach is trading at $33; some 80% return if I have gone ahead and bough at my buy decision.

My inaction cost me here. This one hurts more than General Growth because there was no reason not to buy. I scummed to the fear and paralysis during the market tumble earlier this year. My bias for the status-quo and regret avoidance have cost me.

Hawk Drilling (HAWK): I did not like this spin-off for various reasons. However, the stock has gone from $22 to $35 in the span of several weeks. The business has a lot of ugly factors in it, which is what you want to buy in a spin-off. But again this one I can live with. The price has gone up not to the specifics of the company but because of movement in natural gas as evident of a similar move by its competitor Hero Drilling as seen in the chart; Natural Gas has also moved from $2.7 mcf to $3.7 during the same period. I concluded that this was a leveraged play on Natural Gas and I did not want to call its direction.

Switch of Bank of America to American Express: After BofA bought Merill Lynch I decided to get out and switch to AMEX. My analysis were right that BofA would have tough time with Merill and I am better with a company that have a great brand name and much more easily understood and analysed than a bank. AMEX return 65% from the switch to BofA -14%.

In this instance I did not have any status-quo bias I acted and I did not have a loss aversion bias. I hope I can have the same capacity to perform the same decision in similar situations.

Preferreds (Brookfield and Bombardier) and Senior Loans Positions: I have bought several positions with the credit theme to be a better proposition than equity. All worked very well with most of them 70% gains plus their yield.

However, equity performed very well since its March lows. All my buying from late 2008 to early 2009 has been tilted toward credit instruments rather than equities. There were several companies that I liked that could have provided me with handsome returns over the last six months. Again, some paralysis on my part to pull the trigger on stocks with attractive prices, similar to Coach above.

Teck Resources (TCK): This position has worked as I expected. The assets were too valuable. When it was trading at $4, I did not think there was any chance of loss of capital. Now that the stock is trading at $30 it still has some room to high 30s.

However I made a silly mental error. I sold too early and left a lot of profit on the table by halving my position. The business did not hit my value estimate and I reacted to the price run and I fell to regret avoidance mode. I should have asked what is the value?

FirstService (FSV): I sold at 8% loss when I realized I made several errors in valuation and business model assessment. My mistake here is that those assessment should have been made before hand not afterwards. I rushed to take advantage of price decline before the opportunity escapes me. Little I know the price declined further. Here it was a process violation; the position should have never been established and because of the error I am 8% poorer.

NorthStar Realty (NRF): I am down some 50% on this one. I can be wrong on this one but I followed my process and my thesis still good. I am willing to hang onto it until I see another opportunity with better return profile.

Sears Holding (SHLD): I am down 30% on this position. Again so far I am wrong and the intrinsic value has declined with the name as its real estate assets have went down in value. Moreover, I realize now that valuation discount alone is not enough it has to be coupled with good business model and economics.

Cardinal Health, Peyto Energy, and Burlington Northern: All of these positions are recent and any analysis is not worth its trouble.

I just wonder how this post would have been different if the market have not rallied. I come to remember the quote " rising tide lifts all boats". So I am thankful that I did well but I always think that there is an element of luck in my decisions.

Value Idea: Coach

Coach, Inc. (COH) is a marketer of fine accessories and gifts for women and men. The Company offers lifestyle accessories. Coach’s handbags and accessories use a range of leathers, fabrics and materials. The Company’s product offerings include handbags, women’s and men’s accessories, footwear, jewelry, wearables, business cases, sunwear, watches, travel bags and fragrance. Coach operates in two business segments: Direct-to-Consumer and Indirect. The Direct-to-Consumer segment consists of channels that provide Coach with immediate, controlled access to consumers, retail stores and factory stores in North America and Japan, the Internet and the Coach catalog. This segment represented approximately 80% of Coach's total net sales, during the fiscal year ended June 28, 2008 (fiscal 2008). The Indirect segment represented approximately 20% of total net sales in fiscal 2008.

Business Economics The business is very well managed by all statistical and fundamental measures management has done a superb job. So lets review some of these elements:

• Cash-to-cash cycle has been compressing over the last few years, which always means that inventory and working capital is managed quite well.
• Sales per square foot in north America are increasing while in Japan, where COH has a strong following and a large international presence, has been flat or slightly decreasing over the last few years, but nothing significant. The company reckons that it can have 450 to 500 stores in North America, so I suspect that productivity figures for sales per sqr ft will come down with the expansion plans.
• Revenue growth has been stellar over the last 7 years but it is starting to slow. Some will argue that international growth into China and emerging markets will allow COH to continue its horrid pace, it is a strong possibility if the China story continues, so that remains to be seen. As you can see in COH revenue growth profile its current revenue growth rate is below its 3 year average growth rate and its 3 year average is below its 5 year average growth rate, so growth is starting to slow. Nevertheless we are talking about 19% growth rate in revenue nothing to sneeze at.
• COH margins are very solid and at all time high due to reorganization of their supply chain that managed to reduce their cost of goods sold and better utilize their working capital.
• My only concern here as an investor is the company so well manged that there no more room for improvements. I think margins have reached their limit as most efficiencies from supply chain redesign have been achieved. There is a strong possibility that these efficiencies are going to start reversing. Since their supply chain has gotten longer their transportation costs will increase as a result of higher energy costs.

Competitive Advantage Brand name is what most people will point to as a strong competitive advantage for COH, but the problem with that is there no consumption habit or search cost to deter customers from buying another brand. So I may go with the brand thesis but it is not a very strong advantage overall. This is magnified even more in my second point that COH goods are second tier luxury goods as compared to Hermes, Gucci or others.

COH goods are at the lower ladder of luxury goods. Actually they are geared towards consumers who want to trade up from common brands to luxury brands. Certainly they are not a brand to be associated with the rich. COH brands are associated with middle income who want to pretend or look as if they are rich. In other words COH revenue may be susceptible to economic pressures more than a Gucci, Hermes or Louis Vuitton, as the rich spending is impervious to economic cycles. Recently Hermes, Gucci and other luxury goods companies reported solid growth numbers, see here, although COH reported good growth numbers they were relatively tame in comparison.

COH is trying to be more upscale but it is doing so by raising its price for its leather goods. Several of my female family and friends who I surveyed for this analysis said they would rather own Hermes, Burberry or something from Louis Vuitton collection, if they are going to pay what Coach is asking for its leather bags. So COH may price itself out of the market at the new price points that it is rolling out. Moreover many have objected to the logo imprint on coach bags. COH logo imprints on its bags are so aggressive and the trendy may find it tacky.

Another risk to their brands is the distribution channels that COH is pursuing. Their own retail stores obviously is essential to control the brand but the indirect and outlet channels may lead to brand dilution. Their discount stores will never propel the brand into the luxury category they hope to be one day.

Valuation

Growth rate is what can make this business undervalued or overvalued. COH had an exceptional growth rate over the past several years; it averaged a historical growth rate in revenues 29% over the last 5 years. Do you assume the same growth rate going forward? In my discounted cash flow models I hate to assume anything over 5%, actually I try to assume zero growth to see if the current cash flow stream is undervalued by the market. Take a look at the following table where it displays COH intrinsic value assuming different growth rates. In the vertical column it has revenue growth rates for the next 10 years, while the horizontal line displays its terminal growth rate beyond the initial 10 years. Please see my model here.

G %	5%	7.5%	10%
5%	15.00	17.00	22.25
10%	18.40	25.79	30.00
15%	23.54	28.39	40.07
29%	48.62	61.66	94.77

As you can see if I assume historical growth rates to continue COH is undervalued but if my expectation is right about slower growth rates then valuation by the market is fair.

I figure COH valuation is somewhere between $19-24 where the growth assumptions are very conservative. If I attempt an Earning Power valuation model I come up with an intrinsic value of $19 per share for COH assets. The main adjustment is for goodwill as COH has no history for M&A so its brand name in not reflected on its balance sheet. I have taken multiples of its competitors and looked at revenue to goodwill ratios and applied similar ratio to COH to arrive to a comparable figure.

In conclusion, COH is a well run company that have a fairly valued stock. I have no problem owning Coach but I would rather own it at $20-22 per share and its future growth can serve as my margin of safety.