Don't buy Kraft

Normally, me and mapreet both like spin offs. Spin offs are excellent because there is usually indiscrimnate selling in the companies involved where that is the time where one can get companies for bargain prices. However, kraft was not exactly an attractive one.

Firstly, let me give you the facts surrounding kraft. Kraft is actually owned by Altria, the company that produces marlboro cigarettes. 88.9% of kraft is owned by Altria and for every share of Altria, one is entitled to 0.692024 of Kraft. With regards to the ratio of distribution, there was not much incentive for indiscrimate selling. Take a scenario where for every share of altria that one owns, he gets only 0.1 share of kraft., In such an extreme situation where the spin off is only a small fraction the value of the mother share, one can expect tons of indisriminate selling of kraft from the institutions. But in this case, it was not so as the fraction was larger. Besides kraft was also a very well known brand. Just to break it down further, for every share of altria during the distributions an altria share was valued at market price of $62 while a share of kraft during distribution was $30 which means that every share of altria was entitlled to around $20. If you were an investor you would have probably kept the $20 given to you.

Management owns only a minute portion of the company in terms of restricted stock, options, grants etc and this does not help in aligning the interests of shareholders and management. Irene Rosenfeld earns approximately 9 million annually according to SEC filings and the options given to her to stimulate performance can only help her get 2.5 million richer if the stock price rises 25% from base price of $33.14 which is the excercise price of the options package. To me 2.5 million is not a tremendous stimulus to make her perform and i am sure Joel Greenblatt would agree with me on that.

Despite its industry foothold, its financials were not extremely attractive. Its current Pe was 21 as compared to the industry of 19.5 and its return on equity was poorer than that of the industry standing at 9.4% vs 23.5%.

Although it has embarked on a heavy resturturing program of 3 billion in 3 years and a 2 billion stock repurchase program sinve 2004, its has not significantly impacted the bottom line. It now has in place a new stock repurchase program of $5 billion till march 2009 but i really doubt their efforts will come to fruition as they only have 250 million in cash, not enough to buy back stock that is. Well, they could take on debt but i am skeptical that that might work as prices currently are not undervalued.

According to management discussion and analysis, it 2007 forecasted results is approximately $1.50 to $1.55 and with a PE of 21, it should be trading at $32.55 MAX at the end of fiscal year 2007.It is currently trading at 34.24

Undervalued???? Not a chance.

However, it seems to me and Manpreet that Altria might be the real steal here. Removing kraft from the financial statements would increase altria's earnings per share growth over the next few years. The only reason that is stopping us from investing in Altria is that firstly, it is a "sin" stock and that it has too many litigation woes that might cause uncertainty in its future.

However, there is one reknowed investor that seems to disagree with us and that person is Michael Price.

Value in spin offs!

Value, in the traditional sense as laid down by Graham focuses on the assets of the company. The idea was, if one did buy a company's shares at 2/3 the net current asset value, one was not only assured a margin of safety but one could also realise a potential price appreciation to book value.

Sir Warren Buffet went on to tweak what was conventionally thought of as value. You could sum up buffet's approach in a few words: "Good business at a fair price"

As it is, these 2 approaches in my opinion are used by so many investors in the states that it may be so hard to obtain really deep value with these 2 approaches. Just to illustrate, in the past, when buffet bought into washinton post, he realised the value was 4 times the price he was buying. These days, it is very hard to find such rare gems as because valu investors will buy stocks which have a 40% margin of safety. Also, ben graham stocks are nearly inexistent in the US now and it sure is a rarity. However, this is not to say that Ben Graham or Warren Buffet type stocks no longer yield sufficient return but rather returns in these methodologies are much less as in the past.

That being said, what i am truly trying to say is, if one wants to search for value, one has to in most cases a complete contrarian and example of such a prominent investor is Joel Greenblatt. Let me tell you, this chap, is a brilliant investor and more or less unconventional in every sense of the word.

His particular focus is spinoffs. Spinoffs are actually divisions within a company that are launched as a separate public listed entity. And management spins off other divisions within the company as they want to unlock the value inherent in the spin off.

Preliminary research on my part shows that spin offs can be rather attractive. For one, shares of spin offs are normally discarded by investors as for some reason, institutions were never interested in the shares of the spinoffs as these spinoffs may be too small for their consideration. As a result, the shares of spin offs are normally depresses creating a 'temporary' bargain price. It is not just the institutions that discards the shares. Investors in parent companies who are sometimes given shares in the spinoff would rather discard it as they do not have the inclination nor the time to do the research necessary to justify these spin offs as value plays. Lastly, in my opinion, spin offs are an area still relatively untouched by value investors. The conventional plays are the buffet types companies and spin offs are seldom buffet type companies and hence in my humble opinion, provides situations which can result in a larger than normal return.

Taking a look at some examples:

1)1 year from the spin off of GNW(genworth) from GE, its price rose 50%

2)1 year from spin off of moneygram, moneygram's share price rose 21%

3)1 year from the spin off of Freescale, it share price rose 20%

4)1 year from the spin off of Hospira, its share price rose 15%

If these examples are not enough to convince you, read on for more posts!!!




Lucas

Klarman is not afraid of spin offs

Klarman is not afraid to buy spin offs. In fact, he views such situations favorable for value investors who often look out for ignored and unloved assets.He purchased the shares of two subsidiaries of Tenneco Inc. One was Pactiv Corp which made branded food storage bags and trash bags. Also, the company was the market leader in a range of plastic packaging products. Due to market forces pushing the stock price down, the stock price dropped to about 10 times after tax earnings. The conditions to buy the stock were appealing. Management was loading up stock while earnings growth indicators were solid. There were plans to cut down costs and redeploy assets while price of raw materials was expected to drop. Here was a premium brand selling at a heavily discounted price.

Another spinoff of Tenneco was an automotive company which manufactured branded shock absorbers abd mufflers. Like Pactiv, it was a market leader in its respective product categories.Due to its small market cap, there was a heavy sell off by shareholders who felt that such small caps were ill-suited to their portfolios.This heavy sell off depressed the stock price, making it an attractive target for Klarman.