Rule #1 Finance Blog

With Investor Phil Town

QUESTION OF THE WEEK: FDP HOMEWORK

Here’s a letter from Lynn.  [Names changed to protect the innocent! Letter edited for length.]

Hi Phil,

I have a problem of  a different sort.  I have been studying my butt off with all of this stock research.  I feel like I am understanding more and more but not comfortable yet as I haven’t really paper traded anything and haven’t really spent any money but I know in time that will come and that’s okay.  Like you said, the market isn’t going anywhere.  And, for once in my life I feel I have actually been quite patient and okay with it as that is how you teach it and it makes sense to me.  Plus, I also have not lost any money.  The Rule #1 investing book rocks.

Some guy calls Jerry (my husband) on the phone from S_____ (broker),  telling him he can’t lose any money or at least not much, talks to him for probably 10 – 15 minutes and has Jerry spending $20,000 on FDP (Fresh Del Monte produce).  When I found this out I could have killed him.  I asked him why he felt the need to do that.  He said to make a lot of money.  I’m thinking if it sounds to good to be true, more than likely it is.

I researched this company, I don’t like the sound of the CEO (sounds
shady) and to be honest, I didn’t give Jerry much of a chance to explain
anything as I was so mad.  He can talk to a guy he doesn’t know from
Adam for 15 minutes and throw him $20,000.  I (his wife of 21 years,
lets see if we can make it to 22) can research my butt off and try to
do this the way I feel and also the way I thought he felt, is a safe
yet profitable way, and where does it get me?  And even if the company
does make a lot of money, just reading about the guy was giving me the
creeps and it wouldn’t have been a company I would feel comfortable
investing in and I told him so.  Remember, it needs to be YUMMMMY.
FDP’s numbers are awful. Not a Rule #1 investment at all.  I think I
am going to go crazy.

HELP!  What do I say to my husband other than are you nuts?  I need an answer soon as he hasn’t sent the check in yet.

Thanks Phil,

Lynn

P.S.  I would love to play but my shoulders are weighted down too much.

Yikes!  My response:

Lynn,

Since I’ve been divorced twice I don’t think I’m real qualified to help
you find the right answer to your issues with your husband, except to
say that two heads are often better than one, especially when they love
each other.

But I can look at FDP and give you my opinion for what it’s worth.  And
my disclaimer here is that I am a river guide, I have a license to row
the Grand Canyon, to drive a car, to fly a plane, and that’s it.  So for
what it’s worth here’s how I see FDP:

I want to know whether I can put a value on this business at all.  Is
it predictable enough to be able to make an educated guess about the
future?  Let’s start with the Big Five Numbers:


  1. ROIC
    :
    Long term it looks good — above 10%, but big red flag on the
    latest ROIC numbers at 7%.  This is a sign of trouble.  The CEO is
    having trouble making a decent return on the owner’s equity and
    whatever he can borrow. Red Flag #1.
  2. Sales Growth Rate:  Not bad at all.  Consistent.  Roughly 12%.

  3. EPS Growth Rate
    :
    Whoa.  Now that’s some ugly stuff right there!
    It’s totally inconsistent and over the last 3 years its dropping like a
    brick.  They are selling, but their costs are killing them.  BIG red
    flag.
  4. Equity growth rate: WOW.  Stellar!  24% roughly per year and
    totally consistent for ten years.  Except that seems weird with the
    terrible earnings growth.
    So I dug deeper and noticed that Current
    Assets
    [see Balance Sheet] were keeping up with all that great equity growth. So I clicked
    on the SEC docs and discovered since 1996, Del Monte is a
    foreign business.  Turns out they are a Cayman Island business with
    wholly owned subsidiaries in a whole bunch of different countries
    around the world.Further turns out that the CEO/Chairman and three of
    the six directors are all members of the Abu-Ghazaleh family from
    Dubai, UAR and that this family owns 52% of the stock — and therefore
    totally controls the business and the board of directors.  To ensure
    things stay that way, they put in place “anti-takeover agreements” to
    avoid being kicked out without a huge payoff.

    And there are lots and
    lots of other conflicts of interest discussed in the annual report, ranging from renting the CEO’s jet to buying produce from family
    members’ businesses in Chile.

    Among the gems in the filing is the fact that these guys are paying out
    3.5% of net income to themselves as a bonus.  Which they got in spite
    of the fact that earnings dropped like a stone
    .  And on top of that
    they awarded themselves a nice $3 million in stock options.  15
    officers got most of the $10 million they paid out in salary and bonus
    (not including the stock thing).  That works out pretty good for the
    top guys, I’m thinking, since VP’s don’t usually get more than say
    $400K a year.  Guessing here but maybe the top 2 guys made a few
    million each last year.

    And finally I find the answer to my question about the apparently
    growing equity:
      the only part that’s growing is the intangibles [See this definition of Tangible Assets] — and
    that’s a number I toss out as having no real equity value.  Toss it out
    and you get no equity growth instead of this nice 20% thing.

    So put Equity growth down as Zero lately.  Back farther than a couple
    of years, I can’t get the right number without a lot of research.  But
    hey, this is a quick and dirty look and I’m fairly certain that equity
    growth is as messy as EPS.  So Big Red Flag here.

  5. Free Cash Flow: Dropping like a stone the last two years.  Another Big Red Flag.

So here’s what we have so far:

The Big Five Numbers are inconsistent or negative between them, which is
a sign of a business that is not predictable enough to determine a
retail value by Rule #1 standards — since the real value of a business
lies in its ability to produce future cash flow
, and that seems more
than a bit questionable at FDP.  Moat seems questionable.

While I usually like family run businesses, I’m not a big fan of
officers and directors who put in anti-takeover provisions.  Those
things keep bad guys from being tossed out by the shareholders and are
the opposite of “owner-oriented”.  I also don’t like big companies
having lots of conflicts of interest.  It brings up the question of
honest dealing.  Management seems questionable.

But, hey, maybe the business is so cheap right now that I’d want to buy it anyway — so let’s do the Sticker Price thing:

  1. TTM EPS is $1.84
  2. Future EPS Growth Rate:  Historical Growth is too inconsistent to
    say — so I’m going to use the analysts’ best average guess of 9%.  And I
    think that’s very kind of them.
  3. Future PE:  9% would give us an 18 Rule #1 PE, except the historical PE for this
    biz is a lot lower.  I’m going to be nice and put the PE at 15.
  4. Sticker: Grow the $1.84 at 9% for ten years you get $4.36.
    Multiply by the PE of 15 you get a future stock price of $65.  If you want a 15%
    return, you buy for one quarter of that today:  $16.  And if everything
    works out, you’ll end up with a 15% return.  Nice except that
    everything doesn’t always work out, so we need a big margin of safety in
    the purchase price — so we divide the Sticker by two…
  5. … and get the Margin
    of Safety
    price of $8.


Conclusion

The above is just an example.  I can’t really put a Sticker price on the stock because
it’s too inconsistent to rely on a 9% growth rate or a 15 PE for any
time into the future.

But if everything works out according to what
the analysts think will happen, and you pay today’s price of $16.82,
you are buying at about the retail price.  Not horrible, if things work
out.

That means that this is not one of those terrible deals where you buy
and if everything works out you might make 5% a year.  At least on this
one if it all works out okay you’ll do the minimum rate of return.

Would I buy it?  Ag biz is so loaded with risks that any ag biz is
going to have to be on sale big time to get my attention.  This one has
a strong position in the retail market, but is not a Rule #1 biz — and
beyond that is subject to increasing gas prices and labor issues and
international tariff wars and crops dying and producing too many of
something and having to hedge… and on and on.  It’s really a tough
business and not something I’m real excited about, especially at retail.

Could it shoot up on some good news?  Yeah. Sure. The Big Guys only
care about this quarter, so that can certainly happen.  Maybe your
hubby’s broker has some inside info and this investment is going to
work out great.

On the other hand, the stock has gone from 30 to 16 in
a pretty consistent down trend this year, so he’s betting that the thing
has found the bottom.  There is a base building at $17 and some volume
indication that the big guys are moving back into this right now.  The
price is leveling, the MACD is pushing toward a buy signal.  It could
pop back to $22 for some nice quick money, but it could also continue to
drop like the stone it’s been.  If there was really any good news out
there we’d be seeing more buying — and volume is below its average.


By the way, this stock averages about 500,000 shares a day — which is
right at my minimum for liquidity.
   Be aware that low volume and heavy
ownership by the insiders can make for a very volatile combo both up
and down
.

All it takes to jam this price upwards is the company
deciding to buy stock… and they have a buy-back plan in place so
they could do it.  If they do (and at this low price they would be
incentivized to do so) then they can make this jump all by themselves.
For a while, anyway.


Bottom line

This looks like nothing more than a bottom guess with a
prayer that the FDP CEO decides to use company money to buy the stock
back.  Looks like he did exactly that a couple of months ago and drove
this up from 18 to 22, but it was unsustainable.  He might do it again
and you guys would score.  But don’t hold for a second after it hits
$21 if you decide to roll the dice.

Hope that helps.

And now go play anyway!

Phil

P.S. Lynn wrote back later. It seems she talked her husband out of making the purchase.

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