Commentary

The typical bank model revolves around the concept of borrowing money from one party at a low rate, and then lending to another party at a slightly higher rate.  The old-fashioned savings and loan institutions would take deposits from customers, represented on the balance sheet as liabilities.  The money you deposit at the bank is an asset for you and a liability to your bank because your bank has to return it to you.  After they take your money, they lend it out, frequently to homeowners in the form of a mortgage.  These loans are represented on the balance sheet as an asset because someone owes the bank money (or in the default scenario, a house).  Alongside the deposits, the bank must also have some of its own money invested.  This money represents the shareholders equity, money that either came directly from investors or that has been reinvested from historic profits.  Banks are required to maintain certain equity levels to protect lenders (depositors) from a loss if assets end up being worth less than the bank thought.  The model looks like this…

At Kerrisdale Capital, we’ve written about the housing market before, but estimating the fair value of the US housing market is difficult.  Two of the best ways to estimate fair housing prices are to compare housing costs to household income or rental rates.  Obviously people can only spend so much on housing relative to their incomes, but secular trends in spending, tax rates, and cyclical trends in income make the data difficult to interpret.  Likewise, comparable rental rates do a good job of showing the relative cost of ownership, but in an inflated market, rental rates are likely to be inflated as well…

In recent weeks, we introduced readers to the National Presto business, and then dug into the housewares segment and the absorbents business.  This week we'll look at the munitions business. Munitions The final piece of the puzzle is the munitions business.  Over the past few years, NPK has acquired a number of military contractors; AMTEC in 2001, Spectra Technologies in 2003, and Amron in 2006.  And as US military operations have grown, so has revenue and earnings.  In particular, NPK manufactures 40mm (millimeter, not million) ammunition, grenades launched from a canister attached to an M16.  Military use of this weapon system increased significantly over the past decade.  Every year the DoD releases budget estimates including the past year’s expenditure and estimates for the coming two years.  In 2000, the DoD spent $44 million on 40mm ammunition, compared to $318 million in 2009.  Estimates for 2010 and 2011 expenditures are $176 and $230 respectively.  Looking back over the past decade, we see these estimates are prone to change, but it’s still our best guide.  The table below shows actual military procurement in yellow followed by two years of forecasts.  At the bottom, we compare procurement to NPK sales…

Two weeks ago we introduced readers to National Presto (NPK), a business with three well diversified segments and a very healthy dividend yield in the range of 8%.  Last week we dug into the houewares segment, and this week, we’re going to explore the absorbents business. Absorbents The absorbents business is a small but growing segment for National Presto.  It primarily produces private-label adult incontinence products.  Revenue for the absorbents segment is about half that of the housewares segment, and until recently, it’s been at best a break-even business.  However, in 2009 the segment generated a healthy profit, and that trend has continued into the first quarter.  By comparing the absorbents segment of NPK to the diaper segments of P&G and Kimberly-Clark, we might be able to get a better sense for what to expect in the future.  First, the financial statements for the NPK absorbents segment…

There’s been a lot of talk recently about Hungary following in Greece’s footsteps and potentially defaulting on its debt. Bulgaria and Romania are two other weak economies in Eastern Europe, and the chart below shows bank exposure by country to Bulgaria, Romania, Hungary and Greece…

Teen retailing can be a difficult business, and unpredictable for investment analysts who fear the fickle fashion trends of 16-year old girls. The recession turned the teen retail industry on its head, but this wasn’t necessarily bad news for all. Some retailers actually saw significant improvement in sales, some helplessly watched sales fall off a cliff, and some of the retailers with multiple brands targeting different price points weren’t impacted much at all. This is Economics 101, where we learned about how “inferior” goods such as Spam would see increased demand in a weak economy. Now that we have a sense for what store profitability looks like in both a strong and weak economy, we can better understand risk. And uncertainty in the market has created attractive opportunities across the board…

Last week we introduced readers to National Presto (NPK), a business with three well diversified segments and a very healthy dividend yield in the range of 8%.  This week, we’re going to dig into the housewares segment. Housewares National Presto has a valuable brand name.  In the chart below, we looked at the number of stars Presto products have earned in the Kitchen & Dining section of Amazon.com.  83% of Presto products have earned 4 stars or more, with only 1% (one product) earning one star.  We compared Presto to Black & Decker, George Foreman, t-fal, and Cuisinart.  The results are clear, Presto’s products are rated higher, on average, than their competitors…

Treasury Inflation Protected Securities are government issued securities adjusted bi-annually for inflation. When the urban consumer price index (CPI-U) increases, the face value and the yield on TIPS also increases. If investors are concerned about inflation, TIPS are one method of protection (you can buy them directly from the government here: http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm) given that they are directly tied to inflation. Unlike other investments which “should” appreciate in an inflationary environment, TIPS do appreciate…

National Presto Industries (NPK) operates three separate businesses, each somewhat straightforward to analyze: a housewares business, an absorbents (private label diaper) business, and a Department of Defense munitions supplier.  We originally looked at NPK when it was trading near the $130 range, but decided the stock was a little too expensive for us after a cursory analysis.  We set a price alert at $105 and put it on the back-burner.  When the price fell below our target last week, we resumed the research process.  Over the coming month, we’ll try to determine a fair valuation for each segment independently.  This analysis is being done real-time, meaning we’re not sure what conclusions we will draw from it.  We haven’t yet made an investment and we’re not sure if we will.  But the valuation appears reasonable, definitely worth taking a look at, and we hope that progressing through the research process with us will be an entertaining experience for our readers…

Imagine you’re choosing between investing in two start-up businesses.  Both will start with $10mm and invest in projects expected to generate a 15% return.  The only difference between these two companies is that one will invest in tangible factories and the other will invest in intangible R&D.  So far, you would be correct if you said these companies should be valued equivalently.  But would you be able to tell that these companies are equivalent by looking at their financial statements?  Let’s look at the first 5 years of two startups, starting with the factory builder…

Airlines have been, and will likely continue to be, a notoriously bad investment.  The industry is capital intensive, massively fragmented with hundreds of global players, heavily regulated, and unionized… with no real way for carriers to differentiate their services.  Bankruptcy courts keep carriers alive in a zombie like state allowing them to continually erode margins while regulators block mergers.  And on top of that, the industry attracts new entrants every few years despite low expectations for return.  There is absolutely no reason to expect any player in this industry to generate above average returns on invested capital. But within the industry, there are a number of players that have been able to consistently generate a reasonable return on invested capital, and at the right stock price, that’s all investors need.  In particular, regional airlines and airplane/engine lessors have generally been able to secure long-term contracts guaranteeing rates of return in the range of 3%, which when leveraged 4-5x yields a 12-15% return on equity.  At the moment, there are a number of players in both industries trading at unusual valuations.  In this report, we focus on the regional airline industry.  In the future we will also take a look at equipment lessors…

Every quarter, Fannie Mae and Freddie Mac release a chart depicting the cumulative default rates by origination year.  This chart is usually hidden in the middle of the presentation, but it provides a tremendous amount of information about what's happening in the US housing market.  Below is the cumulative default rate chart from Freddie Mac at year end 2009…