Undervalued Gilead Sciences – FCF/EV Yield 30%, Shareholder Yield 17%

Johnny HopkinsGILD, Stocks Comments

One of the cheapest stocks in our all All Investable – Stock Screener is Gilead Sciences, Inc. (NASDAQ:GILD).

Gilead Sciences, Inc. (Gilead) is a research-based biopharmaceutical company. The company focuses on the discovery, development and commercialization of medicines in areas of unmet medical need. Gilead’s principal areas of focus include human immunodeficiency virus (HIV), liver diseases, such as chronic hepatitis C virus infection and chronic hepatitis B virus infection, cardiovascular, hematology/oncology and inflammation/respiratory.

A quick look at Gilead’s share price history over the past twelve months shows that the price has been pummeled, down 21% to $68.83 since February 2016, and trading just 5% off its 52 week low of $65.38. Hard to believe when you consider that the stock was trading in excess of $100 in April 2016.

(Source, Google Finance)

There’s no doubt that Gilead’s HCV sales are continuing to fall but the company has reported that it still expects FY2017 revenues to be between $22.5 Billion and $24.5 Billion. What seems to be overlooked is that Gilead’s HIV products had one of the company’s strongest years in 2016, led by the rapid adoption of TAF-based regimens. FY2016 new product sales for the company’s HIV and Other Antiviral products were up 17% compared to the previous corresponding period and at the end of 2016, TAF-based regimens made up 37% of Gilead’s HIV prescription volume in the treatment market.

The company is also doing well in terms of its current pipeline. Gilead filed a new drug application for its single-table regimen of SOF/VEL/VOX in December and the FDA granted priority review status with a set target review date of August 8, 2017. Gilead is also continuing advancement of its NASH programs. At AASLD in November, the company presented positive Phase 2 data on selonsertib, showing both an improvement in fibrosis scores, and a decrease in progression of disease after only 24 weeks of treatment resulting in Gilead consulting with regulatory agencies and initiating two Phase 3 studies of selonsertib.

Gilead is clearly looking for and is well positioned for a strategic acquisition. The company has the ability to generate loads of free cash flow with a FCF/Price Yield of $19% (ttm) and a strong balance sheet. At the end of FY2016 the company had $32.4 billion in cash and cash equivalents and zero debt.

In terms of its valuation, this is where I see the real value of Gilead. The company currently trades on a P/E around 7 compared to its 5Y average of 20 and has a FCF/EV Yield of 30% (ttm). Gilead is trading at around 5x cash flow compared to its 3Y average of 16.6 and an Acquirer’s Multiple of 3.28, or 3.28 times Operating Earnings*, that places Gilead squarely in undervalued territory. The company also provides a nice shareholder yield of 17% (ttm) thanks to its aggressive share buy-back program and its distributions.

You can get our full analysis on Gilead Sciences at ValueWalk here.

Undervalued Hawaiian Holdings Well Positioned For Further Growth

Johnny HopkinsHA, Stocks Comments

One of the cheapest stocks in our all All Investable – Stock Screener and the cheapest airline stock is Hawaiian Holdings, Inc. (NASDAQ:HA).

Hawaiian Holdings, Inc. (Hawaiian) is the parent company for its subsidiary, Hawaiian Airlines, Inc.

Hawaiian Airlines is now in its 88th year of continuous service, Hawaiian is Hawaii’s biggest and longest-serving airline, as well as the largest provider of passenger air service from its primary visitor markets on the U.S. Mainland. Hawaiian offers non-stop service to Hawaii from more U.S. gateway cities (11) than any other airline, along with service from Japan, South Korea, China, Australia, New Zealand, American Samoa and Tahiti. Hawaiian also provides approximately 160 jet flights daily between the Hawaiian Islands, with a total of more than 200 daily flights system-wide.

A quick look at the company’s share price over the past twelve month shows that the price is up 26% to $50.30, 31% off its week two week low.

(Source, Google Finance)

Hawaiian is well positioned for continued growth in 2017. The company has clearly transformed itself over the past 10 years by investing in new aircraft and new routes. There’s no question that delivery of the company’s first 3 A321neos, completion of its new maintenance hanger and re-configuration of its A330 cabins will further enhance the company’s ability to compete strongly while reducing costs.

Hawaiian continues to enjoy a strong competitive positive thanks to demand for leisure travel and its strategic geographic location in Hawaii. The company should see further revenue increases due to a strengthening yen and its new Tokyo routes.

Hawaiian is doing a great job of locking in long terms contracts with all of its staff, having recently announced a tentative agreement with the Air Line Pilots Association (ALPA). This comes off the back of its 2016 agreements with three labor unions representing more than 2,200 employees and its current negotiations with the Association of Flight Attendants.

The company is well managed with strong earnings growth, margin expansion, solid free cash flow and a strengthening balance sheet. In terms of its valuation, Hawaiian is currently trading on a P/E of 11.08 compared to its 5Y average of 15.4, a P/S of 1.08, a FCF/Price Yield of 9% (ttm), and an Acquirer’s Multiple of 5.06, or 5.06 times Operating Earnings*, which means Hawaiian is currently undervalued.

You can get our full analysis on Hawaiian Holdings at ValueWalk here.


Warren Buffett – Derivatives Are Financial Weapons Of Mass Destruction

Johnny HopkinsWarren Buffett Comments

(Image Source, Huffington Post, http://www.huffingtonpost.com/john-g-taft/the-warren-buffett-effect_b_5577685.html, [Accessed 19 Feb, 2017])

One of our favorite investors at The Acquirer’s Multiple is Warren Buffett.

As a value investor, one of the most important free investing resources is Buffett’s Berkshire Hathaway shareholder letters. Each contains hidden gems of value investing wisdom.

One of my favorite gems is in the 2002 shareholder letter in which Buffett describes derivatives as ‘financial weapons of mass destruction’, carrying dangers that, while now latent, are potentially lethal. It’s a must read for all investors.

Here’s an excerpt for that shareholder letter:

Charlie and I are of one mind in how we feel about derivatives and the trading activities that go with them: We view them as time bombs, both for the parties that deal in them and the economic system. Having delivered that thought, which I’ll get back to, let me retreat to explaining derivatives, though the explanation must be general because the word covers an extraordinarily wide range of financial contracts.

Essentially, these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices or currency values. If, for example, you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction – with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration (running sometimes to 20 or more years) and their value is often tied to several variables.

Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands.

The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen). At Enron, for example, newsprint and broadband derivatives, due to be settled many years in the future, were put on the books. Or say you want to write a contract speculating on the number of twins to be born in Nebraska in 2020. No problem – at a price, you will easily find an obliging counterparty.

When we purchased Gen Re, it came with General Re Securities, a derivatives dealer that Charlie and I didn’t want, judging it to be dangerous. We failed in our attempts to sell the operation, however, and are now terminating it.

But closing down a derivatives business is easier said than done. It will be a great many years before we are totally out of this operation (though we reduce our exposure daily). In fact, the reinsurance and derivatives businesses are similar: Like Hell, both are easy to enter and almost impossible to exit. In either industry, once you write a contract – which may require a large payment decades later – you are usually stuck with it. True, there are methods by which the risk can be laid off with others. But most strategies of that kind leave you with residual liability.

Another commonality of reinsurance and derivatives is that both generate reported earnings that are often wildly overstated. That’s true because today’s earnings are in a significant way based on estimates whose inaccuracy may not be exposed for many years.

Errors will usually be honest, reflecting only the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them.

Those who trade derivatives are usually paid (in whole or part) on “earnings” calculated by mark-to-market accounting. But often there is no real market (think about our contract involving twins) and “mark-to-model” is utilized. This substitution can bring on large-scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counterparties to use fanciful assumptions. In the twins scenario, for example, the two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.

Of course, both internal and outside auditors review the numbers, but that’s no easy job. For example, General Re Securities at yearend (after ten months of winding down its operation) had 14,384 contracts outstanding, involving 672 counterparties around the world. Each contract had a plus or minus value derived from one or more reference items, including some of mind-boggling complexity. Valuing a portfolio like that, expert auditors could easily and honestly have widely varying opinions.

The valuation problem is far from academic: In recent years, some huge-scale frauds and near-frauds have been facilitated by derivatives trades. In the energy and electric utility sectors, for example, companies used derivatives and trading activities to report great “earnings” – until the roof fell in when they actually tried to convert the derivatives-related receivables on their balance sheets into cash. “Mark-to-market” then turned out to be truly “mark-to-myth.” I can assure you that the marking errors in the derivatives business have not been symmetrical.

Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive “earnings” (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham.

Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely unrelated reasons. This pile-on effect occurs because many derivatives contracts require that a company suffering a credit downgrade immediately supply collateral to counterparties. Imagine, then, that a company is downgraded because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected and enormous demand for cash collateral on the company. The need to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still more
downgrades. It all becomes a spiral that can lead to a corporate meltdown.

Derivatives also create a daisy-chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their business with others. In both cases, huge receivables from many counterparties tend to build up over time. (At Gen Re Securities, we still have $6.5 billion of receivables, though we’ve been in a liquidation mode for nearly a year.) A participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not dangerous. Under certain circumstances, though, an exogenous event that causes the receivable from Company A to go bad will also affect those from Companies B through Z. History teaches us that a crisis often causes problems to correlate in a manner undreamed of in more tranquil times.

In banking, the recognition of a “linkage” problem was one of the reasons for the formation of the Federal Reserve System. Before the Fed was established, the failure of weak banks would sometimes put sudden and unanticipated liquidity demands on previously-strong banks, causing them to fail in turn. The Fed now insulates the strong from the troubles of the weak. But there is no central bank assigned to the job of preventing the dominoes toppling in insurance or derivatives. In these industries, firms that are fundamentally solid can become troubled simply because of the travails of other firms further down the chain.

When a “chain reaction” threat exists within an industry, it pays to minimize links of any kind. That’s how we conduct our reinsurance business, and it’s one reason we are exiting derivatives.

Many people argue that derivatives reduce systemic problems, in that participants who can’t bear certain risks are able to transfer them to stronger hands. These people believe that derivatives act to stabilize the economy, facilitate trade, and eliminate bumps for individual participants. And, on a micro level, what they say is often true. Indeed, at Berkshire, I sometimes engage in large-scale derivatives transactions in order to facilitate certain investment strategies.

Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other. The troubles of one could quickly infect the others.

On top of that, these dealers are owed huge amounts by non-dealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems.

Indeed, in 1998, the leveraged and derivatives-heavy activities of a single hedge fund, Long-Term Capital Management, caused the Federal Reserve anxieties so severe that it hastily orchestrated a rescue effort. In later Congressional testimony, Fed officials acknowledged that, had they not intervened, the outstanding trades of LTCM – a firm unknown to the general public and employing only a few hundred people – could well have posed a serious threat to the stability of American markets. In other words, the Fed acted because its leaders were fearful of what might have happened to other financial institutions had the LTCM domino toppled. And this affair, though it paralyzed many parts of the fixed-income market for weeks, was far from a worst-case scenario.

One of the derivatives instruments that LTCM used was total-return swaps, contracts that facilitate 100% leverage in various markets, including stocks. For example, Party A to a contract, usually a bank, puts up all of the money for the purchase of a stock while Party B, without putting up any capital, agrees that at a future date it will receive any gain or pay any loss that the bank realizes.

Total-return swaps of this type make a joke of margin requirements. Beyond that, other types of derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions. Similarly, even experienced investors and analysts encounter major problems in analyzing the financial condition of firms that are heavily involved with derivatives contracts.

When Charlie and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don’t understand how much risk the institution is running.

The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Knowledge of how dangerous they are has already permeated the electricity and gas businesses, in which the eruption of major troubles caused the use of derivatives to diminish dramatically. Elsewhere, however, the derivatives business continues to expand unchecked. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts.

Charlie and I believe Berkshire should be a fortress of financial strength – for the sake of our owners, creditors, policyholders and employees. We try to be alert to any sort of megacatastrophe risk, and that posture may make us unduly apprehensive about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.

Walter Schloss – The Hippocratic Method In Security Analysis

Johnny HopkinsWalter J. Schloss Comments

One of our favorite investors here at The Acquirer’s Multiple is Walter Schloss.

Schloss was one of the most respected value investors ever to have lived, and is included in Buffett’s list of Superinvestors. He was a disciple of the Benjamin Graham school of investing. He didn’t attend college but took investment courses taught by Graham at the New York Stock Exchange Institute. Fortunately for us he wrote a number of articles over his investing life, one of which was The Hippocratic Method In Security Analysis. It’s a must read for all investors.

Here’s an excerpt from that article:

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Warren Buffett – How to Calculate Intrinsic Value

Johnny HopkinsWarren Buffett Comments

(Image Source, Huffington Post, http://www.huffingtonpost.com/john-g-taft/the-warren-buffett-effect_b_5577685.html, [Accessed 16 Feb, 2017])

One of our favorite investors here at The Acquirer’s Multiple is Warren Buffett.

Yesterday I provided and excerpt from Buffett’s ‘Owner’s Manual’ – In June 1996, Berkshire’s Chairman, Warren E. Buffett, issued a booklet entitled “An Owner’s Manual” to Berkshire’s Class A and Class B shareholders. The purpose of the manual was to explain Berkshire’s broad economic principles of operation.

Today, I provide another excerpt from the same Owner’s Manual in which Buffett explains the principles that he and Munger use to calculate Intrinsic Value. It’s a must read for all investors.

Here’s another excerpt from Buffett’s Owner’s Manual:

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Warren Buffett – An Owner’s Manual

Johnny HopkinsWarren Buffett Comments

(Image Source, Huffington Post, http://www.huffingtonpost.com/john-g-taft/the-warren-buffett-effect_b_5577685.html, [Accessed 15 Feb, 2017])

One of our favorite investors here at The Acquirer’s Multiple is Warren Buffett.

In June 1996, Berkshire’s Chairman, Warren E. Buffett, issued a booklet entitled “An Owner’s Manual*” to Berkshire’s Class A and Class B shareholders. The purpose of the manual was to explain Berkshire’s broad economic principles of operation. It’s a must read for all investors.

Here is an excerpt from the updated version:

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Undervalued Alliance Resource Partners – Remains A Gem In The Mining Sector

Johnny HopkinsARLP, Stocks Comments

One of the cheapest stocks in our all All Investable – Stock Screener is Alliance Resource Partners, L.P. (NASDAQ:ARLP).

ARLP is a diversified producer and marketer of coal to major United States utilities and industrial users. The company is the nation’s first publicly traded master limited partnership involved in the production and marketing of coal. It’s currently the second largest coal producer in the eastern United States with mining operations in the Illinois Basin and Appalachian coal producing regions. ARLP currently operates eight mining complexes in Illinois, Indiana, Kentucky, Maryland and West Virginia, and operates a coal loading terminal on the Ohio River at Mount Vernon, Indiana.

Due to lower gas prices and ongoing emission control legislation, 2016 wasn’t a great year for coal producing companies. However, despite all of the talk about renewables and natural gas replacing coal in terms of electricity generation, the latest Annual Energy Outlook 2017 Report, released by theU.S. Energy Information Administration (EIA) shows that coal will continue to outpace natural gas as a selected fuel through 2020 as natural gas prices rebound from their 20-year lows which occurred in 2016. The same report also shows that while coal production in general is set to drop in a number of regions, the one location set to rise is the Interior Region which includes ARLP’s sites in Illinois, Indiana, and Western Kentucky.

ARLP is a terrific company that has excelled thanks to the strategic location of its mine sites being in close proximity to its customers and the fact that it produces thermal coal. The company is extremely well run with a strong balance sheet and the ability to generate loads of free cash flow. Ongoing improvements in operating efficiency mean ARLP has continued to improve both its operating and bottom line margins while remaining prudent with regards to its capital allocation.

In terms of its valuation, ARLP generated $364 million in free cash flow after dividends for the full year 2016 and remains squarely in undervalued territory with a FCF/Price Yield of 20% (ttm), a P/E of 6.98, and an Acquirer’s Multiple of 6.52, or 6.52 times operating earnings. The company also provides a nice shareholder yield of 14% (ttm) thanks to its outstanding track record of providing shareholders with dividends.

You can get our full stock analysis on Alliance Resource Partners at ValueWalk here.

Warren Buffett – How Charlie Convinced Me To Break My Cigar-Butt Investing Habit

Johnny HopkinsCharles Munger, Warren Buffett Comments

(Image Source, Huffington Post, http://www.huffingtonpost.com/john-g-taft/the-warren-buffett-effect_b_5577685.html, [Accessed 9 Feb, 2017])

One of our favorite investors at The Acquirer’s Multiple is of course Warren Buffett.

As a value investor, one of the most important free investing resources is Buffett’s Berkshire Hathaway shareholder letters. Each contains hidden gems of value investing wisdom.

One of my favorite gems is in the 2014 shareholder letter in which Buffett explains how Charles Munger convinced him to break his habit of investing in cigar-butt companies, it’s a must read for all investors.

Here’s an excerpt for that shareholder letter:

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