Archive for May 2012

OPT-Sciences Corp (PINK:OPST) Write-Up

Here is my OPT-Sciences Corp Write-Up.


TNR Technical (TNRK.PK): A Bargain stock

TNR Technical is a value added distributor of batteries.
It purchases batteries from the manufacturers, assembles and sells them to a variety of customers like electronic wholesalers, resorts, hospitals , churches ,police and fire departments , OEMs etc

The Company also designs and manufactures battery packs to customers’ specifications. These batteries have applications in utilities, personal watercraft, photography, watches, instrumentation, laptops,  surveying equipment, radio control, mobile radios, alarms, U.P.S., door locks, and emergency lighting as well as other various consumer products.

Established in 1979, the Company is an authorized distributor of nickel-cadmium, nickel metal hydride, alkaline, lithium and sealed lead acid batteries manufactured by Saft America, Power-Sonic, Varta Micro-battery, Enersys,  Renata, GP Batteries, CSB Battery, Ultralife Batteries, Energizer Battery, FDK and Sanyo Energy.

TNR’s stock price currently hovers around $11.50 and imparts the Company market cap of just $3.5 million. That makes it a nano-cap and is probably one of the reasons of its stock being mispriced.

So we would start our analysis with safety scores .

Altman Z-score
  calculation                                    Points
A, Working Capital/Total Assets 1.02
B, Retained Earnings/ Total Assets 0.33
C, EBIT /Total Assets                       0.36
D, Market Cap / Total liabilities 3.56
E, Net Sales/ Total Assets                 1.95
                              Z- score 7.22

The Z score above 3 is considered safe .As we can see here that the score is bolstered by ratio of market cap to total liabilities. (item D).The absence of long term debt and very low total liabilities of just $595K relative to its current assets of $4.5 million makes this a safe stock. 


1 Net Income                                        1
2 Cash flow from Operations 1
3 Change in ROA                                   0
4 Quality of Earnings                              1
5 Change in Debt leverage                       1
6 Change in Current ratio                        0
7 Change in Shares Outstanding 1
8 Change in Gross margin                       0
9 Change in Asset turnover                      1
                             F score         6

TNR’s F –score of 6 is decent too. The key measures of trend in Net income, Cash flow from operations and quality of earnings in the score are all positive.

What makes TNR Technical a bargain?

Assets Perspective
Total current assets stand at $14.93 per share.This includes $6 per share in cash.And total liabilities are $1.94 per share.
That gives Net Current Asset value of $12.99
At the current quote Price/NCAV comes out to be 0.89 .This makes it a net-net.

Tangible book value is $13.31 so price to TBV comes out to be 0.86

Earnings Perspective

Peek at the retained earnings of the past balance sheets of net nets, and mostly you will find a negative number sitting there. Most of the net nets-especially American- have an ugly earnings record.
For a net net we are not actively looking for a great business . Just a decent no-loss making business.
TNR is precisely that. There have been no operating losses in the last 10 years. Actually,it can boast of this positive record for straight 17 years.That's something very rare to get in a net net.
 Here is the record:

Year       Sales            Gross Profit Gross Margin           Operating Profit        Operating margin
2011    $91,55,658        $26,41,447 28.85%                        $5,13,538                 5.61%
2010    $93,47,412        $28,32,485 30.30%                        $5,86,710                 6.28%
2009    $87,34,297        $25,72,335            29.45%                        $5,59,905                 6.41%
2008    $93,61,530 $29,52,217            31.54%                        $8,78,731                 9.39%
2007    $96,15,164 $30,68,468           31.91%                        $11,55,016              12.01%
2006    $97,24,432        $29,60,047 30.44%                        $12,09,886              12.44%
2005    $73,17,700 $21,62,466            29.55%                        $7,79,972                10.66%
2004    $79,96,613 $22,11,838           27.66%                        $7,04,081                  8.80%
2003    $81,78,802        $22,73,443            27.80%                        $8,45,364                 10.34%
2002    $79,08,632 $21,33,458 26.98%                        $7,88,212                  9.97%

Boring sales record .Gross margins have remained consistent over the years but operating margins have declined in the recent 4 years. 

Margin contraction is one risk as we will see later. But as we said earlier, for a net –net ,this type of record is really fair.

Return on Invested Capital

YEAR Operating income  Invested capital ROIC
2011         $5,86,710.0         $26,01,723 19.66%
2010         $5,59,905.0         $29,84,161 19.19%
2009         $8,78,731.0         $29,17,534             31.41%
2008         $11,55,016.0       $27,97,222 46.00%
2007         $12,09,886.0       $25,11,040 56.64%
2006         $7,79,972.0         $21,35,916 36.48%
2005  $7,04,081.0         $21,38,238 31.03%
2004         $8,45,364.0         $22,69,267 44.82%
2003         $7,88,212.0         $18,86,105 36.83%
2002 $21,40,013

That's an average ROIC of 35% . Of course it could be difficult to sustain this kind of ROIC in future . But this proves that business is not worthless as Mr .Market is valuing it . Certainly, TNR is more valuable than its net current assets .

Here is the 10 year EBIT record:

2011             $1.67 
2010             $1.93 
2009             $1.88 
2008             $3.04 
2007             $4.13 
2006             $4.47 
2005             $2.96 
2004             $2.73 
2003             $3.33 
2002             $3.18 

That's an average of  $2.93 per share.
Of course what it earns in the future is what will translate into gains for investors of today. But the track record demonstrates the Company's earning power. 
The Company's Enterprise Value is $4.57 per share.

The stock is trading at EV/EBIT of  2.74 (trailing 12 months)
and EV/ 10 year average EBIT  of 1.56

That's cheap.

So we have a good discount relative to earnings- which gives us a good upside potential.And a good discount relative to assets which gives us a good downside protection.

Another positive point to consider in TNR is that insiders hold significant stake. 

TNR Technical is controlled by Thaw Family .Wayne Thaw,the chairman of the board and the CEO owns 30 % of the stock.
Mitchel Thaw, his brother - who serves on the board of directors-owns 7% of the stock.

Their father Norman Thaw owns 17%.

So Thaw Family owns 54% of the stock in TNR .

Mr.Paul Sonkin , the fund manager of Hummingbird Funds owns 21% of the stock. He is a micro cap value investor in the tradition of Graham and Dodd.

Another good point about TNR is that it has a history of returning excess cash to the shareholders.

TNR Technical has paid special cash dividends in the past: $6.50  per share in 2010, $6.75 in 2008 and $4.75 in 2007. 

As the cash-pile builds up on their balance sheet , there is a high probability that it may declare more dividends in the future.

Generally, one of the risks with small businesses like these is customer concentration.

Few customers that account for majority of sales. TNR,on the other hand has a wide customer base. Their 10-K states:

“No one customer accounted for 10% or more of the Company’s total revenues”

But that's not to say that the investment is devoid of any risks.

The company lacks pricing power. As it competes with large number of regional distributors and battery manufacturers it could face significant pricing pressure in the future.
These pricing pressures , as their 10 –k candidly says: "have prevented us from fully passing through to customers increased costs related to increased pricing of raw materials associated with the manufacture of batteries, such as nickel and lead."

And there are low barriers of entry.

Lines to hate in their 10-k :

“We expect heightened competitive pricing pressure as Chinese
manufacturers expand their export capacity and increase their marketing presence in our markets. Our ability to maintain and improve our operating margins has depended, and continues to depend, on our ability to control and reduce our costs.”


" Battery wholesale distributors face increased competition as offshore (specifically China) and U.S. manufacturers continue to sell directly into the marketplace alongside an increasing number of web based operations and expanding local battery franchises. Competitors continue to price their products aggressively which has a direct impact on the Company’s overall sales and gross margins."

Notably, One key competitive advantage they have is the ability to fulfill their orders quickly. Customers are willing to pay them for the convenience they offer, for very low lead time which is due to efficient inventory management. So they have a proven business model. 

And high insider ownership and high compensation make management very well incentivized.

Bear in mind that due to low float the stock is very illiquid and could be extremely volatile. Also it trades on the pink sheets.  But if you are or aspire to be a true value investor -you will have to seek out market’s most inefficient pockets and make volatility and illiquidity your friends.

To recap—good Z and F scores, high insider stake, satisfactory earning power, efficacious business model  and decent discount relative to assets and earning power make TNR Technical a solid net –net pick.

Mesa Labs Write-Up

Here is my write-up on Mesa Labs (MLAB), a good company-in my view- to keep in the watch list.


Meeting Mr. Warren Buffett

One of the best bargains I stumbled upon in 2011 was buying my car insurance from Berkshire Hathaway when it was launched here in India. 

The first hundred to buy were invited to attend the launch event with none other than Mr. Warren Buffett .

And I grabbed this chance and asked Warren a question. 

Here is the video:

Thank You Mr Buffett.

And thank you all at Berkshire Hathaway.

NIHON DENGI : A cheap Japanese stock


Nihon Dengi is a kind of stock that the late Walter Schloss probably would cherish. Only that this one trades outside United States.

Nihon Dengi, established in 1959 engages in designing of building automation and factory automation. It’s a pioneer of the building automation engineering in Japan and provides a system for optimal integration of applications across various buildings like office buildings, hospitals and hotels. It also sells control equipments like thermostats, flow meters and industrial valves.

For example, it implements energy saving measures in factories. Its Industrial Instrumentation segment is engaged in the design, construction, maintenance and inspection of automated control systems for food and chemical production facilities. 
Nihon Dengi trades at ¥590 and with 8.20 million shares outstanding, market cap comes out to be ¥ 4.84 billion.

That’s a very attractive discount considering the following –

  • Total current assets of ¥ 16.3 billion including cash around ¥6 billion and total liabilities of ¥ 8.5 billion giving net-net working capital value at ¥7.8 billion. PRICE / NCAV  comes out be  0.62 
  • Tangible book value of ¥ 11 billion giving Price / book of 0.44
  • Positive EBIT and positive net income in the last 10 years.
  • Positive free cash flow in the last 10 years .
  • Negative enterprise value of ¥ 500 million.
  • 4 year Average CROIC of  around 7%
  • Dividend yield of 5 %
Below is the 9 year record of sales and EBIT (all figures in million ¥)

YEAR SALES         EBIT             EBIT margin

2011        21800          1400       6.42%
2010        21510          1650       7.67%
2009        23160          1900       8.20%
2008        21710          1300       5.99%
2007        21380          1160       5.43%
2006        19400          488         2.52%
2005        20780          899         4.33%
2004        20520         1150        5.60%
2003        22410         1150        5.13%

And here are the cash flows of the last 5 years:

Year    Sales  CFFO  CAP-EX    FCF   Fcf margin fcf/share
2011  2180 0 695     -200.00      495 2.27% 60.37
2010  21510 1128     -140.00     988   4.59% 120.49
2009  23160 1806     -157.00    1649 7.12%         201.10
2008  21710 1317     -236.00    1081 4.98%         131.83
2007  21380 1477     -188.00    1289 6.03% 157.20

Although EBIT margins have remained stable, operating cash flow  declined substantially in 2011. I would prefer not see this but still we do have a nice margin of safety from assets perspective. Employee Stock Ownership Association owns 12.69% of the stock.

Overall, a good stock to own in a basket of Japanese net-nets stocks. 

CLIP Corp (JP:4705): A High Quality Japanese Stock at a Crazy Cheap Price

Founded in 1981, Clip Corp operates cram schools which provide tutorial services to elementary and high school students. And it also operates soccer schools which provide services to children from babies to early elementary school students. These two businesses are the Clip’s bread and butter. It also engages in the business of home delivery of boxed lunches. A segment management wants to expand in future.

Haven’t tasted their boxed lunches but the financials look sumptuous!

Clip Corp's stock currently quotes at ¥ 956 and roughly 4.54 million shares outstanding give the company around ¥ 4.34 billion market cap.

This 4.34 billion yens becomes an interesting figure when you peek at its latest balance sheet which nestles ¥ 4.8 billion cash. Long term debt is zero. Total liabilities stand at ¥ 917 million.
That comes out to be ¥3.9 billion in net cash. And 90% of the company’s market cap soaks in this hard, cold cash. Receivables and inventory make up tiny portions in the balance sheet at ¥ 18 million and¥ 104 million respectively. Total assets stand at a tad above ¥6 billion. All tangible.

A quick glance at the historical balance sheets reveals that the company has always been substantially unlevered. Assets have always sat closer to equity. For the past 5 years the Debt /Equity ratio has been decreasing from 0.28 to the present 0.17.
Overall it sports a liquid, unencumbered balance sheet which boasts of its good quality tangible book value per share of ~¥1130. In a nutshell, we have an excellent quality of assets here.

Let’s check its operating business.

Clip Corp’s 9 year sales and EBIT record is given below:
(all figures in millions of ¥)

Year  Sales EBIT  EBIT margin

2011  4810 983          20.44%
2010  4480 779          17.39%
2009  4470 949          21.23%
2008  4680 1140         24.36%
2007  4720 1190         25.21%
2006  4600 998          21.70%
2005  3990 1000         25.06%
2004  3340 703           21.05%
2003  2910 610           20.96%

A decent sales track record coupled with above average and consistent EBIT margin makes this a very good business. And it shows that the company enjoys pricing power.

Of course no profitability picture is complete without a tale of two metrics- cash return on invested capital and free cash flow margin.
Cash return on invested capital (CROIC) has been calculated by using the following formula:
Free Cash flow (Cash flow from operations –capital expenditures) divided by invested capital.
Where invested capital is Total Assets-(intangibles + cash and investments)

Year Invested capital   Free cash flow  CROIC
2011        1080               756              70%
2010        1088               606              56%
2009        1064               582              55% 
2008        1021               635              62%

And below is Free cash flow margin record of previous 5 years:

Year   Sales     CFFO      Cap-ex         FCF        FCF Margin

2011  4810         783         -26.53        756      15.73%           

2010  4480         621         -15.26        606      13.52%           

2009  4470         599         -16.76        582      13.03%           
2008  4680         643          -7.67         635      13.58%           
2007  4720         780          -14.67       765      16.21%           

Both are excellent.

The business cranks out solid ROIC and spits off tons of free cash.

Return on equity is around 11 % this year .Historically it has been in the range of 20%-13%. This shows that the stock should be worth more than the book value.

The company is dividend paying and at the current price dividend  yield comes out to be 4.18 %. Not at all bad.

Let’s look at its free cash flow generation.

The free cash flow per share (in ¥) generated by the business over the past 5 years are as follows:

Year                             fcf per share
2011                              168.48
2010                              134.91
2009                              129.67
2008                              141.50
2007                              170.45

That’s an average of ¥149 per share. Shares outstanding have remained the same over the past 9 years .

The Enterprise value per share comes out to be ¥95.32
Do we need an intrinsic value calculation looking at EV/ 5 year average FCF of 0.64?

Apart from Ben Graham’s famous Mr Market metaphor I love the simile he uses which you can read on the page 22 of 1940 edition of Graham’s Security Analysis

To use a homely simile, it is quite possible to decide by inspection that a woman is old enough to vote without knowing her age or that a man is heavier than he should be without knowing his exact weight.

And in this case the man is not just heavier.

He’s obscenely fat.

Buying Net-Nets: What is the Right Margin of Safety?

A guy emailed me the following question after reading my report on Japanese net nets:

Hey Gurpreet,

When investing in net-nets, where do you set your Margin of Safety? Graham bought at 2/3 NCAV. Do you subscribe to that? Obviously the line gets blurred when a company is selling at NCAV but the majority of those assets are cash. Do you have a hard and fast rule before you start or stop buying a net-net? And if you were buying at 2/3 NCAV do you use a discounted NCAV, such as inventories only worth 50%, receivables 75%, etc, or just buying at a 2/3 discount to non-discounted NCAV?

I don't have a one-size- fits -all approach towards investing in net- nets. And I do not think value investing in general could be boiled down to any neat equation or an arcane formula. But then yes for value investors it’s vital to set up a margin of safety.  A decent margin of safety. How much? That depends upon quality. Quality of assets and quality of earnings. And the starting point of setting up my margin of safety depends upon these two factors. 

Before I delve further let me tell you that if we are doing value investing especially in the Graham tradition we want to make sure that  we don't just want to read Graham's rules superficially  and miss the spirit of his writing . The subtext of 2/3 this rule is that we cannot determine exact asset values from the balance sheet. As he says in his seminal work Security Analysis that the first rule in calculating liquidating value is that all liabilities are real but the value of the assets must be questioned. The values of most assets are arbitrary except cash.Moreover, the assets especially the liquid assets could be squandered by the management or burned by a bad operating business causing asset values to shrink. So to get margin of safety we have to look for sufficient gap between the net current asset values and the price what Mr. Market is assigning to the company.

Like investment beta which aims to quantify risk but utterly fails to measure it, relying solely on 2/3 rule to measure margin of safety in today's market is flawed.

Also keep one thing in mind about Mr Market and that not only he is manic depressive but evolving everyday too. Especially the American Mr Market. Every day he is getting more efficient and smarter. And he has become lot more efficient today than he was at Graham’s time.

He has become more efficient now because there are more people than before who are looking for value. So there is a high competition. We have the internet where it takes seconds to dig into stuff, access reports and transfer funds to buy stocks anywhere in the world . It has become extremely difficult if not impossible to buy stocks trading at 2/3 of their net- net values.

That is why Walter Schloss said in an interview that after net-nets stocks disappeared they had to lower their standards and look for stocks trading below book values. The idea is to buy stocks trading cheap relative to all asset values. And he said he does it because to buy earnings at discount he has to know more about the business. So he went for an extremely diversified portfolio.

Actually most net-nets deserve to be net-nets because of a terrible underlying business with a long history of operating losses. And that gradually erodes cash and current assets so it could cease to be a net-net after some time. What you want to look for in a net- nets is a business that's not a cash guzzler because if it is one then that can easily change the other side of the equation. And that could shrink the net current asset value over time .Time could be a brutal enemy indeed of this kind of a crumbling business.

So you may look for other positive factors that corroborate this margin of safety. It could be excess cash relative to assets. It could be high return on invested capital. It could be ten straight years of positive operating income. Good management, ample free cash flows and /or combination of all the factors above. In a nutshell, look at business quality that comes from its ability to generate high returns on capital and ability to generate good free cash flow consistently. Some kind of competitive advantage. Again that’s extremely rare to find all this in net-nets stocks. 

Or you may choose not to probe deeper into the business but invest using the statistical approach. So you go for extreme diversification.  That is fine although this is something I can't do because I can’t help delving into 10-K’s,10-Q’s and proxies. And as I said before Mr Market is far smarter now than it was before I also need to answer this key question in my mind: what makes this stock mispriced? 
But more often you will find a business that doesn’t generate acceptable returns on equity or invested capital and could still be a bargain. Japanese net-nets are a good example of these kinds of businesses. Not able to deploy cash to earn high returns they allow cash to build up on their balance sheets. The result: they end up earning paltry returns on equity. 

As I said in first paragraph I look for quality of assets and quality of earnings in a net-nets. And depending upon that I am willing to sacrifice the gap between value and stock price.

From assets perspective I mean the liquid assets in total assets. The more liquid the assets the better margin of safety you get.  Excess cash relative to low liabilities stares at you from the balance sheet and could indicate cheapness. This is obvious. Although keep in mind that it is not completely fool proof. After all it’s liquid -which a bad management can easily piss especially when it has got it in plenty. TV Today which is an Indian stock is a good example. If you take a peek at its 2008 balance sheet you will find it held $22 million in liquid funds. And the stock was trading at enterprise value to operating cash flow of just 3. A clear bargain. But over the next 3 years the management continually squandered the funds into its radio business which resulted in cash of less than $ 5 million in 2011 balance sheet. The terrible radio business that churned out delicious jingles chewed up all the cash.

The problem complicates further when we consider inventories. In researching the Japanese net-net stocks for my report. I used the Price /NQAV ratio instead of usual Price /NCAV. NQAV means Net Quick Asset Value.  Net quick assets are assets which can be turned quickly into cash. Basically, they are cash, securities and receivables.  They do not include inventories. By deducting inventories from current assets we arrive at a better, more liquid asset values and hence greater margin of safety. The problem with inventories is manifold.  It could become obsolete fast like microprocessors or it could be overvalued .You cannot take these at their face value. You will have to know more about the business.

The following excerpt from the famous Tweedy Browne fund's annual report of 1995 perfectly illustrates my point.

In the early 1980s, we had an investor in one of our investment pools who thought he could make just such a selection. Rather than paying us as managers, he redeemed his investment of $100,000 and bought what he believed was the cheapest stock among more than 80 in the portfolio. The company, Lazare Kaplan International, was a diamond wholesaler. At the peak of the diamond market, the market value of its inventory of stones less all liabilities on a per share basis far exceeded the market price of the stock. However, when the bottom fell out of the diamond market, an event few had predicted including us. The value of Lazare Kaplan's inventory plunged and the company was forced into bankruptcy. This was one of the few investments we have owned which suffered this corporate fate.

So you have to look at the quality of assets to arrive at margin of safety. The better quality of assets a net-net boasts the less discount you may be willing to take.  The better the management that controls these assets the less discount you may be willing to take. The better return on these assets the business cranks out year after year the less discount you may be willing to take.

And most important thing: earning power and and its quality. Earnings that are backed up by cash flows. Especially free cash flows. I want to emphasize this because I look at so many net- nets that have bloated inventory and accounts receivables that soak up all the operating cash flows –the life blood of the business. How long do you think will the business be able to continue that?
I also made this point in my Japanese net-nets report.  I gave a bath tub analogy.

Allow me again to quote from the report:

Sometimes what appears as a value stock becomes a value trap because the terrible underlying business that burns cash. So some businesses do deserve to be net -nets. Forever. Which is a better Bath tub? One which perpetually drains its water. Or the one that sports a fancy faucet which keeps on flushing the liquid into the tub. I prefer the latter. Therefore I also looked for ample free cash flow that ensures plenty of ‘supply’ of cash into the company from its operations

So I would rather go for a business that trades tad lower to its net current asset value but has an above average business quality than a poor business that sports a larger discount to its net current asset value. 

People look for net-nets and the first thing they want to know is whether it is going to liquidate or would make an activist target. That’s a wrong approach. The net nets should be chosen for their inherent cheapness and not in a hope for liquidations.

Agreed Graham talked about liquidation value but that was because he used to - it seems to me - assume the worst case scenario: Liquidation .And whether it possible to get his capital back or not. For example , he told Walter Schloss about GEICO that “If this purchase doesn’t work out we can always liquidate and get our money back.” That's why he preferred liquid assets.

Basically Graham liked these stocks because they were clearly selling for less than what  they were worth conservatively.

Warren Buffet during his early partnership days –when he was buying these kind of stocks -once said he doesn’t count on making a good sale. He just buys at a price so attractive that even a mediocre sale gives good results. Walter Schloss also aptly observed: “A stock well-bought is half-sold.”
And here's one of my favourite investors Dr. Michael Burry, who eloquently spills in his fund’s letter:

In fact, at all times I strive to buy stock at prices per share that no acquirer could ever pay for the whole company – not because the prices are too high, but because the prices are so low that a potential acquirer proposing them would be laughed out of the boardroom. Such is the opportunity afforded by the very human market for common stocks. 

So weigh all the factors and then think objectively whether you get an adequate margin of safety or not. Don’t scratch your head about when to buy or setting a precise bar. Just look for obvious bargains where the stock price trades less than what you think it’s conservatively worth.

Way less.

Deep Value in Japan

Here is a report on Japanese net-net stocks which I wrote in January 2012 .And thanks to Geoff Gannon for posting it on his excellent blog :

Deep Value in Japan-5 Profitable Net Net Stocks