In a recent interview with The Motley Fool, prominent value investor Mohnish Pabrai detailed the advice he received from Charlie Munger, Warren Buffett´s partner. Basically, Munger gave Pabrai three specific sources for investment ideas:
1. Following great investors’ ideas
2. Pay attention to companies that buy back their own shares
3. Study spin-off opportunities
In this article, I will focus on the first source of ideas: analyzing three stocks that top fundamental investors bought last month. It is important to remark that 13F fillings are updated every three months, but hedge funds should report material purchases before 13F reporting periods.
That’s why, in this article, I will focus on stocks purchased by great investors recently instead of just looking at the last reporting period (Dec. 31, 2012) which was quite some time ago. Let´s start:
J.C. Penney: Stock or bonds ?
Soros Fund Management recently reported a new position in J.C. Penney Company, Inc. (NYSE:JCP) at an average price of $14.39, purchased on April 15. There is no doubt this is a truly troubled company:
Negative ROE and ROA
Decreasing Operating Cash Flow
Poor same-store sales
Negative Revenue and EPS
Uncertain strategy and future
I think, that at this stage, when all the negativity around J.C. Penney is quite obvious and widely known by the investing community, it is essential to ask if J.C. Penney Company, Inc. (NYSE:JCP) bonds could offer better value and protection than the common equity.
In a recent JPMorgan research report, analyst Michael Boss revealed that J.C. Penney has real estate value of ~$11 using a $7-$15 sensitivity midpoint. Based on recent conversations with industry sources, he gathered a few notable information regarding J.C. Penney’s owned real estate portfolio which is summarized here:
J.C. Penney Company, Inc. (NYSE:JCP)’s 426 owned doors are among the best properties in the portfolio,
~90% of owned stores are likely mall-based (primarily ~110,000 sq ft) with the remaining 10% at strip centers (potentially re-purposed)
The smaller size doors (~20,000-60,000 sq ft) are typically leased locations (likely short-term).
Based on that information, JPMorgan sees
~$11 per share in real estate value (with an incremental $2-$3/share possible from HQ value/remaining
“couple hundred million” of non-core assets). This could be the reason why the stock has a strong support when it approaches 1x P/BV multiple: J.C. Penney´s real estate value strongly supports its valuation in the $13-1$4 range. Probably Soros Fund Management analyzed that buying J.C. Penney Company, Inc. (NYSE:JCP) at $14.40 has all the negativity priced in.
Source: Gurufocus.com Premium Account
Based on the last reported balance sheet, J.C. Penney has no short-term debt and $2.95 billion in long-term debt. Considering it has $5.35 billion in Property Plant and Equipment (valued at historical prices) which Ackman values at $9 billion, the company does not face short-term debt problems. Value investor Todd Sullivan from Valueplays.net recently wrote:
J.C. Penney values its land/building at $4.5B (FY 2009 10-k pg. f-11) excluding furniture and equipment. We’ll say ~80% of this is the retail space, not distribution/corporate (again no details in 10-k so we’ll simple use the sq. ft ratio from above). That gives us a rough $3.5B carrying value for the retail stores ($14/share). If we subtract this from J.C. Penney Company, Inc. (NYSE:JCP) market cap of $7.8B it means the total retail operations (including jcp.com) are valued at $4.1B ($18/share). The company has $3 billion in long-term debt not tied to any specific RE holding
I recommend investors going with the bonds rather than the equity. I do not feel comfortable in this type of turnaround situations when there are so many things to repair in order to make the company work again. Considering that J.C. Penney has no default risks and its bonds yields greater than 8% YTM, I recommend going with J.C. Penney´s fixed income.
My pick is J.C. Penney Company, Inc. (NYSE:JCP)’s 6.375% 2036 bonds, which trade at 80 cents-per-dollar. If the turnaround works well, these bonds could rally to $0.90 and still pay a good carry. If the turnaround is at risk, those bonds won´t go much lower than 75 cents-per-dollar while still paying semi-annual interest.
Confident in Lululemon Athletica and Workday
Top manager Steve Mandel from Lone Tree Capital reported that on April 15, he added to his existing position in Lululemon Athletica inc. (NASDAQ:LULU) at $69.60. The fund has a passive stake of 5% in this company. This is a very interesting clothing pick.
First, Lululemon Athletica inc. (NASDAQ:LULU) has truly outstanding metrics:
Operating margin of 27.5%, ranked higher than 98% of the companies in the Global Apparel industry (source: Gurufocus).
ROE of 30%, ranked higher than 98% of the companies in the Global Apparel industry.
ROA of 27.5%, ranked higher than 97% of the companies in the Global Apparel industry
Average revenue growth of 31%
Average EPS growth of 45%