2008 Wilson Fund Managers
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Changes in Methodology
The Wilson Fund managers embrace the concept continuous improvement when applying investment strategy. As a value fund, the Wilson fund places a great deal of emphasis on intrinsic value, or the actual worth of a company. The fund prefers to buy positions in companies at what is considered a significant discount. Fund managers rely on discounted cash flow methods to determine value and identify these companies.
This past semester, a visual element was incorporated into the valuation, enabling managers to more precisely determine what companies are worth at the time they are being valuated. The visual representation compares the current market value of the company with its “intrinsic” worth at the same point in time. This is an improvement over previous methods which compared current prices with often outdated intrinsic values. The model also incorporates a suggested sell price at any given time. The fund managers believe that the current method is not only more accurate, but also gives the managers a better understanding of the investment strategy. It is hoped that this new concept in the Wilson Fund will help improve the efficiency of trading.
Louis Wilson Fund Economic Outlook
The Wilson Fund managers introduced an economic outlook at the most recent board meeting to better understands the environment and its impact on current and potential holdings. Analysts Will Hippler and Joseph Cavalier used several common indicators including inflation, GDP, housing, and interest rates to evaluate the strength of the economy. Despite a weal housing market, they see good growth potential for the U.S. economy in 2007. Analysts predict real GDP growth of around 3% with lower inflation than in 2006. This indicator all bus rules out interest rate increases in 2007. Further declines in the housing market could lead to rate decreases by the end of the year.
The atmosphere of moderate economic growth with lower inflation gives the Wilson Fund managers a positive outlook for fund performance in 2007. Additionally, the possibilities of minimum wage increases and potentially lower interest rates make the team confident in holding current positions, which are weighted heavily in the consumer discretionary sector, as well as purchasing new holdings in Bed, Bath & Beyond, and Knight Transportation.
Bed Bath & Beyond - Analyst Gabe Briseno
Bed Bath & Beyond is a potential new acquisition for the Wilson Fund. Founded in 1971, Bed Bath & Beyond is a nationwide chain of superstores that sells domestic merchandise and home furnishings. Since going public in 1992, they have had 15 years of profit gains. Bed Bath & Beyond has also generated 19.37% revenue growth over the past 5 years.
Growth – External and Internal
Bed Bath acquired Harmon Stores and Christmas Tree shops in 2002 and 2003 respectively. Recently, they bought buy buy Baby, which did not affect FY '06 sales and will have little impact on FY '07 sales. Bed Bath acquired all three companies with operating cash flow. While it has not released its acquisitions information, it is assumed that Bed Bath both these companies at a Price/Sales ratio of 1.8x, which is equal to that of their own. We expect acquisition growth to remain around 15%—20% of total sales over the next 4 years. Of the 11.95% forecasted over the next 4 years, we expect 2—3% to come from new acquisitions (i.e., CTS, Harmon, and buybuy Baby) and 9% from internal growth and price inflation.
Comparable Store Sales
There are approximately 800 Bed Bath stores which range in size from 20,000 to 50,000 square feet, with some stores exceeding 80,000 square feet. HS, CTS, and buybuy Baby make up less than 100 of single digit comp growth and posed a better than expected 5.2% increase over the last quarter. We expect same stores sales to remain stable at mid single digit growth over the next 4 years due to a slowing of store base expansion aided by continued store level execution.
Leases
Bed Bath & Beyond leases its buildings. Although the company has long-term contractual operating leases totaling $3.1B to finance its stores, Bed Bath has no short-term or long-term debt on its balance sheet.
Competition
While Bed Bath & Beyond is unique in its product mix and independent store management styles, its closest competitors are Linen N’Things, Wal-Mart, Target, and Williams Sonoma. Bed Bath’s current profit margin is 9.9%, which leads its competitors. It also leads its competitors with its 5 year profit margin at 9.1% and 5 year revenue growth rate at 19.37%. Bed Bath current leads the industry in ROA, ROE, and ROI and in the 5 year averages.
Valuation
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Price as of 4/20/07 |
$41.65 |
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Current P/E |
19.8x |
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Current EPS |
$2.15 (FY 06) |
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Forecasted P/E |
17x |
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Forecasted EPS |
$3.71 |
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Intrinsic Value |
$50 (using a PE Valuation; PBV and EV Valuations similar) |
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Margin of Safety |
$39 |
Berkshire Hathaway – Analyst Will Hippler
Berkshire Hathaway is a current holding of the Wilson Fund. Berkshire Hathaway has contributed to the Fund’s growth in 2006 and it was recommended that it continue to be held. This recommendation was based on a valuation of Berkshire that was different from that of the other companies. Aside from using a price to book multiple approach for valuating the company, the analyst used a “segmented valuation approach”. Using this approach, the company is broken up into smaller pieces that are valuated separately and added back together. This method takes into account many different factors including the amount of cash held, the value of subsidiary companies, and the cost of insurance float. This in-depth analysis gives the Fund the confidence that Berkshire remains undervalued. It is hoped that the development of this detailed valuation strategy for Berkshire will help future analysts understand this unique company.
Best Buy – Analyst Joseph Cavalier
Company Rationale
Best Buy offers a unique shopping experience compared to its competitors. I believe that BBY’s customer centricity model, selection of specialty goods, knowledgeable staff and the services it offers will distinguish it from its competitors in the future.
Industry, Competitive, and regulator Factors and Risk
Best Buy is the best in its industry. However, there are many economic factors and pressure from competitors that could have an impact on the profitability of the company. One economic impact that could hurt BBY’s bottom-line is pricing pressure from flat-panel TV sales. Over the 2006 holiday season, prices, and ultimately margins, for flat screens were very low. This affected everyone in the industry, some more than others.
Circuit City, a close competitor of BBY, had a tough time with these low margins and in response laid off employees and replaced them with low-cost (and probably less knowledgeable) sales staff. It is too soon to tell how this will affect Best Buy. But it seems this is a sign that Best Buy is pulling away from the pack.
Growth
Best Buy should grow its business at a more sustainable pace over the next five years. The company’s earnings per share are expected to grow 9% next year to $3.25 per share. The company is considering growing internationally. BBY currently operates in Canada and China. The company recently announced that they would increase their operations in those countries, and additionally expand to Mexico and Turkey.
Valuation
The company is currently trading at a multiple of 19 times its earnings at $48. Over the next five years, the company is projected to trade at a price to earnings multiple of 20. The analysts believe that a good price to buy Best Buy is at $46, with a projected sell price of $97 in five years.
Wal-Mart – Analyst John Fournet
Wal-Mart Stores, Inc., is a current holding of the Louis Wilson Fund. Looking at the Fund’s portfolio guidelines, Wal-Mart matches most of our criteria. They have one of the strongest business franchises in the world and continue to strengthen their image through strong yearly returns. Competing in an industry with which the Fund is very familiar (consumer products), Wal-Mart’s goods, services, and future capabilities are well understood by our members. This understanding, however, points to some warning signs in Wal-Mart’s future earnings prospects. We are uncertain in whether it can maintain its growth in a saturated domestic market and raise its lagging margins, urging us to look elsewhere for better portfolio returns.
One of Wal-Mart’s most intriguing growth opportunities lies in international retail operations, where they currently operate over 27,700 stores in 13 different countries. This segment made up almost one quarter of Wal-Mart’s total revenues of $350 billion in 2006. Despite these promising growth prospects, the risk of international business concerns many investors, especially since Wal-Mart’s latest departure from underperforming German and South Korean markets. Also, the operating margin for the overseas retailers is lower than the struggling domestic operations, indicating that the internal segment is not matching expectations.
Renowned for its innovative supply chain management, Wal-Mart is the world’s largest retailer and number one on the Fortune 500 list. However, overexpansion in the U.S. (over 4,000 stores) has cannibalized same-store sales and weakened margins. Wal-Mart is a world-class company, but needs to refocus on the core competencies that brought them and their investor’s success in years past. Until then, the market seems to be willing to keep a heavy hand on Wal-Mart’s value.
In the fall of 2006, a group of Millsaps Wilson Fund members had the opportunity to travel to the Berkshire Hathaway headquarters in Omaha, Nebraska to meet with Warren Buffett. Will Hippler, Todd Merchant, and Robin Perry attended the meeting with finance students from Mississippi State University. After an inspirational talk by Mr. Buffett, students were able to ask questions about international investment, succession planning for Berkshire Hathaway, and social responsibility.
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