Scott Black
Barron's: How are you holding up in this market, Scott?
Black: All our accounts are in the plus column, which is good. Of the five stocks I recommended in January, only BTU International is down, and it was up until a few weeks ago. But it has been brutal in the past few weeks. We actually have a mild recovery in the economy, although there are mixed signals. Using the S&P 500 as a proxy, the market is very expensive. The index is selling for 24.6 times earnings, based on $42 in operating earnings for 2001. This is not like the bottom in August 1982, when stocks were selling below book value and at P/E's of 7. The only industry group that's statistically cheap, and it has the kiss of death thanks to Adelphia Communications, is cable. Comcast, Cox Communications and Charter Communications are decent companies with great operating earnings. In most industries there is no pricing power, however, which is why we have a profitless recovery.
Q: So you're still not looking for a pick-up in the market this year?
A: We are paying for the excesses of the past decade. We need corporate profits to catch up before there's any big increase in stocks. As a homogenous risk class, equities probably aren't going to do much more than grow by 7%-8% compounded over the next few years. It's still better than the bond market, but ultimately the stock market can't outgrow the growth in real GDP and corporate profits. We had an unsustainable boom from the bottom of the 1982 market through the peak in 2000. Those days are over.
Q: Well, then, what's ahead for you?
A: As Ben Graham used to say, value will out. One business that's actually strong is property and casualty reinsurance. My top pick is IPC Holdings, a reinsurer based in Bermuda. It's been around since 1993 and was put in business by American International Group, which owns 24.3%. The stock trades on the Nasdaq at $30.38, and has a market capitalization of about $1.47 billion. Book value is $23.50 a share, and there is almost no water in that. So the stock is selling at 1.3 times book. In the old days, in 1996 and '97, when the industry was doing well, this company earned $3.55 and $3.79 a share, and made a 20% return on equity. Last year obviously was not good, and they had a $75 million hit on the World Trade Center. But on an apples-to-apples basis, they are averaging 30% price hikes on their policies, of which they have roughly 2,000 issued worldwide. For clients who had prior claims in prior years, some rates are up 100% to 200%.
Scott Black
Company Symbol Recent Price
IPC Holdings IPCR $30.35
Maxtor MXO 4.43
Q: That's a good sign.
A: At the end of last year IPC sold some stock and raised $546 million, which lifted their capital over $1 billion, to $1.135 billion. That gave them more underwriting capacity, which we saw in the first quarter. They wrote gross premiums of $147 million, compared with $65.6 million last year, a gain of 124%. The combined ratio in the first quarter was an unusually low 33.4%. There weren't a lot of incidents. Roughly half the premiums are written in the first quarter, and get booked over the course of the year. For the year they could do about $300 million in premiums. A combined ratio of 60 would mean $120 million of underwriting profit. As for the investment portfolio, which is run by AIG, there are no junk bonds whatsoever, so you don't have to worry.
Q: What's the risk?
A: If there is another big catastrophe, the combined ratio could go back to over 100 and wipe out a lot of the profits. Catastrophe reinsurance is a volatile business. I've modeled $52 million of net investment income, and $3.50 to $3.60 a share in earnings for the year. So the stock sells for 8.4 times projected earnings, not bad when the market multiple is 24. We just had the management in, and we think they'll see 10%-15% rate hikes next year, which would put earnings over $4, all things being equal.
Q: What else do you like, Scott?
A: I've got something Art Samberg recommended earlier in the year, but he paid a higher price. It's Maxtor, the disk-drive maker. If we live long enough, the turn will come, probably in the third or fourth quarter. The stock is trading at $4.54 and there are 236.9 fully diluted shares, so the market cap is $1.075 billion. Management owns 3.3% of the company. Stated book value of $3.57 a share is all goodwill, so it's meaningless. But the balance sheet is bulletproof, which is what I want in a tech company. They have $337 million or $1.42 a share of net cash. Last year they bought Quantum, which added quite a bit of revenue. In the first quarter, revenues were $1.05 billion versus $631 million, but there is a lot a price competition. Gross margins were 11.1%, down from 14.1%. On an operating basis they lost 16 cents a share, against a penny in earnings a year ago. This is not terrific.
Q: Where's the growth?
A: When they acquired Quantum they promised to take out $200 million in operating costs. They've already taken out $148 million. There will be more savings in August when they shift some production from a Quantum joint-venture in Japan to their own plant in Singapore. Maxtor is No. 1 in the desktop computer market, with a 34.3% market share. Now, through Quantum, the company is entering the enterprise market, where they will have an 8.9% share. Enterprise computing is only 10% of their business, but they would like to grow this to 35% because the average enterprise disk drive sells for $220 to $230, compared with $65 to $70 for desktops. Maxtor is also getting into consumer electronics. The company has a secular growth rate of 6% to 8%.
For various reasons the company probably will have slightly negative free cash flow in 2002. But don't be surprised if cash and equivalents end up in the $550 million range by yearend. Next year revenues could grow to about $4.6 billion, which would give you $92 million in after-tax net, or 39 cents a share. On the upside I see 41 cents a share. And a liquid balance sheet means they'll live to fight another day.
Q: For your sake, and Art's, we hope so. Thanks, Mark.
BLACK
Price Price Percent
Company Symbol 1/7/02 6/14/02 Change
BTU International BTUI 4.88 3.90 -20.08%
Southwest Bancorp OKSB 18.05 23.80 31.86
XTO Energy XTO 16.61 19.42 16.92
Textron TXT 43.66 45.17 3.46
PepsiAmericas PAS 13.77 15.37 11.62 |
