Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Strategies & Market Trends : Buffettology -- Ignore unavailable to you. Want to Upgrade?

To: James Clarke who wrote (2431)	4/12/2000 9:13:00 AM
From: Brendan O'Connor	Respond to of 4691

Maybe saying "probably $100mm to $150mm" is a bit too positive. I should say "possibly", or else lower the numbers to "probably" $50mm to $100mm. Here's where the idea came from: Starting with $407 million cash owner earnings before interest for the pet food business, subracting off $155 million for interest payments and another $176 million for the (assumed) 3.0% dividend (.03 x $19.50/sh x 301mm shrs = $176mm) gives me $407 - $155 - $176 = $76mm. This is $76mm free cash flow unaccounted for using trailing 12 mo. numbers. The real number might be higher if they have some positive cash flow from passive investments. Also, it could increase faster than operating cash flow over time if they 1) buy back shares, thus decreasing the cash needed for dividend payments, or 2) pay off debt, thus decreasing the cash needed for interest payments. Another potential positive: The assumption that they pay dividends of 3.0% (current dividend is 1.4% @ $19.59/sh) is a conservative assuption for the use of free cash flow--reinvestment in operations (to grow the business at faster than our 11-12% assumption) or in share buybacks would be preferable, if available. (Even using it for debt reduction would probably be somewhat better economically than paying more dividends.) If dividends remain the same (1.4% @$19.50/sh) and they use the cash more productively, that would result in an economic positive for the owners, relative to our assumption that they use it to pay dividends. <<We're close until you said this: <<<<there is probably another $100 to $150 million of free cash flow unaccounted for which could be used to pay debt or buy shares. <<Where did that come from?

To: James Clarke who wrote (2431)	4/12/2000 10:05:00 AM
From: Brendan O'Connor	Read Replies (1) \| Respond to of 4691

Some tentative conclusions: I am of two minds logically at this point: 1) I believe the current price of $19 to $19.50 is a good one (I estimate expected 5-10 year return at about 14%), but I also believe that Mr. Market is likely to sell at lower prices in the near future (1-2 months). I have no real reasoning for this except for experience watching random price fluctuations, and the fact that it sold for as low as $18 1/8 a couple of days ago. (If I were to use techni-speak, I might say that I believe it will probably "test the $18 level at least one more time".) 2) Even though Mr. Market might value it lower, my ability to predict those movements is so poor that I must assume the price is at least as likely to move up as down. Given my value assumption and the rarity of the opportunity, I should logically take a position of some size, in case the price just goes up from here. I am also of two "minds" emotionally: 1) I have a gut feeling that in determining our valuation, we've pushed the numbers just a little more than we should have if we want to be really conservative. Buffett was quoted by Hagstrom in W.B. Portfolio as using the term "inevitable" when describing his perception of the economic success of his core holdings (KO, G, and maybe WPO). He also said that since he realizes there are very few inevitables, he adds to his portfolio some "highly likelies". I would not call a 14% return on RAL inevitable. My gut says that at $19.50 a return of 13-14% is highly likely, however. 2) I have noticed in myself a habit of paying a little too much for some companies because I emotionally want to own them and I'm afraid of missing the opportunity altogether. For example, I initially paid over $2200 for a few BRKB shares, because I thought it was a good price and, athough I logically thought the odds were very high it would go lower, I emotionally wanted to be sure I would own at least a little. I did buy more at lower prices, but my average cost would have been somewhat lower had I not had this emotion. I know this because all my clients got their shares of BRKB at lower average prices than I did--this is because for their accounts I only make decisions I can thoroughly justify with logic and my personal account doesn't have that constraint. In the present case of RAL, I feel there is some of this "great company, gotta own some" emotion at work. In moments when that emotion is eliminated, my conclusion reverts to the logical one above. What price then? My logical intuition tells me that it is highly likely Mr. Market will test $18 again, and that there is a good probablility that he will test $17 before moving up out of this range permanently. Again, this is logical intuition, based on my perception of others' likely perceptions so it may mean absolutely nothing. I am still happy with my decision to take a small-to-medium position at a good price (in case we never get a great price) and reserve some capital in case we get a great price. I would probably call $17.00 to $20 the "good" price range and something around $12 to $14 a "great" price (a.k.a. the inevitable no-brainer price). Note that they do not overlap. To me, the difference between a good price and a great price involves a paradigm shift in the thinking of Mr. Market. The current paradigm for RAL seems to be that it should be priced at the low end of the range of values you would give an excellent consumer-non-durables franchise with unproven management in a time when Mr. Market is down on these types of companies due to recent interest rate increases and potential economic slowdown. I believe that as long as this paradigm is intact, the price will not go below about $17.00. To get a the price down to the $12 to $14 range would require a significant paradigm shift, like a confirmed recession with fear of a deep recession, or something else having just as much perceived economic impact. Judging whether the price will move into this range requires the ability to predict the macroeconomic future which I do not have. That's enough. Brendan