Inside Investing

Dad is still finding his “equilibrium” at home, so it is likely to be a quiet summer here at the Blue Ridge, although I will be checking in periodically with occasional musing on markets. In the meantime, we’ve done some writing for CFA Institute that might be of interest for value investors.

Earlier this month, we outlined our investment thesis in shares of Hospira (HSP) on a napkin, which is available here.  As a follow up to our work on this high quality healthcare company, we offered up a different perspective in valuing the stock, in order to obtain a conservative range of values for our investment.  In this article titled, A Case Study for Strategic Valuation, we conclude with the following analysis:

We calculate Hospira’s Earnings Power Value (EPV), by capitalizing our adjusted income estimate above at the company’s WACC, which generates a total enterprise value of $10.9 billion. Netting out debt and cash brings our total EPV to $9.9 billion, nearly $50 per diluted share and 35% above the current stock price. In other words, Hospira offers investors a significant margin of safety based on current earnings power, with additional upside potential in biosimilars and emerging market growth opportunities.

We’ve recently learned that Mylan Chairman, Robert Coury, looked at a possible deal with Hospira, per his comments at a recent GS Healthcare Conference.  Coury also said that he expects more consolidation in the generic-drug industry while his company continues to scout for acquisitions.  We couldn’t agree more and noted in our initial report:

We believe Hospira would be a particularly good fit for many of these businesses looking to acquire a large share of an attractive market at a bite size which could be easily swallowed. If Hospira can’t fix their problems themselves, it’s likely that other, bigger fish have noticed that the problems are fixable.

While shares of HSP have rallied strongly from a low of $29 to current levels north of $36, the company everybody suddenly loves to hate, hasn’t moved since we published a piece titled Bad Apple at CFA Institute back in March. The full article, which discusses the psychology of investing in “story stocks” is available here, along with a number of links worth reading for AAPL investors.  The bottom line:

Although leadership in technology can change extremely fast, we think Apple is remarkably cheap for such a high-quality company with the brand recognition and customer loyalty it commands. Given the dramatic shift in sentiment and corresponding reduction in expectations, we think the stock offers investors a cheap option on continued innovation with a number of potential catalysts on the horizon that may trigger a turn in currently depressed sentiment and the stock’s equally depressed valuation. With the market now discounting zero earnings growth in the current year, upside surprises may come from new product cycles (i.e. iPhone, iPad, etc.), growing distribution (i.e. NTT Docomo, China Mobile, etc.) and expansion into untapped market niches (i.e. iTV, iWatch, etc.). Finally, with one-third of its market value in cash, Apple can unlock value by deploying that cash productively, returning it to shareholders or lowering its cost of its capital.

Our thesis is intact and AAPL is trading hands at roughly the same price it did a few months ago.  Yet, we have much greater clarity on the company’s capital allocation plans today as management recently announced it will return $100 billion of cash to investors through 2015 in the form of dividends and share repurchases, partially funded by a $17 billion bond issuance at an average cost around two percent.  At it’s peak, Apple may have been bigger than the entire 1977 domestic stock market, but at today’s price, we’ve got a bit of iFever.

travolta