28 Dec 2012 by Jim Fickett.

Encana scraped through 2011, keeping reserves and production approximately constant while also keeping free cash flow (barely) positive. This was accomplished by a (continuing) strategy of selling some assets and partly funding development through joint ventures. It remains the case that the market values Encana's proved reserves at just the value of the sunk capital costs, and values the resources beyond that, which include much that is of comparable quality to proved reserves, as worth nothing. The wait has already been long, but this undervaluation will change.

This post brings some past analysis up to date with more recent data, and addresses some general concerns about the gas industry. All data not otherwise attributed in this post is from the company website.

The slump hit Encana at a bad time. They were in the process of ramping up production when it became unprofitable to produce at all. And they let all the oil assets go to Cenovus in a company split, just before all the gas companies began to emphasize liquids production to keep revenues going. But their balance sheet was reasonably strong, and they have adjusted their strategy in a reasonable way.

Their current strategy (based in part on the latest earnings call) is:

• Keep the machine going so as to be ready for better times. Reserves and production were more or less level from 2010 to 2011. In 2012 they shut in production for part of the summer, but started it up again when demand began to pick up in the fall.
• Fund capital expenditures from cash flow, not new borrowing. This has been possible by doing some joint ventures and selling some assets.
• Ramp up liquids. This is difficult for Encana because of the Cenovus split, but they are making progress. In 2012 liquids are estimated to be about 7% of production (by heat value; more by revenue), and they may come close to doubling that in 2013.

Arthur Berman, an engineering consultant and general skeptic of the shale gas revolution, suggested in a 2011 presentation that many gas companies had taken advantage of a 2009 rule change by the SEC to increase their reliance on undeveloped reserves. That is, their reserve quality had gone down, starting in 2010, because they were relying less on reserves associated with producing wells, and more on reserves interpolated between wells, based on geology.

Here are Encana's proved reserves over the last decade, broken down into developed and undeveloped.

All of Encana's reserves went down in 2009, because of the spin-off of Cenovus. However the roughly even split between developed and undeveloped has persisted since 2005, and there is no evidence of a decline in reserves quality.

Backing off from this particular issue, note that Encana goes to great lengths to ensure that their annual reserves estimate is carried out in a fully independent manner, by outside experts; their reserves estimates are quite solid.

Recall that free cash flow is cash flow from operations less capital expenditures. Since, in this industry, a major capital expenditure is the purchase of new land, I have included all the effects of acquisitions and dispositions in capex.

In 2011 Encana spent more than its available cash flow on exploration and development, replacing production by 180%, but then sold several assets, with the net effect that free cash flow remained positive (just), and reserves about level. This was a reasonable way to take advantage of plentiful, undervalued, resources.

Overall I think it is accurate to say that at 2011 gas prices, with half their sales hedged at higher-than-market prices, they were just breaking even. 2012 production was also about half hedged at well above market prices, so perhaps results will be similar.

Some companies, for example Chesapeake, have run into serious problems with debt during the natural gas slump. This does not appear to be the case with Encana. Long-term debt has not increased in the last few years. Over the last decade Encana has maintained a cash reserve of about 1.9 times annual interest costs, on average. At the end of 2011 that ratio was 1.6, which still leaves a comfortable margin. And operating cash flow for 2011 was about 9 times interest cost. So it seems very unlikely that Encana will have any problem servicing its debt.

To keep the cash flow positive while the gas price is low, they are continuing to divest some assets.

On the plus side, Encana's management

• foresaw the importance of shale gas, and bought up assets when they were cheap
• has a reasonable, straightforward strategy now, and has successfully kept cash flow positive and kept the balance sheet out of trouble through a difficult time
• is generally careful with money; for example, the employee stock plans and retirement plans have modest liabilities
• has enough respect within the industry to succeed with a number of joint ventures in which they provide less than their share of the capital, in exchange for providing more than their share of the expertise

On the minus side, the timing on the Cenovus split, and the push to ramp production up strongly just before the gas bust, is disappointing. Still, I don't know of any management team that did succeed in preparing beforehand for the gas bubble and bust.

On the whole Encana's management seems reasonably competent, careful with money, and, as far as I can tell, quite honest.

I'll repeat, with current data, what I think is the strongest argument making clear that the stock price is unreasonably low.

Reserve replacement cost is the cost for adding to reserves, expressed in dollars per thousand cubic feet of gas ($/Mcfe). It is calculated as capital spending per Mcfe added to reserves. Taking all capital expenditures (including net acquisitions), and all additions to reserves, for the years 2003-2011 (leaving out 2009 because the split with Cenovus muddies the accounting) gives a long-term average of $1.70/Mcfe. This is close to the industry average for the last three years, estimated from Ernst & Young data, of $1.60/Mcfe. Let's split the difference, at $1.65.

With proved reserves, at the end of 2011, of 14.2 trillion cubic feet (Tcfe), that means Encana's proved reserves represent a sunk capital cost of roughly 14.2 * 1.65 = $23 bn.

At the end of 2011 enterprise value, what you would spend to buy out all stock holders and debt holders, and own the company's assets free and clear, was $21 bn. It is in the same neighborhood now; perhaps a bit higher.

So according to the current market valuation of Encana, a reasonable outlook is this: current reserves will bring in only enough to cover sunk capital costs, with no profit, and all the resources that are not yet proved reserves are worth essentially nothing.

This is particularly astonishing in view of what Encana calls “economic contingent resources”. These resources are supported by roughly the same level of evidence as reserves, and are expected to be produced profitably, just as reserves, but are not yet proved reserves because some part of the infrastructure is missing are the plan is to produce more than 5 years in the future. Those economic contingent resources that are known with 90% certainty are larger in volume than current proved reserves, and are receiving a valuation of essentially zero from the market.

The three classifications of contingent resources have the same degree of technical certainty as the corresponding reserves category. For example, the 1C contingent resources meet most of the same criteria as proved reserves; most importantly, they have the same degree of technical certainty – a 90 percent probability that the quantities recovered will equal or exceed the estimated number. The major factor that prevents them from being included as proved reserves is time. Generally, 1C contingent resources exceed the five-year regulatory guideline for proved reserves development. By adding the qualifier that the contingent resources are “economic”, the resources are high-graded. Shareholders then understand that these resources are expected to be economically recoverable under the fiscal conditions that Encana expects to prevail.

1C contingent resources at end 2011 were 25.0 Tcfe, compared to proved reserves of 14.2 Tcfe.

The market is putting this valuation on the company because, it is true, gas being produced currently is NOT making a profit. In fact, to keep the cash flow positive, Encana (and other companies) have been selling assets. But it would be remarkably illogical to assume that gas companies will continue selling gas at a loss for the long term – they would all go out of business. When the gas price again rises to a level that results in profitable production, the market will suddenly attribute value to Encana's reserves and resources.

Encana is hardly the only gas company that is being forced to sell assets. It would seem that those with cash to buy such assets are probably getting excellent prices. This suggests that one should look into some of the MLPs that are currently buying gas assets, e.g. EV Energy Partners.

30 Oct 2012 by Jim Fickett.

Last week's announcement from Best Buy included some very encouraging strategic news. On the whole I remain optimistic that the company will bounce back. Since the future of Best Buy depends on convincing customers that it is worth paying a little more to take advantage of a network of physical stores, no one can predict sure success. I will increase my position a little and leave it at that.

Last week a press release from Best Buy caused rather a negative reaction from analysts and a fall in the stock price. Part of the press release is indeed bad news – a pre-announcement that for Q3 earnings will be down year over year and same-store sales will continue to decline:

The company is providing an update on its expected results for the fiscal third quarter ending November 3, 2012. Comparable store sales are expected to decline at a rate consistent with the range of results for the first two quarters of fiscal 2013 (-5.3% in the first quarter and -3.2% in the second quarter). Gross profit rate is expected to decline at a rate similar to that experienced in the fiscal second quarter of 2013, with a decline of more than 100 basis points compared to the prior-year period, due to the impact of product mix and product transitions in advance of several key new product launches. The company expects SG&A expense percentage growth to be in the low single digits over the prior-year period, due to investments related to the company's strategic focus on improved customer service (including increased training and higher compensation costs for sales associates). As a result, the company expects fiscal third quarter adjusted (non-GAAP) earnings per diluted share will be significantly below the prior-year period.

Although this is not happy news, it is not unexpected. The company is making changes, like closing stores, retraining employees, and strongly building up its web capabilities, and these changes cost money and take time. So things will not get better right away.

The other major part of the announcement, on strategy and personnel changes, also produced negative reactions from analysts but in fact it holds very positive news. The new CEO, Hubert Joly, is taking more direct control, moving those responsible for the current stagnation out of the way, promoting people who have gotten good results, and increasing the prominence of internet sales (newly reporting to Joly).

Effective January 1, 2013, Best Buy's operations in the U.S. will be structured around the following groups:

• Two Channels - Online and Retail: While online continues to be overseen by Stephen Gillett, president of Digital and Marketing, Shawn Score is appointed to lead the U.S. retail channel.
• Three Business Groups - Connectivity, Home and Services: Jude Buckley is promoted to head the Connectivity Business Group, succeeding Shawn Score, while Home and Services will continue to be led respectively by Mike Mohan and George Sherman.
• Support functions, including Human Resources, Finance, Legal and Marketing, where there are no leadership changes.

In this phase of Best Buy's transformation, these groups will report directly to Joly. The current president of Best Buy's U.S. business, Mike Vitelli, will retire from the company at the end of the fiscal year. He will work closely with Joly to ensure a smooth transition. Executive Vice President of U.S. Operations Tim Sheehan will leave the company at the end of the month.

“Shawn Score and Jude Buckley have done a great job growing Best Buy Mobile and then leading the Connectivity Business Group. I look forward to working with them and the rest of our team as we re-invigorate and rejuvenate Best Buy,” said Joly. “Mike Vitelli and I will work closely together during the next few months to ensure a smooth transition. I am very grateful to him for everything he has done for the company and for his terrific support.”

So Joly is getting started on some important big changes right away, but is not going to make the changes effective until after the key holiday season. In the meantime, a promise to match Amazon prices evidences a strategy of holding on to market share now, and then working to compete more effectively at more realistic margins starting next year.

Critics are right that there is some risk in getting rid of Vitelli and Sheehan. These two know how to make the business run in its current form. However that is also exactly the reason to get rid of them. If Vitelli and Sheehan really appreciated the importance of the internet, Best Buy would not have given online sales such minimal attention over the last few years. And the only way to make big strategic shifts is to move the powerful people who have resisted the new direction out of the way.

A bio of Vitelli and a video interview with Sheehan are both long on generalities and short on ideas for producing satisfied customers. On the other hand, a five-part interview with Shawn Score, who will now be in charge of the physical stores in the US, discusses specific customer needs and specific Best Buy responses to meet those needs.

So all in all, I think the reaction to this press release was in the wrong direction – it contains more good news than bad.

At this point, I'd like to make a summary of the main points for and against Best Buy as a value play.

1. The long-term track record is impressive

When evaluating a company, it is good to look not only at recent events, but at the long-term record. Best Buy has done extremely well, growing from nothing to become the single largest US player in consumer electronics. And even after investing strongly in growing the business, it has produced remarkably high free cash flows over time.

Is that changing? There is no evidence yet that it is. Since capital expenditures are so volatile, let's look at operating cash flow. This should not be confused with free cash flow, of course; the two differ, in the long run, by the average of capital expenditures. But if the business is really becoming unprofitable, as so many think, then we should see operating cash flows trending down.

The low value in Q2 could indeed be the beginning of the end, as many think. It is certainly cause for concern and vigilance. But it is not that different from other low points in the past, and so does not really indicate any serious downward trend just yet.

2. Current changes in strategy look smart

I am very impressed with Joly so far. It looks to me as if he is tackling exactly the right issues:

• Improvement of the online “channel” is receiving top priority
• Personnel changes at the top indicate a focus on the customer experience
• He has highlighted the difference in performance between stores, probably indicating a willingness to change management at underperforming stores
• Some of the big stores are being closed, and the successful small mobile device stores are expanding

1. Consumer electronics is a tough business to be in

Many people compare Best Buy to Amazon, Target, and Walmart, its three biggest competitors. But the comparison is not very helpful, as none of these three concentrates exclusively on consumer electronics. Perhaps a better comparison is to Dixons, a European retailer whose stores look very much like those of Best Buy.

Dixons reported a net loss in four of the past five years. This certainly means it is a tough business, and it might even mean that we should give up on Best Buy. Note, though, that the euro zone problems mean Europe's recovery from the great recession has been even rougher than that in the US. The euro zone problems are evident in Dixons performance – for the most recent quarter, same store sales were up 5% year-over-year overall, but were down 10% in Italy, Greece and Turkey. Incidentally, Dixons' turnaround plan looks very much like Best Buy's – closing excess stores, improving customer service, and putting a greater emphasis on “multi-channel” sales (buy on web and pick up in store; up 39% YOY).

2. Falling margins are scary

The fact that margins have fallen significantly in the last couple quarters certainly is not good for an investor's peace of mind. But it is to be expected in a situation where the company has to spend money, and take losses on previous bad decisions, in order to switch strategic direction.

It is extremely important for Best Buy to maintain its dominant market share. Think of the biggest challenge you would face if trying to build up a competitor from scratch. That challenge would be scale. A key reason that consumers are still attracted to Best Buy is that there is always a store nearby, and the selection available is very broad. That advantage must be maintained. So it makes perfect sense to put the first priority on holding onto customers, and let margins fall temporarily while improving the customer experience, and then to attempt to charge more fairly for what is provided.

3. Falling same-store sales are not a good thing

The bad news that is most often mentioned in the news is the falling same-store sales and, indeed, this is not a good thing. Many of the costs at any particular store are fixed, and so falling volume means reducing revenue while expenses fail to fall as much. This problem must be fixed. But the good news is that overall revenue and market share have not fallen significantly, and the problem is probably one of too many stores, and of some badly managed stores. That is fixable.

1. Best Buy is about to go under

Only a few very uninformed people are writing such things, but it contributes to the pessimistic mood. In fact free cash flow set a record in fiscal 2012, working capital (current assets minus current liabilities) at the end of fiscal 2012 was $1.4 billion, and free cash flow in fiscal 2013 is again expected to be healthy.

2. The costs for supporting retails stores is so much higher than the costs of an online business that Best Buy cannot possibly compete with Amazon

In fact the bulk of Amazon's advantage comes from not collecting sales tax, and this advantage is going away.

3. Showrooming is killing Best Buy

Although showrooming, in which people go to see the item at a retail location but then buy it online for less, might or might not really be a problem. But there is no evidence that it is a major one, and investors worry so much about it only because the idea seems plausible and the fear is often restated. As for evidence, Deloitte has shown that people who refer to their mobile devices while shopping in a physical store are actually more likely to buy. And in a recent Google survey of shoppers, half of respondents said their strategies include the opposite of showrooming – to research online and then go to the store to buy.

Soon after I began my career as a manager I was in a position to hire. As I prepared interview questions, a good friend looked over my list, which included many questions designed to probe knowledge, philosophical approach to the job, past relationships with colleagues, etc. His response shocked me. “Forget all that. Hire someone who has done the work you want done, and has done it well before. Then you know he/she can do it again.” It was good advice, and extends in a natural way to investing. Buy the shares of companies that have shown over the long haul that they can make money and grow a business. So I put a great deal of weight on Best Buy's long record of excellent free cash flow. Yes, they have some big challenges right now, but they have done very well in the past, and their strategic direction seems right.

The negatives most often mentioned in the news are myths, but there are real negatives, the most important being falling margins. On balance I think the evidence suggests that they have real competitive advantages, and can bring margins back up in a year or so. But they have to make some significant changes to show customers that they are really a top choice for shopping, and no one, certainly not I, can know for certain that they will carry this off.

On the whole it seems to me the burden of proof should be on those who say a successful business will be successful no longer, and I do think Best Buy will bounce back. So if the price tomorrow, when the markets reopen, remains in the neighborhood of Friday's closing, I will add to my position. But given the uncertainties, I will probably stop there.

• 3 Sep 2012. Best Buy has healthy cash flow
• 27 Sep 2012. Best Buy's balance sheet is not strong
• 30 Sep 2012. Not time to declare the winner in consumer electronics retailing just yet
• 8 Oct 2012. Best Buy's core business is roughly stable
• 9 Oct 2012. Best Buy is very likely undervalued

22 Oct 2012 by Jim Fickett.

Recently I took a small position in Peabody Energy, as a way of betting that the market for coal had been unfairly beaten down by excessive pessimism. As of this morning, that position was up 41%. Since my continuing study of Peabody shows that an objective valuation is very difficult, I took my short-term profits and will look for a more transparent company for future investment.

In Peabody's 2011 annual report one finds the following impressive graph:

That looks somewhat less striking when one includes one more year and compares to the price of coal:

So most of the impressive performance is due to the period covered being one of a strongly increasing coal price. (Concerning the period covered: the company has existed in a number of different forms for more than a century; the latest incarnation began with an IPO in 2001, so 2002 is the first full-year result.)

Here is a long-term view of the real price of bituminous coal:

Clearly there is a large cyclical component to coal prices, and the recent runup is not necessarily going to continue.

The above is just one example of the company reports being too much under the control of the PR folks, and not really geared to the needs of a rational investor. There are many other examples: reserves, basic to any mining company, are not given in the annual reports at all; you have to go dig through the SEC filings to find them. And “tons [of coal] sold”, which figure prominently in the annual reports and 10-K's, turn out to include trading; the number of tons produced is much more modest.

But the main point I want to concentrate on in this post is cash flow produced and what is done with it – a key measure of the successful operation of any business.

Over the period 2002-2011, Peabody has had average free cash flow of -$173 million. Negative free cash flow is not necessarily a problem, if the money is being used to grow the business. Indeed, capital expenditures and acquisitions have been high, and shareholder's equity has grown from $1.1 billion in 2002 to $5.5 billion in 2011. So it would seem the company has grown significantly.

In what way has it grown? Most often, when one analyzes a growing resource company, one finds purchases of new land, exploration and development, and the growth of both reserves and production over time. But while equity grew 400%, reserves shrank slightly, and production grew only 30%:

It could be, of course, that the quality of reserves and production has increased, or that the reserve of unexplored land has been built up.

For example, Peabody has worked hard to increase its business in Asia. 2% of Peabody's reserves were in Australia in 2002, but 13% were Australian by 2011. In particular, this year Peabody bought MacArthur, an Australian coal miner, for $2.8 billion. Since Australia is close to China, the increased emphasis on Australia was good for business over the last few years (though much less so this year, as the slowdown in China has hit mines in Australia very hard). On the whole a shift to move part of the company's business from the US to Asia is a good one, even if future Chinese growth is generally over-rated.

Metallurgical coal might provide another example of improving asset mix. Metallurgical coal, used as both a heat source and a chemical reactant in the production of steel, has fewer impurities and fetches a higher price than thermal coal, used in power plants. Peabody often brags about its metallurgical coal, and occasionally offers data. Part of the reason for acquiring properties in Australia was probably that the deposits are rich in metallurgical coal. While only about 4% of production was metallurgical coal in 2011, Peabody's Australian reserves are about 32% metallurgical, allowing for increased future production.

Unfortunately, although these examples provide some qualitative evidence that the company really is using cash to increase value, it is impossible to make a quantitative case. For example, since mine acquisitions are listed on the books at cost, there is some suspicion that the Peabody has bought mines at peak prices and that, therefore, assets are overstated on the balance sheet. More generally, there is simply not enough information in the company filings to tell

• whether this year's reserves, in toto, are more valuable than last year's
• whether capital expenditures on mines overall can provide increased production over time, or are simply maintenance
• what the company's overall strategy is in which deposits to keep, which to dispose of, and which to acquire

All in all, looking simply at P/E and the historical share price, I suspect Peabody is reasonably valued. However without being able to do a serious free cash flow analysis or reserve valuation, I not willing to make Peabody a long-term holding. So today I will took the short-term profit of 41% and began looking for a more transparent company.

• 7 May 2010. Selling coal, buying Proshares S&P 500 ultra-short
• 18 Oct 2010. Coal gains in share of energy mix over medium term
• 23 May 2012. Time to take a close look at coal
• 12 Jun 2012. US coal consumption down 14% from peak
• 14 Jun 2012. Coal inventory does not vary much
• 19 Jun 2012. A rapid rise in US coal exports has temporarily compensated for falling demand
• 20 Jun 2012. The global picture for coal -- rapidly growing consumption of a cheap, abundant resource
• 24 Jul 2012. Taking a small position in Peabody Energy

16 Oct 2012 by Jim Fickett.

A number of European stock markets are undervalued. I wrote about this, basing my analysis on data from a paper by Joachim Klement, earlier (Belgium, France, Germany and the Netherlands have attractive CAPE). There I made the case for buying a French index fund (EWQ), but wasn't quiet comfortable with it at the time. Two recent bits of news changed that.

First, the Global Financial Stability Report that just came out had an overview of investment-grade credits in several countries, and this shows that, for investment-grade companies at least, French balance sheets are in about average shape:

Corporate fundamentals and funding conditions remain strong in advanced economies outside the euro area periphery. Although earnings growth is slowing sharply in all countries amid a generalized economic slowdown, funding conditions and the debt servicing capacity of businesses in most countries remain strong. …

The analysis of corporate fundamentals of investment-grade companies shows a significant divergence between, on the one hand, U.K., U.S., and core euro area firms and, on the other, firms in the euro area periphery (Table 2.4.1). Debt servicing capacity (interest coverage) remains favorable for the former group of countries despite the recent decline in profit growth (as measured by EBITDA) in a slowing economy.

The units in the table are standard deviations. So the ratio of income (as measured by EBITDA) to interest payments on debt is almost 2 standard deviations higher in France than in the other economies listed. On the other hand, the ratio of free cash flow to total debt is almost one standard deviation below average. Overall, French balance sheets are in decent shape.

Second, Pacific Capital Associates just put out a ranked list of the Shiller cyclically-adjusted P/E for a number of countries that helps to put things in perspective (no link). Here is the list up to and including France (ranked by increasing CAPE):

Greece, Ireland, Portugal and Spain are sufficiently likely to experience really deep disruption that I'm not very comfortable with investing there without really understanding how a currency change or government default would affect individual companies, and Belgium is on the edge of that group. The law is a foreign concept in Russia, which for me makes it an unappetizing investment destination. I would guess Austria has such a low P/E because the country has a very large banking sector, and the banks are heavily exposed to the peripheral countries – again not a situation I want to get into.

Unfortunately Italy was not covered in the Klement study, so I don't know how predictive the CAPE is for the Italian market. Netherlands and France remain. I think both are potentially interesting investment destinations.

I will start a position in EWQ. I suspect the European crisis will heat up again and perhaps give a better entry point, so for now I'll invest only 1% of the portfolio.

9 Oct 2012 by Jim Fickett.

Best Buy remains a dominant player, and its cash flow remains very strong. Today I took an initial position of 1% of the portfolio.

In the story that Amazon is killing Best Buy we have another great example of “truth by repetition”. The facts are that Best Buy's market share and revenue are stable; its online market share is actually growing; and its free cash flow has been and remains very healthy. So the default outlook should be that recent years provide a decent baseline for future free cash flow.

This would suggest future free cash flows of somewhere between $640 million (if one foresees some future shrinkage, and takes the long-term average free cash flow that includes years when the company was much smaller) and $810 million (the average of the five years 2009-2013, including the midpoint of current guidance). With a current market cap of $6,000 million, that range gives a free cash flow yield of 11% to 14%. That is very high, and suggests the stock is quite undervalued.

A widely quoted fact that supports a more negative view is that same-store sales have been dropping. However, if revenue and market share are stable, this means, by definition, that the sales lost at some stores are being picked up by other stores or the online business. Falling same-store sales are not good, but the company is not actually losing the business.

It is certainly true that, in the past, Best Buy has paid insufficient attention to its online business. They completely missed the importance of the iPod in its early years and, until just recently, one could barely find any mention of the web or the internet in the annual reports. But this is changing. In the last two years online revenues have grown 20% and 14%, and this year the company hired two new high level people who understand the internet – former Expedia president Scott Durchslag and former Starbucks CIO Stephen Gillett.

I have mentioned before that Best Buy does not have a very strong balance sheet. I think the strong cash flow largely mitigates this, provided that the strategy going forward does not require extremely large capital expenditures. This seems to be the case, with the main strategic points being to improve the website, improve personnel training, and slowly move towards smaller stores.

The weakest point in my case for Best Buy is that I assume market share and revenue can continue to be converted to income. But lately there has been pressure on margins. Here is a graph of Best Buy's operating income as a percent of revenue:

Obviously the company is currently feeling great pricing pressure. It is not clear how much of this is from online-only retailers (the CFO recently named some one-off pressures on margins), but probably Amazon is at least part of the story. On the one hand, Amazon is losing its biggest price advantage, in that more and more states are forcing it to collect sales tax. On the other hand, the former Best Buy CEO Brian Dunn said in 2011, “Taxing all online sites equally would be a major, but not complete, closure in the pricing difference.”

My case rests on the thesis that physical stores do, in fact, have some advantages, and that people will not mind paying, say, 2% more, in order to talk with a real person and then immediately buy. I think that is true, but it is always hard to know such things. So the biggest risk to this investment is not that Best Buy will soon disappear, but rather that profits and free cash flow could be lower if the company feels it has to match Amazon's prices.

• Best Buy has no legacy retirement benefit costs; i.e. it never had a defined benefit plan for employees.
• One can find many complaints about poor customer service. An objective measure of customer satisfaction can be found in data from the American Customer Satisfaction Index. According to Best Buy's 2007 annual report, the company scored almost exactly at the national average.
• I am not trying to guess whether Schulze will succeed in taking the company private. If he does, it will almost certainly be at a greater price than where I bought. If he does not, I am betting on a stable continuing business resulting in a higher stock price.
• The current dividend yield is 3.8%. There is much talk in the annual reports about returning money to shareholders via stock buybacks; but in fact at least half the buybacks simply cover employee stock options.
• Best Buy is trying out a new strategy of providing turnkey IT for small businesses, included equipment, setup and repairs, cloud services, etc. If done well, this seems like it could be a winner.

• 3 Sep 2012. Best Buy has healthy cash flow
• 27 Sep 2012. Best Buy's balance sheet is not strong
• 30 Sep 2012. Not time to declare the winner in consumer electronics retailing just yet
• 8 Oct 2012. Best Buy's core business is roughly stable

9 Oct 2012 by Jim Fickett.

Today I added to my position in PELAX, PIMCO's emerging market, local currency bond fund. I've explained my interest before (Purchasing two PIMCO bond funds); in short, this is a fairly safe, non-US dollar place to park money, both for current income (paying about 4%) and safety from future US inflation. I brought my position up from 3% of the portfolio to 4%. It may be there will be a better opportunity next time worries about Europe heat up. If so I'll use that opportunity to bring the allocation up to my target of 5%.

26 Sep 2012 by Jim Fickett.

I would like to own more assets in countries where inflation is viewed as a dangerous scourge. Germany is at or near the top of that list. While I do not think one can predict how the euro zone sovereign debt crisis will work out, I'm quite sure that the ultimate solution will not involve high inflation in Germany. Germans mostly save by putting money in the bank, so currency stability is of prime importance to a large fraction of the population and, further, the great hyperinflation of the 1920's is remembered vividly and often referred to in current dialogue.

Daimler is a large, old company best known for their largest division, Mercedes-Benz cars. If you've spent much time in Europe you will have noticed that they also manufacture a large fraction of the commercial vehicles there – buses, trucks, and vans. More recently they're also into green, making, for example, the Smart car and hybrid versions of many of their other vehicles. No one is going to break in on the territory of the Mercedes name any time soon; with the much-bemoaned inequality of incomes in the world today, luxury cars will continue to see solid demand; and well-made trucks will always find a market. So Daimler is worth a look.

For many basic valuation questions it is important to know whether a company is growing. The data are somewhat ambiguous for Daimler; the company is either stable or growing gradually.

(All data are from the annual reports. All euro amounts are inflation adjusted and reported here in 2011 euros.)

The core business is in Mercedes-Benz cars. The recent impressive growth in sales is mainly because of Daimler's expansion into China – sales were up 39% from 2010 to 2011 in China, compared to sales down 2% in Western Europe. Daimler is banking heavily on China, expanding operations there and projecting continuing growth. I am somewhat less optimistic about China's growth but, even so, the car business is at least stable over the long term, and probably growing via emerging markets.

Revenue has clearly dropped, over the whole period shown. However this is, to a large extent, due to the disposition of Chrysler (after the disposition in 2007, results back to 2005 were retroactively restated for Daimler without Chrysler).

Shareholder equity has been flat.

With my skepticism about continued supercharged growth in emerging markets, I view Daimler as a stable, mature company with modest growth prospects.

The first thing one notices about income, free cash flow, and the dividend, is the strong cyclicality:

A 10-year average is probably long enough to get past the high variation. Adjusting for inflation, the ratio of the current market capitalization to the 10-year average income is 13.3, which is a reasonable P/E. The 10-year average free cash flow gives a yield of 8.1%, which is very good for a mature manufacturer. The 10-year average dividend gives a yield of 3.6%.

The large cash flow yield suggests the dividend yield is sustainable. So Daimler looks to me like a bond with a reasonable, fairly safe yield and a somewhat volatile, inflation-protected principal – hence a decent place to preserve capital.

One remaining hesitation I have is that I prefer to invest in companies where I can admire the management. The fact that the free cash flow yield is much higher than the dividend yield, and yet shareholder equity is not growing, is somewhat worrying. I would like to know where all the cash is going, and whether it is really contributing to the future value of the company. Tracking this down may or may not be straightforward – the company is complex, with many subsidiaries and joint ventures all over the world.

After looking into the cash flow issue and recent quarterly results, I will probably wait a bit and see if things deteriorate further in Europe (quite likely and soon), China (quite possible) and the US (likely but with uncertain timing). Further economic bad news would probably give a more attractive entry point.