[robot.sonic]

Thanks TSO!

Pashare din ng analysis mo kung ok lang sayo ha.

Naghahanap din ako ng mga undervalued companies ala clifftheinvestor. P/E at P/B nga lang ang indicator ko tapos tingin sa interim EPS. So far ang nakita ko pa lang ay yung RCB. Nakabili ako kanina at tumaas naman ngayon.

[TSO]

TSO,

why is it so that you consider 0.9 beta as high?  what is your acceptable beta range before you invest?

I just recently invested on a firm with a beta of 0.5 and likewise invested on another one last year with a beta of 1.7

of course, in my decisions, beta alone is not the trigger point.

I have no beta range.

However, I prefer any beta that is approximately equal to 1.0 and anything up. So if it's 0.9, I consider it "high". I love volatility, you know.

[drenevich]

TSO,
Salamat. Ang galing naman ng ginawa mo dito sa thread. Not to mention that it's free pa. It's very generous of you to provide such informative analysis.
I know you're busy. But if you happen to have some time. Can you make an analysis on FDC?
I hope it's not too much to ask. And please, take your time. Ayaw ko po makaistorbo sana but I badly need help.

[akira0422]

hi TSO!!! can i ask your opiniion on your view on EDC's managemnt.... i feel that its drag is currently due to perception of how mangement is dealing with the impairments they have.... the business though has no question, however growth myt be hampered with fuzzy direction... THNX XD

[panitanfc]

Looks like I need to wait a day, huh? Hmm...

Anyway, here's the third and final portion of my EEI Corporation report.

Hope it helps. The entire thing was 15 pages long...


Future Prospects
Still, just because a company has a pretty good chance of manipulating its accounting records for the investing public doesn’t mean it has no decent opportunities for growth.

In addition to a special section from EEI’s 2010 SEC 17-A, I have four sources here that attest to the wonderful opportunities available to this corporation today, one of them being a company update written by a chartered analyst working for Citisec Online.

The Saudi Gazette (released on Nov 2010)
-   The KSA is expected to award contracts of up to $86 billion in 2011.
-   There were, at the time of writing, $624 billion worth of projects underway or being planned
-   Demand for construction in the Middle East, according to UAE-based Proleads Global, is set to soar as the industry is faced with major developments and impending recovery from economic downturn.
-   Business Monitor International reports, the United Arab Emirates government has appropriated almost $12 billion for infrastructure projects from 2010 budget

Asia Today (released on 15 Mar 2011, written by AME Info FZ LLC)
-   Construction projects in the KSA, the Middle East’s largest construction market, are expected to be worth “around SR237.4bn in 2012 as the Saudi Government proceeds with its Five-Year Development Plan” (note added: 237.4 billion Real is approx. $63.31 billion)
-   “The rapid expansion of the construction sector is driving parallel growth in the Kingdom's construction machinery market, which is expected to expand further by 20% through 2015.”
-   “The Saudi Government's 2011 budget is currently funding construction-intensive, multibillion-riyal projects ranging from ports and roads to rail networks and communications facilities.” Infrastructure enhancements will account for a significant portion of Saudi Arabia’s development over the next five years.

Construction Week Online (released on 7 Aug 2010, written by Andy Sambidge)
-   Business Monitor International forecasting almost 7% growth in KSA’s construction sector in 2010, fueled by “billions of dollars of projects either in the pipeline or currently underway”. BMI analysts estimated a 4Y CAGR of 4.13% from 2010 to 2014, based on number of on-going projects. Industry value forecast should rise from SR92.2 billion ($24.57 billion) to SR122.48 billion ($37.7 billion) over same time frame.
-   Saudi’s native population is a key factor behind the stable and growing demand for infrastructure. The government has also shown a commitment to infrastructure development and its ability to support these plans through funding.
-   This is incredibly strong growth, taking place during a recession and thus, difficult access to credit. It illustrates resilience of the Saudi Arabian construction industry and the demand from the locals, whereas other countries rely on expatriates and tourists for infrastructure development. (emphasis added)

COL Company Report (released 8 April 2011, written by Richard Lañeda, CFA)
-   the significant increase in oil prices (now over US$100 a barrel) should lead to more investments in refineries and petrochemical facilities
-   Lañeda estimates a 12% success rate in EEI’s bidding for projects, all of which were reported by EEI to be valued significantly higher than pre-crisis levels (emphasis added)
-   Domestic operations also looking great. Property developers are launching multiple projects, supplying a very favorable demand-supply situation of the Philippine construction sector. Philippine government is also launching infrastructure development through a public-partnership program (PPP) that would hurl P38.9 billion in projects on 2011.
-   The tsunami-earthquake combo that brought Japan to its knees might provide more opportunities for EEI, since it can participate in the restoration efforts of damaged Japanese industrial facilities, refineries, and power plants. EEI has had previous partnerships with Japanese companies, so this direction may actually bear fruit.

Regarding the chartered analyst’s report, I investigated the PPP and discovered that the Philippines has a website for it, which details the projects it intends to roll out.
-   NAIA Expressway (Phase II)
-   DaangHari – SLEX Link Road
-   MRT & LRT Expansion (privatization of LRT 1 and maintenance)
-   NLEX & SLEX connector
-   MRT & LRT Expansion (LRT 1 South Extension)
-   CALA Expressway (Manila Side section, approx. 27.5 km.)
-   Airport Developments for Puerto Princesa, New Bohol, and New Legaspi (Daraga)
-   Privatization of Laguindingan Airport Operation and Maintenance
-   LRT Line 2 East Extension
-   Over 30 national projects for medium-term rollout, among the departments of agriculture, transportation and communications, and public works and highways, education, health, along with the MWSS and National Irrigation Administration

 The American Chamber of Commerce senior adviser John Forbes told ANC’s Business Nightly in an interview that the Philippine economy could grow 9% a year “by doubling government spending on infrastructure and pushing private-public partnerships. (Philippine PPP Center, 5 May 2011)

SEC 17-A 2010 Report (released 2 May 2011)
-   The Philippines’ economic growth for 2011 and the medium-term is expected to be sustained, though not as outstanding as the year 2010. The projects handed out by the PPP should contribute significantly to this.
-   Growth drivers of the construction industry are presently the acceleration in construction, expansion in mining, and the housing sector’s recovery. An immense interest in biofuel and renewable energy has picked up, especially now that the attractions of nuclear energy thanks to the aftermaths of the recent Japan tsunami-earthquake event.
-   The political unrest in the Middle East aren’t expected to drastically impact ARCC’s operations; the King of Saudi Arabia had taken preemptive measures and declared benefit programs for his citizens. An increase in the number of projects should impend.
-   EEI’s presence in Guam    was made due to its medium-to-long0term need for workers for the construction of a US naval base that will eventually be transferred to Japan, as well as other renovation projects. Further, the company is preparing to set foot in Australia and Dubai, which EEI said are showing signs of recovery from the global crises.
-   Modular fabrication is seen to have enormous potential. The Saudi Arabian steel fabrication shop is currently operational, complementing its shop at Batangas.


EEI will focus on its core competencies: construction of industrial facilities, buildings, steel fabrication, and infrastructure. Through ARCC, it is a preferred contractor for heavy industrial projects in KSA and it plans to penetrate more countries overseas, throwing around its experience in petrochemical, oil and gas, power, and mining sectors.

To ensure the maximization of these opportunities, manpower is a critical priority. EEI would continue to focus on recruitment and training for the next few years, in order to meet the workforce requirements of the projects they will bid for. Safety and quality are the top value propositions offered to clients through EEI’s workforce, and, to complement their numerous training programs, the company began the process of acquiring the OHSAS 18001 certification and hopes to bag it by 2013.

Increasing efficiency of its operations remains an important initiative. EEI is in the process of modernizing the equipment and software used for construction and steel fabrication. In fact, there are layout improvement plans already underway for the Batangas shop, which would accommodate more machines and smooth the workflow, essentially increasing production caps. Internal businesses processes would be upgraded by a document management system that would save paper and facilitate data sharing.

It goes without saying that EEI’s future prospects are strong.

III. VALUATION ANALYSIS

Going back to what I stated in the executive summary of the risk assessment, EEI Corporation’s operational efficiency, decent profitability, inherent stability, and awesome prospects for the future pointed to low-to-moderate levels of risk. However, my own misgivings on EEI’s financial reports, as you have just read in the previous section, bumped up this perception to MEDIUM-HIGH.

As per my May 4, 2011 update, my valuation analysis will no longer assign a subjective discount rate tied to the perceived risk of the company for the deep scans. This has been changed to the weighted average cost of capital (WACC). You may find my reasons in my thread.

Historical interest rates on interest-bearing debt, ± any adjustments, were used to estimate EEI’s cost of debt-funded capital. Cost of equity, on the other hand, is computed using a modified capital asset pricing model.  The risk-free rate is set at 5.875%, the 7-year T-bond’s coupon rate last month. The market return is a 6-year geometric growth rate computing using the ’10 and ’04 quarterly averages of the Philippine All-Share Index, which was 15.24%.

Thus EEI’s WACC—as well as my discount rate—is approximately 18.36%.

Returning to the topic at hand, EEI’s book value currently stands at P3.74B, translating to P3.61 a share. Net income for FY10 was P657.2M, or P0.63 a share. The prevailing market price as of 6 May 2011 was P3.6 a share (P3.73B market cap). Converted to the usual valuation ratios, we find that EEI is priced at 5.71 times ‘10 net profits, and at almost exactly the level of book value.

However, the P27 billion worth of backlogs on ’10, when discounted to the present on a three-point premium above gross margin realized for the year and divided into its costs and estimated earnings portion, will add P1.1 billion to equity. Forcing consolidation of ARCC into the financial statements would increase it further by P965M (deducted for a corresponding decrease in “investments in associates”).

The adjustments would leave total equity with a balance of approx. P4.8 billion, or P4.63 a share. EEI may have been fairly valued at reported book value, but it is 22% undervalued when the analyst keys in the impact of uncompleted projects and ARCC.

Once again, we are faced with the question, is the EEI Corporation a good investment at P3.63 a share? Because it is undervalued (and continued analysis would only serve to accentuate this), will P3.63 a piece provide a large margin of safety, just in case everything goes to hell?

Net Asset Value
First of all, I had to estimate the value of EEI’s assets. Because of the long-term nature of its operations and its good prospects for the future, it was fairly obvious to me its executives weren’t going to be interested in liquidation within the next six or seven years.

The net reproduction cost method of asset valuation popularized by Bruce Greenwald was hence used for this. Before delving into the heart of the matter, my assumptions were relatively simple: everything is 100% except for investments in associates, Net PPE, Investment Properties, and net receivables.

Investments in associates were tripled to reflect the assets owned by ARCC. I am fully aware this might end up overstating the other joint venture EEI owns, but that doesn’t really matter since its assets are so small in value, any overstatement is laughable.

Net PPE’s value was reduced to 62% of its value (to P663M). To explain, EEI’s PPE consists of (1) machinery and construction equipment, (2) land, buildings, and improvements, (3) furniture, fixtures, computers, and office equipment, (4) transportation and service equipment, and (5) construction of fixed assets in progress. Obviously, anyone who was going to setup a company just like EEI would spend less for the same construction equipment, the same furniture and office gear, and the same transportation and service equipment.

That assumption is even more valid considering these same assets have remaining lives less than half their implied useful lives.  To convert it into plain language, I ask a simple question: if I buy an iPhone 3G for $300, would you be interested in buying that same phone a year later at the same price, when the iPhone 4 is already being sold for roughly the same amount?

Out of conservatism, I reduced the net figures of these items by 50%. I made no adjustments whatsoever to construction in progress, and land, buildings, and improvements due to the fact I know nothing about all the land under EEI’s ownership and whatever they are constructing for their own use. This reason also applies to investment properties, which was left to 100%.

As for net receivables, all I did was add-back the allowance for doubtful accounts. Combined with the present value of uncompleted contracts (assets) and that of their costs (liabilities), I ended with approx. P6.99 billion in reproduction costs.

This total is further adjusted by the value of their customer relationships (estimated by a small percentage of construction COGS and SG&A to represent operating expenses spent on finding new contract partners and clients and maintaining current ones, which is capitalized and depreciated over a five-year period) and of their expertise in electromechanical structures (estimated the same way as customer relationships).

Inputting those two modifiers, I arrived at roughly P8.1 billion in net reproduction costs—P7.82 a share. To add a layer of safety, this valuation is reduced by WACC, bringing it down to P6.38. Juxtaposed to the market price, we are left with a 43.6% margin of safety. Sweet!

Value of Zero Growth
Second, I had to approximate the intrinsic value of EEI’s earnings power, again as prescribed by Greenwald. The sustainable level of revenues that could be earned by EEI’s four business segments was assessed at P8.5 billion, including ARCC’s contribution to it. This is about 22% less than what EEI usually makes every year.

Operating margins are assumed to be at the median 4.1%. Effective taxes were set at 30% to effectively eliminate EEI’s skills in tax management. Maintenance capital expenditures were estimated at the adjusted depreciation expense.

We are left with an income metric of P477.8M, representing a margin of 5.6% (versus the median net margin of 6.5%). Capitalized using WACC and adjusted for cash in excess of what is needed for operations and interest-bearing debt, the value of EEI’s earnings without any growth whatsoever is roughly P2.5 billion—P2.41 a share.

The estimation shouldn’t be a cause for concern. Although the current price is almost 50% overvalued with respect to this value estimation, two things must be remembered. One, this does not include growth. Two, based on the discount rate used to obtain the nominal EPV, the highest price we must be willing to pay for this company is P7.09 a share (which is equivalent to Graham’s maximum 16 P/E prescription).

What matters is the discrepancy between the estimated values of EEI’s assets and its sustainable earnings. There would only be two reasons why the net asset values are higher than the values of earnings without growth: bad business fundamentals or poor management. The 62% gap between assets and sustainable earnings simply reaffirms my concerns with EEI’s risk profile. (Review Risk Assessment for more information.)

Value of Growth
Third, I had to bring in the check how much growth could impact the stock price of the company. The process used to estimate the value is the popular DCF model used by analysts everywhere, based on residual owner earnings projected over the next six years using a plethora of conservative judgments that effectively forecast the income statements. Before I proceed, note that my biggest assumption here is that EEI’s debt payments are all below 1B.

Scenario analysis is exercised to check the effects of all growth scenarios. Realism is also confirmed by juxtaposition of forward 6Y CAGR’s with historical figures and the proportion of terminal values in the net present value of owner earnings.

As I don’t want to kill brain cells rambling, I will cut to the chase. The DCF valuation produced forward 6Y CAGR’s weaker than what has been observed historically. Construction revenues, for instance, supposedly grew at 13.4% a year since ’04. My models all churned out forward rates of 6% and less. Furthermore, the net present values calculated using the financial models were mostly a result of yearly income rather than the hold of terminal values.

In the end, I arrived at P3.00, P4.58, and P7.17 in share prices for pessimistic, neutral, and optimistic growth scenarios, providing margins of safety of 21% (neutral) and 50% (optimistic). Pessimism was keen to remind we could end up losing 20% on this investment in the long run. Nonetheless, the value of growth is 24% higher than that of stagnation at a minimum. 

IV. PERSONAL CHOICE OF ACTION

The margins of safety are high as far as assets are concerned. It is 50% overvalued in comparison to earnings power, but the overvaluation is at a level we can accept based on the level of risk and the highest purchase limit prescribed for guidance in our decision-making. Growth scenarios present us with ample margins of safety, and chances of the company sticking to the pessimistic forecasts (or doing worse) are low, considering the opportunities available in its grasp.

Priced under adjusted book value and facing the impending opportunities ahead with 80 years of experience and a verified reputation for efficient operations, I personally think EEI Corporation is a company worth buying into in spite of my own reservations.

Of course, once I have a position in here, vigilance must be exercised. The quarterly statements are crucial in tracking the over/under-billing and the amount of money EEI is spending to pay its short-term bank loans. Anything related to Saudi Arabia should be observed regularly as well, as a majority of EEI’s construction revenues (reported and stashed away in ARCC) are straight from there.

Ample margins of safety aren’t viable excuses in the face of constant vigilance.

Ah this is a great company..waiting for correction!

[TSO]

Hillenbrand, Inc.
Country:      United States
Ticker Symbol:      NYSE – HI
Industry:      Manufacturer – Death and Process Equipment
Current Price**:   $22.78 a share ($1.42B market cap)
NOPAT*:      $100.20 / $99.93 / $113.43
Net Income*:      $102.36 / $91.73 / $106.44
Adj. GAAP EBITDA*:   $188.91 / $185.73 / $215.83
Periods Analyzed:   2004 to 2011
Date started:      28 Dec 2011
Date finished:      29 Feb 2012
Report written by**:   1 Mar 2012
* For fiscal years 2009, 2010, and 2011, respectively. All in millions of US dollars.
** Finalized and updated the report on June 2012. Market price of HI was $19.09 on the most recent trading day ($1.19B market cap).


I.   PROFILE

Hillenbrand, Inc. (NYSE: HI) is the parent company consisting primarily of three companies: Batesville Services, Inc., K-Tron International, Inc., and Rotex Global, LLC. HI proclaims itself in its 2011 10-K as a “global, diversified industrial enterprise with two platforms that manufacture and sell premium business-to-business products and services for a wide variety of industries”.

For Hillenbrand, stability is the name of the game. Its presence is felt in the deaths of thousands of Americans and Canadians alike, the funeral products it manufactures (e.g. caskets, cremation urns, and vaults) contributing about 80% of sales from year to year. Two years ago it has begun diversifying from the scythes of death, expanding through M&A transactions into process equipment, machines aimed at automating and maximizing the efficiency of manufacturing processes (i.e. feeders, industrial crushers, and dry-solid screeners).

The business of death rests mostly in Canada and the United States, with the company holding about 25% of the $2.6B industry on 2011 year-end.  Process equipment, on the other hand, has a larger geographical and customer distribution, with sales across both the globe and multiple businesses, catering to the likes of General Mills, DuPont, Dow Chemical, MasterFoods (Mars), Merck, Pfizer, Nestlé, and Saudi Basic Industries (Zack O’Malley Greenburg, “Counted, Weighed, and Divided”, Forbes.com, 29 Oct 2007).

Three “enduring core competencies” (2011 AR) permeate their operations:
•   Strategy Management: sharpens focus on critical objectives
•   Lean Business: a philosophy nitpicking on methods of eliminating waste and inefficiencies
•   Talent Development: the custom of developing and retaining in-house talent from the ground up.

II.   EXECUTIVE SUMMARY

Hillenbrand seemed like an excellent target...

First brought to my attention by Anand Chokkavelu, an analyst of the Motley Fool who mentioned it in an article he wrote five months ago, Hillenbrand seemed to have everything I looked for in a lucrative investment: high margins, high returns on equity, a dividend yield no less than 3%, and a viselike grip on its market share.

The company’s stock, on further investigation, seems fraught with inefficiency. No more than three analysts covered this stock in the past three years (S&P’s Quantitative Services, Quantitative Stock Report, Standard & Poor’s, 24 Feb 2012, accessed via E*Trade). No articles about it exist on GuruFocus or SeekingAlpha. How can a business as great as Chokkavelu claimed escape the scrutiny of multiple, intelligent eyes? The answer to this, apparently, lies in its special situation (More info in “Disclaimers” under Section III.)

…but the company proved resilient to analysis.

Much time was spent and wasted on planning my attack strategy for this monster of a project. Industry-related information relevant to the analysis was scarce. Opacity and obscurity veiled the company reports, shielding it from investors and talented analysts alike. The footnote for “Segment Information” was more an obstacle than a tool of illumination. Standard procedures employed in appraising a business’s long-term value floundered in the face of Hillenbrand’s complexity, requiring much creativity and mental fortitude from the analyst.

By the time I have begun diving into the business, a month has already passed.

Hillenbrand represented the most difficult project I have ever undertaken in my entire history as an analyst (as of writing). Writing this research report filled me with as much pride…

…As my agonizing disappointment in this company.

Perseverance and determination uncovered damaged credit…

The company’s creditworthiness are troubling, but still enough to keep Hillenbrand out of trouble, provided it acts with caution and prudence, especially in its M&A dealings.

Debt ratios stand in the 60’s, and solvency ratios saw less profit metrics meeting the safety marks. Asset liquidity may be adequate, but earnings coverage has worsened considerably, which will certainly result in refinancing of debt in the near future should HI permit the permanent expiry of its $400M revolving credit facility in 2013.

…obfuscation of operating efficiency…

Opacity impedes understanding of the company. Management has consistently provided zero transparency on the nature of its operations in any of its filings. Even the investor-oriented presentations provide little help, tailored to a gross exhibition of pie charts stripped free of the numbers. Backlogs of the Process Equipment business aside, operational efficiency was analyzed using the financial statements alone.

The computed information suggest improving efficiency across the board, with discrepancies between LIFO and FIFO inventory accounting indicating both rising costs and an ineptitude in anticipating future demand.

Asset turnovers, an overused ratio for efficiency, are distorted further by the K-Tron and Rotex acquisitions, for the massive levels of goodwill added to the balance sheet would certainly exude the illusion of drastically falling turnovers, when in fact the plunge is not as dramatic as it seems.

…and a struggle to defend profitability.

Hillenbrand deserves a round of applause for keeping its gross margins consistent for the past eight years, despite the pressure exerted on it by cremations and their steady rise since the 1960’s. However, operating profits have gone defensive, squeezed by unidentifiable operating costs, depreciation and amortization, and pension liabilities.

Restructuring and acquisition costs chip away at the profits retained by Hillenbrand, as do the litigation costs that hound its cases against the unrelenting plaintiffs of the 2005 antitrust case and the more recent lawsuit involving its fellow competitor, Matthews. Whatever is left behind is eaten away by a growing base of interest-bearing debt—leverage employed to fuel HI’s acquisitional expansion in process equipment.

Considering the amount HI has paid and must pay towards debt principals, it is clear the attractive dividend yield of no less than 3% is illusory, being purely debt-financed, limited by the separation agreement between HI and its parent, Hill-Rom (NYSE: HRC), and under threat by unseen catalysts.

Although the company is stable, immune to death…

Any idiot can easily figure out Hillenbrand’s product lines are enduring, if not everlasting. Caskets, cremation urns, and vaults are facts of life as is the scythe of mortality.  Machinery such as crushers, screeners, and conveyors are critical components in large-scale processing, with no alternatives available save for manual labor: tedious, expensive, and error-prone.

Roughly 75% of the Process EQT segment’s revenues are driven by six industries: plastics, food, chemicals, coal mining/power, pulp/paper/biomass, and pharmaceuticals. Certainly it wouldn’t be hard to imagine how large are the demand for these products when aggregated.

…it is undermined by both management…

For all the stability and invulnerability dominating Hillenbrand’s lines of work, I harbor heavy distrust for the management. An analysis of internal accounting and the variances between cash and accrual bases imply moderate consistency, a neutral observation had “C” and “F” scorecards convinced me Hillenbrand’s leadership isn’t likely to screw its owners.

The management clearly doesn’t want serious investors and analysts from fully understanding their business, a desire deduced from the nondisclosure of KPI’s in their public reports, conference calls and presentations tailored to selling their story and “double-digit growth” instead of apprising the shareholders on more important matters with far-reaching ramifications on Hillenbrand’s future value.

Trouble encountered in catching a knowledgeable person from investor relations and a leadership willing to overpay for M&A transactions and partially finance them with debt to boot have both eroded my faith in the leadership.

These are giant red flags that mustn’t and shouldn’t be ignored, whether or not the management maintained satisfactory levels of efficiency, profitability, and growth.

…and uncertain prospects for the future…

There is little growth awaiting Batesville. With the market pool pinned to approximately 2.7 million Americans and Canadians on average, year after year, it is clearly in a zero-sum game poised for shrinkage as healthcare, biotechnology, and lifestyle quality advance. Lawsuits battering Hillenbrand and Hill-Rom portend serious damage should their defenses flounder. On top of it all, gross margins are still under threat from the evolving preferences of their weeping, grieving consumers.

...which are hazy at best.

The process group’s upside potential, furthermore, is uncertain, tied not only to the economic cycle but also to the growth catalysts of so many industries they are too broad to specify and too many to factor in quantitative models. But whatever potential this business segment may hold is nonetheless exposed to the high possibility of Hillenbrand being ripped off by its M&A targets.

Thus Hillenbrand’s margins of safety are clearly insufficient.

Hillenbrand’s passable credit, generally improving efficiency, a preservative state of profitability, and strong competitive advantages all point to a “low to moderate” (Level 2) risk rating at best and a “moderate” (Level 3) risk rating at worst. However, the frustrating efforts it took to contact management, their acquisitional conquest in a different market combined with the likelihood of accepting overpriced deals, opacity in their public documents, negative catalysts for Batesville, and the diversified but uncertain growth outlook for the Process Equipment segment have all led me to conclude, after much review and reflection, Hillenbrand, Inc. represents a MODERATE TO HIGH RISK (Level 4) to the investor.

This risk rating produced a WACC of 9.65%. HI’s market price of $22.78 contains an 18% premium for growth and implies a yearly revenue growth rate of negative 0.7% for the next seven years and a 2.4% rate of growth for the terminal period thereafter.

DCF models assuming maintained gross margins and the eventual payment of 50% of known potential litigation damages during the terminal period point to 48% overvaluation on a pessimistic scenario, and an inadequate 10.4% margin of safety for the neutral scenario. Should the company escape the lawsuits unscathed, HI would be undervalued by 20% on a neutral outlook and overvalued by 18.5% on pessimistic.

I do not recommend HI for short or long operations. However, its beta of 0.74 (according to Google Finance), Europe’s continuing problems, America’s struggling recovery, the uncertainty of Batesville’s litigation outlook, and the excellent stability of the company’s manufacturing businesses are compelling enough for continued observation until a suitable buy price has been reached.

June 9, 2012 UPDATE:

With the current price of Hillenbrand now at $19.09 a share, owing to developments during the ongoing Euro crisis and its May 7, 2012 guidance (when its FY12 expectations were revised downward).  This is definitely a potential entry point, as this represents:
-   A 2.5% discount to stagnation value
-   22% overvaluation to pessimistic growth and 25.6% margin of safety for neutral growth, taking into account the impact of failures to defend against litigations.
-   2% margin of safety for pessimistic growth in the absence of litigation damage. (35% for neutral!)
-   Expected revenue decline of 1% a year for the next seven years with a damning stagnation for the terminal period. (Expected decline of four percent yearly if terminal growth rate equaled long-run inflation.)
-   A dividend payout ratio of about 4%, whereas the price three months ago represented a DPR of 3.2%

However, I will not be editing the majority of this research report since it will not be necessary.


You may find the full analysis on Gurufocus. BE WARNED: IT IS EXTREMELY LONG. (Twice as long as my usual write-up!)

[finance123]

TSO, I like the way you write. Saang business school ka nag aral sa manila?>

[TSO]

ADMU.

You like it, huh?

That's good. I was thinking my Hillenbrand report was a little too flashy.

[alacrity]

Hi TSO, this is off-topic, but what do you think of conglomerates, in general?

[finance123]

K lang naman. Masyado lang syang mataas but it is good. I always read your analysis.

[TSO]

@ Fin 123

Okay. Just a little concerned since my professional contacts all tell me that I need to be more concise and direct, and less flashy, if I'm going to show my write-ups to hedge fund managers.

@ alacrity

Conglomerates are a lot like trying to analyze forests.

Analyzing them from the top-down helps, but ultimately, you want to know how they are doing on a per segment basis. Furthermore, you need to understand how their major businesses operate.

This all depends on the generosity and largesse of the management to disclose information to you, the analyst-investor, and in such a manner that it is consistent and relevant.

[finance123]

Ano ba ang inaral mo sa ADMU finance, accountancy or economics?. Ako din ay finance major sa isang university sa province. Hopefully, I will graduate in 2014.

I think tama sila. Its too long. Can you write your research as if your writing for bloomberg news at hindi pang academics?

[TSO]

Management lang. Hindi pa nga honors eh haha.

Hmm, well, I'm writing my next report on Diamond Offshore (DO). I'll make it more direct then.

[alacrity]

@TSO

Thanks for pointing me in the right direction and for the quick reply.

@ alacrity

This all depends on the generosity and largesse of the management to disclose information to you, the analyst-investor, and in such a manner that it is consistent and relevant.

Mind if I ask what information from the management you're pertaining to? Because all I look at are annual reports and the other disclosures on the PSE website.

[TSO]

This is basically info that has nothing to do with the financial statements, which are useful on their own or can be combined with financial info to produce meaningful data on their operations.

Examples: unit sales, breakdown of ppe (from my experience, found in PFRS & IFRS, but not US GAAP), customer base, etc.

Problem here is that a transparent management can be TOO transparent and inadvertently expose either the investor to information overload or their internal data to competitors.

Just because a company complies with regulatory standards doesn't necessarily mean everything's okay with that company. Look at Enron. Look at Green Mountain. You need to read between the lines. And even then, you can't trust even the very information provided by the company... not without being conservative in your risk assessment, in your valuatin, or both!

It is better to encounter false negatives (you're wrong, but price goes up) than false positives (you're wrong and price falls for the long run), because recoveries can cripple your absolpte performance.