November 2012

……………….Thoughts and Comments

 

World Economic News

Blah, blah, blah, blah, fiscal cliff, blah, blah, blah, blah-blah, China, blah, blah, Japan, blah, blah blah, blah, Spain, blah, blah blah, blah Italy, blah, blah blah, blah blah, blah France, blah, blah, blah blah.

Nothing has changed since last month and reviewing it in any greater detail is both unproductive as an investor and apt to send many (including myself) off screaming and pulling their hair.

 

Real Investment Thoughts

Gold has been struggling recently, as the markets whipsaw up and down with every word someone in the media spouts about the fiscal cliff.  For once, there is some logic to this struggle, even though it is very short-sighted.  If we run into a recession because taxes are raised and/or spending is cut dramatically, it is very logical that gold should sell off because the likelihood of inflation drops dramatically – short term.

Gold as represented by GLD – the Spyder Gold Trust – 1 Yr Chart

 

Long term, the Fed is likely to continue its QE spending (many expect them to announce QE4 at their December meeting) which means that the devaluation of the dollar will continue over time, even if short term the economy struggles.  At the same time, Japan’s next Prime Minister has announced that he wants to join the rest of the world’s devaluation process so that their currency will be more competitive.  This is very much like wanting to be competitive with the others clowns racing their cars across the cliff to see who can crow about being the fastest as they plunge to their death.  All this means is that many, many currencies are going to be so questionably weak that anyone who happens to have money isn’t going to want to hold it in their currency, which leads us to gold.

 

Gold as represented by GLD – the Spyder Gold Trust – 5 Yr Chart

 

Note that South Korea has increased their gold holding by nearly six-fold in the past year, Brazil has increased their gold holding to the highest level in a decade, and China continues to be the largest buyer of gold in the world.

So while short term, there could be continued pressure on gold prices, investors have to remember that their focus must be much longer than the average market participant.  When gold finally starts to make its final push upwards, it will be swift and dramatic, so you want to have boarded that train already, even if a little early.

 

Putting Thoughts into Actions

As we have mentioned in prior months, we think that staying focused on companies that provide opportunities will be more advantageous than getting caught up in media/trader hype.  Recently we have added several positions that we think are good opportunities and below provide an example of our thought process.

Kraft Foods (KRFT)

KRFT is the North American grocery foods spin-off from “old Kraft” (now Mondelez, focused on international snack foods and beverages). The new business is defining itself largely as a beverage, cheese, and convenience product company, with flagship brands Maxwell House, Country Time, Capri Sun, Philadelphia, Kraft cheese and dinners, Velveeta cheese and dinners, Oscar Mayer and Lunchables cold cuts, along with moderately recent acquisitions of niche brands MiO and Tassimo beverages and Athenos cheese.

The spin off left the company with tremendous amounts of debt (approximately $6 billion) and leverage of 139%.  Their historical net profit margins are 10.5% however; and the business is a stable one that is very attractive is such unstable economic times.

What makes this interesting is the management team and what we believe to be the three-year goal.  The new Chairman of the Board and the new CEO are both from Ripplewood Investments, a Chicago based private equity company that specializes in recapitalizations and turn-around investments, and they both have experience at large companies (Pepsi and Johnson & Johnson respectively).

The management team has announced a strategy of thinning unprofitable brands and products, aiming product innovations at both the bottom-end convenience-store market and the premium shopper, and focusing on cash flow, with a goal of free cash flow equal to 85% of revenue.

Furthermore, the management has stated that it will emphasize incentives and stock options rather than high base pay.

Finally, the company is expected to announce a dividend later this month ,which is expected to be $2.00/share or about a 4.4% yield based on the current price.

Having looked at their brands and what we think might be sold and what they could get for them, and reviewing management compensation, we believe that over the next three years they will sell about $3 billion in assets, cutting their debt level in half and allowing for future dividend increases.

With much of senior management’s pay in restricted stock and stock options, their goal is to get the price up.  If the stock were to $50 from the current price, this should give the Chairman somewhere close to $12 million in stock-based compensation compared to about $4 mm in salary over the same time frame.

At that point it would not surprise us if the company were to be sold, leaving the management with a golden parachute.   Thus, our goal is about $55/share based plus a 4.4% dividend yield, or a total return of 33% with 10% downside risk.

Please note we purchased this stock at significantly lower prices this past month for clients.  This is meant to illustrate our thought process only, not to make a recommendation for the reader to buy this security or to purchase it at current prices, which we would not do without knowing the reader’s goals, risk parameters and investment needs.

 

The Bottom Line…

Not much has changed since the last month and so this month’s letter is short.  We continue to focus on finding companies with good management and good opportunities.  We have added several in the past month as stocks sold off and have a number on our target list that we expect to be able to acquire at attractive prices over the next few months.  Portfolios compositions continue to be a balance between cash, short term fixed income, gold and equities.

As the Spanish philosopher Baltisar Gracian said, “Good things, when short, are twice as good.” So I hope that this month’s letter is twice as good as the last.

 

Alan E. Rosenfield, Managing Director

12/06/12

 

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