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Bill Frels Buys Nalco, Adds Target and Badger Meter

August 18, 2011 | About:
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Bill Frels is the lead manager of Mairs and Power, an investment firm that utilizes a conservative investment approach. The firm targets growth stocks and higher rated fixed income securities that are traded at a discount to their true valuation. Equity securities are typically held for relatively long periods of time to maximize tax efficiency and enable compounding to build on principal. Fixed income securities are usually held to maturity, with the firm looking for strong credit quality and ability to produce regular income. Securities are sometimes sold when fundamentals change, investment strategy shifts, or when equities become overvalued, but the firm generally has low portfolio turnover. Over the past decade, the Mairs and Power Growth Fund has produced a ten-year cumulative return of 81%, outperforming the S&P 500's return of 16.4%. In his second-quarter portfolio update, Frels bought Nalco (NLC) and added Target (TGT) and Badger Meter (BMI).

Nalco Holding Co. (NLC)

In the second quarter, Frels bought 348,340 shares of Nalco at an average price of $27.68, impacting his portfolio by 0.26%. The price has since increased by 20%. Nalco Holding Company engages in the manufacture and sale of specialized service chemical programs worldwide. It includes production and services related to the sale and application of chemicals and technology used in water treatment, pollution control, energy conservation, oil production and refining, steelmaking, papermaking, mining and other industrial processes. It operates in three segments: Water Services, Paper Services and Energy Services.

According to Nalco's second quarter report, sales were a second quarter record of $1.2 billion, up 8% over last year. Excluding approximately $70 million sales from the Gulf of Mexico emergency response last year, sales grew 16%. This was driven by a 3% increase in price, an 8% increase in volume growth and a favorable currency impact of 5%. Adjusted EBITDA was $175 million, down from last year's $199 million which included $44 million of adjusted EBITDA associated with the Gulf response. Diluted earnings per share was $0.42, up from last year's $0.41 per share. Excluding restructuring expenses, adjusted EPS was $0.47 for the quarter, up from last year's adjusted EPS of $0.41 which included $0.20 related to products used for the Gulf response.

Across Nalco's different business segments, sales in Paper Services grew 11% organically to $211 million, led by double-digit growth in the Americas. Direct contribution improved 11% over the prior year due to volume growth and pricing gains, although direct contribution margin decreased 80 basis points as a result of rising raw material and freight costs.

Sales in Water Services increased 11% organically to $489 million, led by double-digit growth in Food & Beverage and Mining sales. Heavy industry sales grew 12% while light industry sales grew 3%. Direct contribution improved 7% due to volume growth and pricing gains, although direct contribution margin decreased 110 basis points as a result of raw material headwinds and more hires.

Sales in Energy Service, excluding Gulf response sales, grew 11% organically to $476 million, led by strong growth in Adomite and enhanced Oil Recovery as well as double-digit downstream sales growth. Direct contribution, excluding the Gulf response, increased 16% due to volume growth and pricing gains. Direct contribution margin, excluding Gulf response sales, decreased 20 basis points due to increased raw material and freight costs.

On 7/20/2011, Nalco announced that it had entered into a definitive merger agreement with Ecolab Inc. (ECL), a global leader in cleaning, sanitizing, food safety and infection prevention products and services. According to J. Erik Fyrwald, Nalco's chairman, president and CEO, "This is a strategically and financially compelling transaction that brings together two highly complementary businesses - combining Nalco's leading positions in water and energy services with Ecolab's strength in the food and beverage, healthcare and institutional markets. Moreover, this transaction delivers substantial value to our shareholders through an immediate premium to Nalco's share price as well as the opportunity to participate in the upside potential of the combined company. We are confident that our strong momentum, along with the combined enterprise's significant financial resources, will enable us to deliver both accelerated growth and improved profitability."

Nalco has a market cap of $4.6 billion. It trades with a P/E ratio of 15.5, below its five-year average. Its P/S ratio is 1.1, near a five-year high. Its P/B ratio is 4.7, roughly even with its five-year average. Its debt-to-equity ratio is 2.72 and the company has decreased debt-to-equity every quarter since 2009.

Target Corp. (TGT)

Frels has owned shares of Target since 2006, when he held more than 2.8 million shares and the average price of the stock was $50.58. He has made slight moves in his holdings nearly every quarter, generally purchasing shares when prices decrease and selling shares when prices increase. When Target stock prices flirted with $30 in early 2009, Frels held on and the stock has rebounded to around $50 again. In his most recent move, Frels added 3.52% to his holding in Target at an average price of $49.00, impacting his portfolio by 0.12%. He now holds 2,697,879 total shares of Target, making it one of his largest positions at 3.4% of his total equity portfolio.

Target Corporation operates large-format general merchandise and food discount stores in the United States, which include Target and SuperTarget stores. They offer everyday essentials, apparel and accessories, home furnishings and decor and food and pet supplies. They also operate a fully integrated online business, Target.com and offer credit to guests through branded proprietary credit cards.

According to Target's second quarter report for the period ended July 30, total revenue for the quarter was $16.2 billion, up 4.6% over last year's $15.5 billion. U.S. Retail Segment sales increased 5.1% to $15.9 million. This included a 3.9% growth in comparable store sales which featured an increase in number of transactions, average transaction amounts, units per transaction and selling price per unit. Gross margin for the retail segment declined from 32.0% last year to 31.6% as a result of the company's growth strategies.

U.S. Credit Card Segment sales decreased 15%, with average receivables declining 12.4% from $7.1 billion to $6.2 billion. Bad debt expense was $15 million, a marked improvement from last year's $138 million, due to improved trends in risk. Segment profit increased to $171 million, up from last year's $149 million. Pre-tax return on invested capital was 28.5%, up over last year's 20.2%.

The company continues to prepare for its market entry in Canada in 2013, incurring start-up expenses and depreciation costs. Overall for the company, net earnings were $704 million, an increase over last year's net earnings of $679 million. Earnings per share increased 11.5% to $1.03, up from last year's $0.92. The company also repurchased approximately 14.3 million shares of common stock at an average price of $48.11 for a total investment of $688 million.

Target has a market cap of $35 billion. The stock trades with P/E ratio of 12.3, below its ten-year average. Its P/S ratio is 0.5, slightly under its ten-year average. Quarterly sales per share have been trending steadily upward. Its P/B ratio is 2.3, also below its ten-year average. GuruFocus has awarded Target a five-star predictability rating for its extremely consistent annual revenue growth.

Badger Meter (BMI)

Frels first bought into Badger Meter in the third quarter of 2009, purchasing 40,900 shares of stock at an average price of $38.16. He has since increased his position every quarter as the stock price has stayed mostly flat. In his most recent move, Frels added another 20.26% to his position in Badger Meter at an average price of $38.68, impacting his portfolio by 0.08% and giving him a total of 496,164 shares in the company. The price has since decreased by 7%.

Badger Meter Inc. is a marketer and manufacturer of products and a provider of services, using flow measurement and control technologies serving markets worldwide. Their products are sold to water utilities, original equipment manufacturers and various industrial customers primarily operating in the following markets: water, wastewater and process waters; energy and petroleum; food and beverage; pharmaceutical; chemical; and concrete.

According to the company's second quarter report, Badger Meter reported record second quarter sales of $75.15 million, a 1.2% increase over last year's $74.29 million. The sales growth was driven by a significant increase in sales of specialty products, including Badger ORION radio transmitters for natural gas meters and Research Control valves. The second quarter also included sales from Remag AG, which was acquired in January.

However, sales in the municipal water market were down in the quarter. Richard A. Meeusen, chairman, president and CEO of Badger Meter, stated that "we believe some customers are waiting for the release of the Badger® ORION® SE two-way advanced metering analytics (AMA) system, which is scheduled for full rollout in the third quarter. ORION SE is a major new technology advancement that takes the industry to a new level. We believe some customers are taking time to evaluate this new technology in advance of the full rollout. Our experience has been that once a thorough analysis is completed, customers move ahead with orders."

Gross profit margin was relatively flat at 36.2% for the quarter, compared to 36.4% last year. Increased sales of higher-margin specialty products, price increases and lower manufacturing costs as a result of production shifts offset significantly higher copper prices. Overall, net earnings were $7.83 million for the quarter, down from last year's net earnings of $8.03 million. However, excluding a pretax gain of $740,000 received from a settlement related to the company's plant in Mexico last year, earnings increased year-over-year.

Badger Meter has a market cap of $516 million. The stock trades with a P/E ratio of 19.5, slightly below its ten-year average. Its P/S ratio is 1.9, slightly above its ten-year average. Its P/B ratio is 2.9, roughly in line with its ten-year average. Book value per share has been steadily increasing since 2007, now at a high of $11.84. The company has a very low debt-to-equity ratio of .034. GuruFocus has awarded Badger Meter a three-star predictability rating.

This is part of GuruFocus Real Time Picks report, which reports the stock trades of Gurus within the last few days. For more information, go to Real Time Picks.

Rating: 2.9/5 (7 votes)

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