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Francis Chou Buys Sears Canada, Adds to Prem Watsa's Resolute Forest and MEGA Brands

Holly LaFon

Holly LaFon

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Founder of Toronto-based Chou Associates Management Francis Chou is a celebrated value investor whose philosophy rests on rigorous analysis of each company’s “balance sheet, cash flow characteristics, profitability, industry positions, special strengths, future growth potential and management ability.” The more a stock appears undervalued as calculated with the above data, the more of his fund he allocates to it, and margin of safety is paramount. For instance, he bought a sizable position in computer-maker Dell (DELL) when it fell out of favor in the latter half of 2012.

Chou is also a fan of Berkshire Hathaway (BRK.A)(BRK.B), Resolute Forest Products Inc. (TSX:RFP) and Overstock.com Inc. (OSTK), which along with Dell hold the top four places in his funds.

This week, Chou updated his RRSP Fund, which because of Canadian rules is only reported biannually. He disclosed a purchase of one new position, Sears Canada Inc. (TSX:SCC) and the increase of two others, Resolute Forest Products (TSX:RFP) and MEGA Brands Inc. (TSX:MB).

Sears Canada Inc. (TSX:SCC)

Chou purchased 292,830 shares of Sears Canada in the second quarter when the price tumbled to a 10-year low, averaging $10 per share. The price has since jumped about 27%. His holding has a 4.2% portfolio weight.

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A Toronto-based company, Sears Canada operates 196 corporate stores across all of Canada’s provinces and territories. The U.S. retailer Sears reduced its stake in Sears Canada to 51% from 96% by distributing a large quantity of shares to shareholders in 2012.

Sears Canada’s stock price resurgence beginning in June was precipitated by several events. First, the company June 14 announced that it would receive $191 million for the for the sale of two stores it co-owned, paid on June 24, 2013. All employees of the stores would also have the opportunity for continued employment at other Sears stores in the Greater Toronto area.

The company also began to see a glimmer of improved financial results from its turnaround measures. While revenue slid in the single digits for the first and second quarters, its net loss improved to $31.2 million in the first quarter, compared to $93.1 million the same quarter a year previously. In the second quarter, the company reported net earnings of $152.8 million, compared to a net loss of $0.8 million the same quarter the previous year, boosted by the $185.7 million pre-tax gain incurred from vacating two stores and granting of an option to vacate another.

Sears CEO Calvin McDonald noted that the results demonstrated the efficacy of its three-year transformation plan, which is it half way through. The most positive area of growth was apparel and accessories, offset by home and hardlines, which have been dampened by the struggling housing market. Its major appliances segment continued its multi-quarter market share gain.

Sears Canada’s revenue and earnings history:

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Sears Canada has a P/E of 9.2, close to a five-year low. It also has a P/B of 1.14 and P/S of 0.3.

Resolute Forest Products (TSX:RFP)

Chou increased his holding of Resolute Forest Products, formerly known as AbitibiBowater Inc., by 127.48% in the second quarter, for a final holding of 624,188 shares, or 11.4% of his portfolio. The stock traded at $15 per share on average during the quarter. It declined 11% since and is down almost 38% over the past 10 years.

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Notably, Chou’s fellow Canadian investor, Prem Watsa, is the largest shareholder of RFP, with 29.72% of shares outstanding. His company, Fairfax Financial Holdings (FFH), last purchased shares on April 4. RFP voted Fairfax Financial Holdings vice president Bradley P. Martin as its new non-executive chairman of the board at its annual meeting in May. Martin has a background in mergers & acquisitions.

RFP is a global forest products company making newsprint, market pulp, wood products and commercial printing papers. It is based in Motreal, Québec, and operates in the U.S., Canada and South Korea.

In the second quarter RFP reported a net loss of $43 million, widened from $17 million a year previously, an sales of $1.1 billion, slightly off of $1.2 billion the previous year. Net income results included $61 million of special items, and would have been $18 million without them. The company preserved its margins through cost reductions and other efficiencies in a soft pricing environment during the second quarter.

RFP revenue and earnings history:

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The company is trading significantly under book value, with a P/B of 0.39 and P/S of 0.27.

MEGA Brands Inc. (TSX:MB)

Chou increased his MEGA brands position by 30.26% in the second quarter, or a total of 626,411 shares at 12% of his RRSP Funds portfolio. The company traded at an average of $15 per share during the quarter and has gained 4% since. Overall year to date, the stock gained 55%, making three-year highs recently. The company was one of the “major positive contributors to the Fund’s performance,” Chou wrote in his semi-annual letter. He also owns debt securities in the company, which were detractors from performance in the first half of 2013.

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MEGA Brands is a toy and stationery company, making products aimed at boys, girls and families in over 100 countries.

In the second quarter, reported Aug. 7, Mega Brands reported a 4% year-over-year increase in consolidated net sales to $98.1 million, with 4% growth in sales for its Toys segment on higher shipments of Preschool & Girls construction toys. Its Stationery & Activities segment also reported 3% growth.

Earlier, in March, Mega Brands announced it would reduce its debt load by CA$62.4 million and offer a cashless exercise right to warrant holders. The reduction of debt would also translate to improved net earnings through lowered interest expenses, which was reflected beginning in the second quarter. In the second quarter, the company carried long-term debt of $59.14 million, reduced from $113.2 million at Dec. 31, 2012.

MEGA Brands revenue and earnings history:

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MEGA Brands has a P/E of 22.9, P/B of 1.62 and P/S of 0.61.

See more of Francis Chou’s Canadian holdings in his Chou RRSP Fund portfolio here. Also check out the Undervalued Stocks, Top Growth Companies and High Yield stocks of Francis Chou.

To see more international stocks at historical low P/B ratios, try the all-in-one screener. Interested in GuruFocus Premium Membership? Try it free for 7 days.


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