While monitoring the international investing gurus at GuruFocus, I noticed some new purchases by the Signature Select Canadian Fund. The fund recently added new positions in NXP Semiconductors (NXPI), Power Corporation of Canada (TSX:POW, PWCDF), and Valero Energy (VLO). As I take a closer look at the new positions, Power Corporation of Canada stood out to me because of its huge amount of free cash flow. On a price to free cash flow basis, it is trading at a multiple of only 2.32, making it a cash flow generating machine. This stock has not hit my radar before, and I needed to take a closer look at it.
As I did, I found an investment holding company that has grown under the control of a powerful investing guru that has managed to keep a low profile throughout his lifetime. Paul Desmarais had plenty of political connections including a friend in ex-French President Nicolas Sarkozy. He has also had visitors to his private estate in Canada that included George H.W. Bush and Bill Clinton. He recently passed away last year, but his sons, Paul Jr. and Andre, have been in control of the day-to-day operations since 1996. Since then the company has outperformed Berkshire Hathaway (BRK.A) and has blown away the S&P 500 with compounded annual returns of 10 percent without including the dividend. The S&P 500 increased at a rate of 6.5 percent over the same time period and Berkshire Hathaway has increased 10.3 percent. The dividend is what makes Power Corp top Berkshire. Berkshire Hathaway does not pay a dividend, and Power Corp’s dividend is currently yielding 3.91 percent. It may have been lower in the past, but it was far greater than the 0.3 percent to make up the difference.
Company Background
Initially, Power Corporation of Canada was an electric utility holding company that was formed in 1925. By 1930 it was operating 40 power plants across Canada. In the 1960’s Canada nationalized its hydroelectric industry as an essential public service, and Power Corp liquidated about 80 percent of its portfolio. With a large cash position, the company purchased larger interests in fewer, more diversified companies in energy, finance, industry, and real estate. In order to protect and nurture those investments, Power Corp sought a more active role in monitoring their management and direction.
Paul Desmarais gained control of the company in 1968 through a share-exchange offer through his company, Trans-Canada Corporation Fund. His strategy was to increase Power Corp’s cash flow; to consolidate its control over a limited number of large, diversified, long-term holdings; and to concentrate on improving their performance. He was able to navigate the company through rapid inflation in the early 1980’s by strategically divesting of certain holdings and paying down long-term debt. By the 1990’s the company was cash rich and debt-free. It then made large investments in China and Europe. In 1996, the sons took over, and the company has continued to grow.
Today the holding company is comprised mainly of Power Financial Corporation (TSX:PWF, POFNF) with a 65.8 percent stake in the company. Power Corp also has 100 percent ownership in Square Victoria Communications Group, 100 percent ownership in Power Energy Corporation, as well as other investments. Just like the guru-controlled companies of Berkshire Hathaway, Fairfax Financial (TSX:FFH, FRFHF), and Markel (MKL), the insurance business is the primary source of revenue. Great-West Lifeco (TSX:GWO, GWLIF)) is the largest of the subsidiaries with a market cap of C$30.32 billion. It is 67 percent owned by Power Financial which is 65.8 percent owned by Power Corp. Great-West Lifeco provides insurance, retirement planning, and asset management.
Financial Strength
At first glance, Power Corp looks sub-par when it comes to its Business Predictability score of 1/5, Financial Strength of 6/10, and Profitability & Growth of 4/10. The company currently has a high debt-to-equity ratio 1.18, but the company has the cash and investments to cover it. Power Corp also has enough operating income to cover its interest expense 7.86 times. The debt that shows up on the balance also includes debt issuance from its majority owned subsidiaries.
Earnings per share have been increasing at a rate of 9.48 percent over the past five years after its drop in 2008-2009. Return on equity is at a similar level at 9.31 percent. Where the company shines is its return on capital of 310.78 percent and free cash flow of C$12.79 per share for the last twelve months. Free cash flow per share has been flat for the past couple of years, but it is already at a high level.
Management
As mentioned above, the Desmarais family is still in charge of the company. Paul Jr. and Andre have been at the helm since 1996. Paul is 60 years old and Andre is 57, and they will likely lead the company for the next couple decades. The Desmarais family has plenty of political connections and some say that it gives them an unfair advantage. If that is the case, it would be great for shareholders. It could also be that Power Corp is a large corporation in a country of about 34 million people and chances are some of their employees will end up to be politicians. Also, Paul Sr. was a billionaire and one of the richest men in Canada. That kind of wealth will draw politicians into his sphere of influence.
Valuation
On a price-to-book basis, Power Corp seems to be fairly valued on a comparison basis with similar companies. It has a P/B ratio of 1.30, the same as fellow holding Canadian holding company, Fairfax Financial. Berkshire Hathaway has a similar P/B ratio of 1.38. The free cash flow per share is what makes Power Corp a bargain. If valuing the company based on its free cash flow of $12.79 per share, it has a fair value of C$95.53 per share without factoring in growth. That is a 69 percent margin of safety with the stock closing at C$30.15 on 7/3/2014. Plus the company has a price to free cash flow ratio of 2.35. That means that the company is generating enough free cash flow to pay back the price of its stock in 2.35 years.
Risks
Investment portfolios of insurance companies have been struggling in the low interest rate environment. Even with equity investments, the lackluster returns of low interest rates on fixed-income can hold back the portfolio. Although over time the stock has delivered excellent returns, it is only up a total 13 percent over the past ten years without including dividends, vastly underperforming the S&P 500.
The company is also carrying a much higher debt load than it did during the financial crisis in 2008. At the end of 2007, the debt to equity ratio was at 0.75 when the crisis hit, driving the stock down nearly 60 percent. A crisis of that magnitude is not likely to occur soon, but if it did, Power Corp would be hit even more with its current debt-to-equity ratio of 1.18.
Outlook
If the company can maintain its free cash flow as it has for the past ten years, the stock is grossly undervalued. Overall, the stock has barely budged over the past ten years, and at some point it will start to get some more looks if it can keep the cash flowing. Power Corp has an excellent track record of shareholder returns and has been run by the same family since 1968. It will likely continue to be a well run company in the future.
