Most people do not have to expend a great deal of time to begin to understand tow of the regular themes to be found in many of the businesses I analyze and into which I allocate my own investment capital. First, I look for well-run businesses that are deeply discounted to my estimate of their fair value. Next, I love to find these values in businesses that produce products or deliver services we can’t live without.
I know this sounds like it would be very difficult to accomplish; but, in reality, it is more time consuming than it is difficult. The fact that it is so time consuming is, in all likelihood, highly correlated to the fact that so few investors actually do it. It is probably much easier for me to understand why others do not perform this type of research and due diligence than it is for them to understand why someone like me does. I do it because I enjoy it. I find it relaxing and it allows me to compete against true professionals head to head and compare my results to theirs. The fact that there are few things I hate more than losing at anything is also helpful in what I do as it drives me to find only the best opportunities for the allocation of my capital. When I choose wrong, I not only lose in my “competition” against the investment pros, I lose my money. It creates a REALLY bad version of a two-for-one deal. So, you might say that I have to be a big believer in eating my own cooking.
And What’s Cooking Today?
Whirlpool Corporation (WHR, Financial) is a maker of all things appliance that we find throughout our homes. I grew up hearing the Whirlpool name but only now realize how much more it represents beyond just Whirlpool products. This business also owns the Maytag, KitchenAid, Jenn-Air and Amana brands among others as well. There is not a name in that list that I didn’t already know and I was completely unaware that Whirlpool owns them all. Best of all, when I say each of those names aloud, there is not a single negative thought that comes to mind.
I remember for years the Maytag repairman being the “ loneliest person around” (because the products are so reliable and I have owned a Jenn-Air cooktop range that I absolutely loved. KitchenAid products have been found on my counter tops for as long as I can remember and I’ll be willing to wager that most of you are in the same position I find myself right now. Who would have ever thought? It seems the answer is: “Not many.” That is how great brands become great buys.
Not only does Whirlpool offer great products to consumers that they need and want, at today’s price, it offers value oriented investors an exceptional value as a long term investment vehicle that should produce double digit returns for years to come.
Great Brands Are Great But They Don’t Guarantee Profits
While it is always good to find a company producing well-known products that serve needs almost every consumer needs to have filled, that doesn’t mean the company is a good value as an investment. After all, I can go to the store and buy the products without ever owning the stock. Consumers only care that the company sells great products that they need; investors must also insist that they sell those products very profitably. For value investors, it takes even more.
To provide the most attractive opportunities, businesses not only must supply products or services that fill a need of their customers and be profitable in the process of doing so, they must also be priced at a level that in no way comes close to reflecting the intrinsic value of the business. I believe that Whirlpool Corporation meets my needs outside the kitchen as well.
The first bridge we have to cross as value-oriented investors is to establish the safety of our capital. The debt to equity ratio of the business is a manageable 52% and the company produces enough cash to cover the payments required to service the debt 6.38 times. Furthermore, the business is currently valued at a very inexpensive 9.14 times free cash flow compared to the industry average of 10.07 times cash flow. For a business that owns so many iconic brands to be priced at a 10% discount to the overall industry based on free cash flow just doesn’t make sense and is, most likely, not sustainable. Businesses that own brand names like this should trade for at least 15 times free cash flow.
In terms of the price to book valuation of the business, it would not appear to meet the requirements of a value investor at first glance with its 2.13 multiple. However, upon closer inspection, we can find that the industry average price to book value is 3.38 times book. Clearly, a business that would have to rise over 50% in value to simply trade on par with its respective industry average is deeply discounted.
Based on the consensus analysts’ earnings expectations, Whirlpool is projected to earn $12.09/share in 2014 and $14.35 in 2015. These numbers produce respective P/E ratios of only 11.54 and 9.72 compared to the projected 5-year annual growth rate of 20.9%. The analysts would have to be off by 50% in their projections for the current valuation of this business to be “fair”.
Finally, the company pays a $3.00 dividend that produces a yield of 1.88%. Over the last five years, the dividend has grown at an annualized rate of 6.67%, so it has easily out-paced inflation. The current payout ratio for the dividend is only 27.37%, which leaves lots of room for increases even if earnings fail to rise substantially.
Undervalued? Yes, but why?
Great brands at bargain prices? The old adage goes: “If it sounds too good to be true, it probably is.” As a value investor, I am well aware that this sage advice does not always hold true in the stock market; but, I am also aware that it often does. If you are going to make a living as a value-oriented, contrarian investor, you had better be willing to spend lots of time digging for dirt. Usually, there is an identifiable reason when a business with iconic brands is cheaply valued and I think that is the case with Whirlpool as well.
The trick is finding those businesses where the reaction to the reason far exceeded what would have been a rational response. I think I have found the reason this stock is cheap today. I also think it is far too cheap based on the facts.
Wall Street and average investors are driven by quarterly earnings reports and Whirlpool has failed to meet the expectations of analysts in 3 of the last 5 quarters. When a tiny miss in one quarter can cause a stock to be crucified by panicked selling, missing in 3 out of 5 quarters can be horrific. But, it is of utmost importance to keep these “earnings misses” in perspective. The company “missed” earnings by only 4.35%, 1% and 1.25% in those three quarterly disappointments. For the other two quarters in that period, the company beat expected earnings by 1.03% and 3.03%. Wall Street is far more punitive for disappointment than they are rewarding for positive surprises. But, the question for investors should be whether these little quarterly fluctuations actually change the value of the underlying business in any meaningful way. The answer in this case should be “no” but appears to have been “sell now and ask questions later”.
Final Thoughts And Actionable Conclusions
I am used to finding valuable assets that can be acquired at bargain prices; it is what I do and how I win. I love to win. At today’s valuation Whirlpool represents a basket of household names trading at a serious discount to its industry. It is poised for long-term growth as a supplier of products that we all need in our homes and brands we all know.
For this business to trade on an equal valuation to its industry, it would need to rise at least 10%. For this business to trade at a fair value to its projected earnings growth rate, it needs to double. My feeling is that the stock is undervalued by 40% right now and that its earnings growth over the next five years should produce 10% to 12% annualized gains in the share price. Combining these two figures indicates buyers of the stock today could see annual returns of between 15% and 20% a year for the next five years.
For those investors who insist on buying everything at a discount to current price, you might want to consider selling the August 16, 2014 expiration $130 strike price put option contracts for about $1.40/share. For each contract sold, the seller would be obligated to buy 100 shares of Whirlpool stock for $130/share ($13,000/contract), at the option of the buyer, in exchange for receiving the $140/contract premium. This transaction produces an immediate return on the capital required to purchase the shares at $130 of 1.07% or 14.46% annualized over the 27-day life of the contract. This transaction would also provide the seller with obligation to buy the shares only if they are trading at a discount of 6.8% to the current price by August 16th.
For those investors who find the current value of this business to be compelling but would still like some immediate return on their capital, there is the option of buying the stock at the current market price and simultaneously selling (1) $145 strike price, August 16, 2014 expiration call option contract for each 100 shares of the stock purchased. As of this writing, these options can be sold for about $2.45/share and provide an immediate return on capital of 1.75% or 23.6% annualized over the 27-day life of the contract. Selling these option contracts would obligate the seller to sell, at the option of the buyer, 100 shares of the stock at a price of $145 at any time between now and August 16th. Should the stock price rise above $145 by August 16th, the seller would collect an additional $5.50 short-term capital gain and exit the position with a profits of $7.95 (5.69%) on the original capital invested over 27 days. This outcome would produce an annualized return on capital of 76.92%.
Should the shares not rise above $145 by August 16th, investors who choose this approach would simply keep the premium collected for selling the option and the shares as well. This would have the effect of lowering you entry cost into the position to $39.50-$2.45 or $37.05/share.
