Charlie Munger (Trades, Portfolio) once stated an investment idea he had from Barron’s which made him $80 million. It was a little automotive supply company that offerred a no-risk investment with several years horizon and a profit of $80 million.
In other words, it was a cigar butt. The company's name is Tenneco (TEN, Financial). Munger mentioned that it took him an hour and a half to decide. He already knew about how sticky some of the secondary auto market was and checked how many old cars needed Monroe shock absorbers, a product that Tenneco offerred. Basically, it was a cigar-butt that was too cheap to ignore based on potential sales. At that time the stock was sold at around $1, and the junk bonds were at 35%.
Tenneco in 2002
Let’s have a closer look at the 10K filing of the company to see just how cheap it was. By 2002, the operating income had improved from the losses of $130 million in 2001 to the profit of $31 million in 2002. However, due to the high depreciation and amortization, the operating cash flow had been positive in those two years, totalling $188 million in 2002 and $141 million in 2001.
At the end of 2002, Tenneco had $54 million in cash, a huge number of receivables of $409 million and inventories of $352 million. The total interest-bearing debt came in at $1.445 billion, while shareholders’ equity was negative due to large accumulated losses and treasury stocks.
Source: Tenneco's 2002 10-K
It seemed to be extremely highly leveraged with a lot of debts and negative equity. However, it was not too high compared to cash flow generations. In 2002, the EBITDA to interest expense ratio was 2.2, while the total debt to EBITDA ratio was 4.6. The ratio of arnings to fixed charges at that time was 1.17. So, Tenneco could use the cash flow to service its debts.
At around $1 per share and total shares outstanding of 41.67 million, the total market capitalization of Tenneco was around $41.67 million at that time, less than the cash it held on hand. Munger bought the 11 5/8 bonds yielding 35% to maturity in a very high yield play with potential upside.
In 2002, Barron’s mentioned that Tenneco Automotive held the No.1 position in shock absorbers. Tenneco had the strong position in the market, but it was highly leveraged and producing positive cash flow, which was enough to service the debt. If Tenneco were downsizing its leverage, the equity would move up a lot.
Munger ended up selling the stock at $15, but if he held on to it till $40, he would ended up at more than $200 million.
Lessons learned from Munger's Tenneco investments
Munger's story here teaches us several great lessons.
First is to have the patience to wait for clearly undervalued opportunities. After 50 years of reading Barron’s, he found only one investment worth taking. When he found it, he bet heavily. An 80-year-old man at that time was investing and ready to wait for several years, not just days or months in the positions. Personally, I also learned a lesson of not acting too heavily on a clearly undervalued position.
Second, with small sums of money, cigar-butt investing is still one of the keys to investment success, as many cigar-butt positions can turn into multi-baggers. That is why in the past year I only focus on looking for those cigar-butt positions globally. Those are companies which are profitable in their businesses but trading less than their net cash (after deducting total debts).
Third, most of us often sell out when an investment has the high return, especially at double or triple our inital price. It is very hard for investors to hold on and wait for a higher return. Thus, we should analyze carefully all of the holdings to drive out losers and ride winners.
Wishing you happy and successful investing!
Disclosure: The author does not own Tenneco.
Read more here:
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- Warren Buffett: How to Really Value a Business
- 2 Strategic Moves for Better Operating Performance at Noodles & Co.
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