Lululemon valuation

I notice that John Hempton of Bronte Capital is scratching his head with Lululemon’s (Nasdaq: LULU) valuation.

I’ve been scratching my head since they had a $2.8 billion market cap, and now they are trading at $9.2 billion.

They are headquartered in Vancouver, British Columbia, Canada, which is right in my backyard.

The after-tax profit margin (19%, trailing 12 months) is just incredible for a clothing company. It is right up there with handbag producer Coach (NYSE: COH), although in the latter’s case they have a somewhat more reasonable valuation.

In both cases, understanding women’s sense of fashion is the key investing variable. What’s the next meme after yoga pants?

First stock purchase in some time

For the first time in about half a year, I’ve purchased a straight stock (not preferred or ex-income trust) for my portfolio. Current position is 1% but I am targeting a 5-7% position, so I am currently in accumulation mode. I’d be a little miffed if it moved up to my fair value tomorrow, which is about double-to-triple the current stock price.

Some metrics include roughly a $50M enterprise value (i.e. market cap minus cash plus debt), revenues of a quarter billion, negative profitability in the past 12 months and a brand name moat that some, but not most should recognize. In terms of expenses, over 60% goes to sales and marketing expenses. No dividends.

The “over 60% goes to sales and marketing expenses” should give the reader a hint that I am not talking about a company that is related to commodities!

The general thesis is that while revenues have appeared to be flattening, this company is generally regarded as the best of breed in its product category, and they should be able to reduce expenses to restore profitability.

If the world economy goes into a 2008-style meltdown, there is some downside protection in the stock, mainly embedded in the huge cash position it has relative to its market cap.

Using my not-patented risk-reward measure, I would say this is a low risk, medium reward type situation.

Rogers Sugar

The last little bit of my longest-term holding, Rogers Sugar (TSX: RSI) I have unloaded today. The company is very well run, but substantially all of its free cash flow is sent out the window in dividends – at a yield of roughly 6-6.1%, historically this is expensive and by virtue of being in the sugar refining industry, isn’t exactly in a position to dramatically expand revenues and earnings.

Investors are paying bond-like premiums for equity-like returns. At the rate that yield-chasing is going, investors might even bid up the company to 5.5% or even 5%, but I won’t have any part of it. The golden moment was when in early 2009 it was trading at $3/unit and I did load up during this time since the stable 15% pre-tax returns made much more sense in terms of valuation. The only problem was that most other equities at that time were also exhibiting high risk-reward potential!

Apple and the winner-take-all market

Every media outlet is reporting the blowout quarter that Apple had – the financials are just something to be salivated at. With $46.3 billion in sales, $25.6 billion in cost of sales, you are left with $20.7 billion of gross profit. Subtract $3.4 billion in operating expenses and you are left with $17.3 billion in operating income.

This was in a single quarter. A lot of people must have wanted their iPhones and iPads for Christmas.

Subtracting taxes and other matters still left shareholders with $13 billion net at the end of the day.

When you add up the cash and marketable securities, they still have $98 billion to splash around.

Normally in technology, companies face incredible price pressure as competition is very fierce. Apple behaves as if it has a monopoly on its market, and in the minds of many consumers, they might as well.

There is erosion potential with the iPhones (specifically with Google’s encroachment with Android), and the iPads are starting to face some functional competition. However, this will not dissuade people from the name brand, as Apple has turned into somewhat of a status icon – this in itself will make it more difficult for competition to break.

The question for Apple – can they keep it up?

The question more relevant for investors would be – what technology upstart ten years from now will be doing the same thing?

Thumb twiddling

The biggest mistake any investor can do is just invest cash for the purpose of investing it in something instead of investing it in something proper.

Hence, I am still twiddling my thumbs.

Curiously I do notice Encana (TSX: ECA) is up about 6% despite the fact that natural gas futures are still depressed. Might be a sign of short covering?

I’ve also been doing some research on R.R. Donnelley & Sons Company (NYSE: RRD) – I have owned their corporate debt in the past so I have not had to do much additional work. They are facing the same issues that Yellow Media had, mainly a good chunk of their business (catalogs and cheque printing) is getting enveloped by the online world. Still, the company is hugely cash flow positive and doesn’t even have the debt albatross that Yellow Media has. If it wasn’t for the fact that they are a well-known case, I might dip my toes in.

There are a couple other smallish-cap companies ($100M-$250M range) that I am reluctant to mention here that seem to have very compelling valuations, plus almost no financial pundits are paying any attention to them.

The great thing about having a large cash position is that it feels like I am working with a blank canvass. Despite earning almost nothing in yield for cash, I also do not feel pressured to make any portfolio decisions. If I have to wait out an entire year without hitting any candidates, so be it.