Thursday, July 16, 2009

High margin, low or reasonable capex businesses (part 3)

Business : Value Line provides investment advisory services to mutual funds, institution and individual clients, and publishes investment related periodicals. The company's publishing arm offers investment-advisory publications in print or electronic form that evaluates common stocks, options, mutual funds and convertibles. Value Line licenses certain Value Line trademarks and Value Line proprietary ranking system information to third party under written agreements for use in third party managed and marketed investment products. The company also offers investment managment and distribution services to the Value Line mutual funds, institutions and individual accounts.

Competition : The investment management and the investment information and publications businesses are very competitive. There are many competitors and a wide range of product offerings. Some competitors are far larger and have greater financial resources than Value Line. The internet has also increased the amount of competition in the form of free and paid investment research on the Internet. The absence of significant barriers to entry by new players in the mutual fund industry increases competitive pressure. Entry barriers in the publishing investment periodicals have been reduced by the minimal cost structure of the Internet. Competition is based on business reputation, investment performance, quality of service, marketing, distribution services offered, range of products offered and price charged.

Financials ($'000,000) :

Net profit25.5524.6123.4421.3220.35
Profit margin as a % of revenue30.90%29.42%27.52%25.23%23.87%
Total asset137.95128.96119.2198.87266.92
Return on asset18.52%19.08%19.66%21.56%7.62%
Net cash provided by operating activities20.3625.1818.9236.597.77
Capital expenditures-0.34-0.74-0.72-1.44-1.91
Free cash flow20.0124.4418.235.155.86
Diluted no. of shares9.989.989.989.989.98

The company's market capitalization is about $340 million.

Comments : Value Line is an old-line company whose services and products are found virtually in every brokerage office, library, hedge fund company, and in the homes and workplaces of individual investors throughout America. It is critically acclaimed by Warren Buffett: "I don't know any other system that's as good." The company has one of the largest independent research staffs of investment analysts and statisticians in the world who operate both objectively and unbiased. "The Value Line Investment Survey" is one of the most widely read investment periodicals in the world. Most serious equity researchers will at least consult the latest Value Line report on a stock before making their buy/sell decisions whether they are ultimately influenced by the report. The company is totally debt-free and has always been a good net cash generator that in 2004 they paid an $18.50 per share special distribution. However, the company has taken a hit to its investment management and licensing business, experiencing a drop of 19% and 35% respectively, in the first 9 months of its 2009 financial year. The licensing business fall was particular spectacular, plunging by almost 60%. The severity is felt across the asset management industry. According to the Investment Company Institute (ICI), the combined assets of the mutual funds in the U.S. (excluding money market funds) declined by $3.1 trillion or 36% for the nine months ended January 31, 2009. As a result, Value Line's asset under management also declined by 36% in the quarter to $2.33 billion. All told, its operating income before tax to decline by 34%, though was made up by an investment gain but such gain is a one-off. Thus, the company had cut its dividend from $1.6 per share to $1.2 per share, which still gives a yield of 3.4%. Even though with the drop in operating income, the operating income before tax is estimated to churn out about $22 million, after a tax rate of 35%, it would be about $14 million. Over the coming few quarters, the company will face a strong headwind. But given its pristine balance sheet, it has substantial liquidity, holding over $39 million in cash and $59 million in securities. But investors today will probably face a fairly flat capital return except for the dividend gain.

Business : J&J is organized into three business segments: Consumer, Pharmaceutical, and Medical Devices & Diagnostics. The company's operating model is highly decentralized with each operating companies - over 250 of them - makes decisions on their own.

Competition : The company faces intense competition in all product lines without regard to the number and size of the competing companies involved. Competition in R&D and the improvement of new and existing products and processes, is particularly significant. The development of new and improved products is key to J&J's success in all areas of its businesses. As a result, substantial investments in R&D is needed.

Financials ($'000,000) :

Net profit129491057611053100608180
Profit margin as a % of revenue20.31%17.31%20.73%19.92%17.28%
Total asset8491280954705565886454039
Return on asset15.25%13.06%15.67%17.09%15.14%
Net cash provided by operating activities1497215022142481179911089
Capital expenditures-3066-2042-2666-2632-2175
Free cash flow11906129801158291678914
Diluted no. of shares2835.62910.729613002.82992.7

The market capitalization is about $167 billion.

Comments : The advantage of its decentralization empowers its subsidiaries with the power to make decision, rather than creating a big bureaucracy. The role of the HQ is responsible for the allocation of resources for the group. It is very similar to how Berkshire Hathaway's business model. For the first time, the Medical Devices & Diagnostics segment has outsold the Pharmaceutical division, for the first half of 2009. Overall, sales for first half have declined by 7.3%, felt across all business divisions, in particular contributed largely by a 11.8% drop in pharmaceutical sales. The stronger dollar will weigh on the results. Indeed in the second quarter, the impact of currency contributed to a negative 6% decline. The some of the consumer division which have a discretionary component is likely to be hurt by the economic condition. All said, on a per share basis, earnings are likely to be relatively unchanged, due to better cost control and a lower stock count. J&J has proved to be able to grow prudently. With its great balance sheet - one of the few AAA-rated left - it leave a lot of room for them to do acquisitions. Already, JNJ had done a couple of tug-in acquisitions - Mentor as well as Omrix Biopharmaceuticals - this year. This good-quality stock is likely to return above-average returns as well as the ability to pay a decent dividend.


Daniel M. Ryan said...

This post is off-topic, but I saw that you put my blog up on your blogroll. Thanks for doing so.

[Your own blog is on mine. That's how I stop in regularly.]

Berkshire said...

Hi Daniel,

Thanks for dropping by.

This post gives examples of businesses with high profit margin, i.e. net income as a percentage of revenue. And low requirements for capital expenditure, which leaves more free cash for the business to either distribute back to shareholders or to acquire more businesses. This is similar to the topic of the previous two posts if you notice. So I don't really understand how it is off-topic.

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