A simulation-based valuation of Eletrobrás (EBR): September 2021

Summary

- EBR is the largest utility company, both in Brazil and in Latin America, and one of the biggest clean energy utilities in the world – owing to its widespread use of hydroelectric facilities to generate energy (). It generates about 40% and transmits about 70% of Brazil’s electricity.

- In this post we provide a simulation-based (sim-based) valuation () of EBR.

- If we use 1% as our estimate of earnings growth for the next 5 years, which is the expected growth rate for the Brazilian economy, our sim-based analysis results suggest the following fair values – stock price: $8.02, and price-to-earnings ratio: 7.54. At the time of this writing, EBR trades at $7.11, so it appears to be undervalued, with a potential upside of 12.80%.

- If we use 10% as our estimate of earnings growth for the next 5 years, which seems more reasonable given a likely increase in electricity demand and the possible sale of carbon credits, then a new sim-based analysis suggests the following fair values – stock price: $12.67, and price-to-earnings ratio: 11.92. With these numbers, the potential upside moves up to 78.20%.

Centrais Elétricas Brasileiras S.A. - Eletrobrás (EBR)

EBR is the largest utility company in Brazil and in Latin America, and one of the biggest clean energy utilities in the world – owing to its widespread use of hydroelectric facilities to generate energy (). It generates about 40% and transmits about 70% of Brazil’s electricity.

The Brazilian federal government owns a bit more than 50 percent of the company. The company is expected to be privatized soon. Nevertheless, some of its assets should remain under government control even after privatization – e.g., the binational Itaipu hydroelectric power plant.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation () of EBR.

At the time of this writing the company had a profit margin of 27.08% and a price-to-earnings ratio of 6.69. The expected growth in earnings for the next 5 years is not clear; but recent trends in electric vehicle adoption projections suggest solid potential. We will assume an earnings growth rate of 1%, which is the expected growth rate for the Brazilian economy, to be the sim-based earnings growth rate for the next 5 years.

The table below summarize our sim-based results.

Since our sim-based analysis uses a S&P 500 return as a basis, our results summarized on the table above suggest the following fair values – stock price: $8.02, and price-to-earnings ratio: 7.54. At the time of this writing, EBR trades at $7.11, so it appears to be undervalued, with a potential upside of 12.80%.

Final thoughts

Our 1% growth projection is arguably very conservative, given the prospect of higher productivity from privatization, higher demand for electricity motivated by the growth in electric vehicle adoption, and the possibility of additional income via carbon credits.

It should be noted that hydroelectric generation is considered to be “green”, but the construction of hydroelectric plants usually has a devastating albeit localized environmental impact. Given this, income via carbon credits is very likely, because of the opposition to the building of new hydroelectric plants by the same groups who consider the ones already built to be green sources of energy.

If we use 10% as our estimate of earning growth, then a new sim-based analysis suggests the following fair values – stock price: $12.67, and price-to-earnings ratio: 11.92. With these numbers, the potential upside moves up to 78.20%. Overall, EBR seems like an asymmetric investment option at the moment, with limited downside and significant upside.

Disclosure

The author owns EBR shares at the time of this writing.

Must see video on historical progression of nominal GDPs over time

Must see video on historical progression of nominal GDPs for various countries over time.

A simulation-based valuation of Albemarle Corporation (ALB): August 2021

Summary

- ALB is a multinational producer of specialty chemicals, and the largest provider of lithium for electric vehicle batteries ().

- In this post we provide a simulation-based (sim-based) valuation () of ALB.

- At the time of this writing, the company had a trailing twelve months price-to-earnings ratio of 38.

- According to our sim-based analysis, the fair price-to-earnings ratio should be 63.57, leading to a current fair value of $393.14.

- ALB currently trades at $235.00, so it appears to be undervalued, with a potential upside of 67.23%.

- The above assumes an earnings growth rate of 43.85% per year going forward.

Albemarle Corporation (ALB)

ALB is a multinational producer of specialty chemicals, and the largest provider of lithium for electric vehicle batteries in the world (). Headquartered in Charlotte, North Carolina, the company operates in three main areas: Lithium and Advanced Materials, Bromine Specialties, and Refining Solutions. It serves several sectors, including: petroleum refining, consumer electronics, energy storage, construction, automotive, lubricants, and pharmaceuticals.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation () of ALB.

At the time of this writing the company had a profit margin of 21.78% and a price-to-earnings ratio of 38. The expected growth in earnings for the next 5 years is not clear; but recent trends in electric vehicle adoption projections suggest enormous potential. We will assume an earnings growth rate of 43.85%, which is the expected growth rate for the coming year, to be the sim-based earnings growth rate for the next 5 years.

The table below summarize our sim-based results.

Since our sim-based analysis uses a S&P 500 return as a basis, our results summarized on the table above suggest the following fair values – stock price: $393.14, and price-to-earnings ratio: 63.57. At the time of this writing, ALB trades at $235.00, so it appears to be undervalued, with a potential upside of 67.23%. Yes, the company seems to be undervalued at the moment, even though its shares gained more than 150% in the last 12 months.

Final thoughts

Analysts have been slow to increase their fair value estimates for ALB, consistently lagging the market in this respect. For example, one of the highest fair value estimates at the moment is $250.00, by BMO Capital. There are many reasons for this disconnect, including: the expectation that supply of lithium will surpass demand, destroying profit margins; the possible availability of batteries using little or no lithium; and a decrease in demand for ALB’s other specialty chemicals.

ALB’s guidance tends to be conservative. Based on that, and other factors, the forward predicted price-to-earnings ratio is at the moment estimated to be 75, which does not look very good compared to the trailing twelve months price-to-earnings ratio of 38. However, the most recent (previous quarter) forward price-to-earnings ratio was 52, which turned out to be a poor predictor and much higher than the current 38.

Disclosure

The author owns ALB shares at the time of this writing.

The massive 2020 to 2021 return of Danaos Corporation (DAC): Compensatory adaptation in practice

Summary

- DAC is a marine shipping services company based in Piraeus, Greece ().

- This post discusses the massive 2020 to 2021 gain in the company’s shares, which investors who acquired shares in March 2020 would have obtained at the time of this writing.

- Even with the recent drop, the gain is of 2,309.35%. An investment of $100 thousand would have turned into approximately $2.4 million during this period of slightly more than one year.

- This case highlights the need for investors to think in compensatory adaptation terms ().

Danaos Corporation (DAC)

DAC is a marine shipping services company based in Piraeus, Greece (). It provides seaborne transportation services; notably chartering vessels to liner companies, vessels that it purchases from ship builders in South Korea and other major producing regions.

The massive 2020 to 2021 return

The graph below shows the massive 2020 to 2021 gain, which investors who acquired shares in March 2020 would have obtained at the time of this writing. Even with the recent drop, the gain is of 2,309.35%. An investment of $100 thousand would have turned into approximately $2.4 million during this period of slightly more than one year.

DAC’s dividend yield was about 3% at the time of this writing. While the company is very leveraged, with significantly more debt than its combined EBITDA and cash, it is arguably not a speculative investment at the moment (although it is hard to argue against the idea that the “easy money” has already been made). It certainly was not a speculative investment in March 2020. I say this because many seasoned investors would associate this type of gain with very speculative and high-risk investment instruments.

Could the move have been predicted?

What a few investors saw in March 2020 was that two factors were to play a key role in the following months and year. The first was that COVID-related disruptions in international flights would significantly limit the flow of manufactured goods via air, increasing demand for sea transportation. The second was that many companies decided to increase their inventories, to be able to meet demand in spite of the disruptions, further exacerbating the need for sea transportation.

Final thoughts

While everything seems clear in hindsight, DAC’s case highlights the need for investors to think in compensatory adaptation terms (). Shares of many transportation and logistics companies fell precipitously in March 2020, because of the serious supply-chain disruptions, but those disruptions caused compensatory responses that disproportionally benefited some companies. Understanding this may help investors spot future opportunities.

Disclosure

The author does not own DAC shares at the time of this writing.

A simulation-based valuation of Conn's, Inc. (CONN): June 2021

Summary

- CONN is an American furniture, mattress, electronics and appliance store chain headquartered in The Woodlands, Texas ().

- In this post we provide a simulation-based (sim-based) valuation () of CONN.

- At the time of this writing, the company had a trailing twelve months price-to-earnings ratio of 7.83.

- According to our sim-based analysis, the fair price-to-earnings ratio should be 15.30, leading to a current fair value of $49.25.

- CONN currently trades at $25.20, so it appears to be undervalued, with a potential upside of 95.44%.

- The above conservatively assumes a positive earnings growth rate of 15%, about half of the average for specialty retail companies.

Conn's, Inc. (CONN)

CONN is an American furniture, mattress, electronics and appliance store chain headquartered in The Woodlands, Texas (). The company caters to credit-challenged customers, and also operates in the lease-to-own space. It has been around for a long time. It was founded in 1890 as Eastham Plumbing and Heating Company, having been rename as Conn's in 1934.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation () of CONN.

At the time of this writing the company had a profit margin of 6.9% and a price-to-sales ratio of 0.53. The expected growth in earnings for the next 5 years is uncertain; but recent trends are very encouraging. To be conservative, we will assume a positive earnings growth rate of 15%, which is about half of the average for specialty retail companies, to be the sim-based earnings growth rate for the next 5 years.

The table below summarize our sim-based results.

Since our sim-based analysis uses a S&P 500 return as a basis, our results summarized on the table above suggest the following fair values – stock price: $49.25, and price-to-earnings ratio: 15.30. At the time of this writing, CONN trades at $25.20, so it appears to be undervalued, with a potential upside of 95.44%. In fact, the company seems to be quite undervalued at the moment, even though its shares gained more than 200% in value in the last 12 months.

Final thoughts

A little over a year ago, we conducted a sim-based analysis of CONN, which suggested a fair value of $18.20. Why the much higher fair value now? The reason is expected future yearly earnings growth, which we assumed to be of 15% in this post’s sim-based analysis. A little over a year ago, the expectation was of negative or no earnings growth, based on forward guidance provided by the company.

CONN’s guidance tends to be conservative. Based on that, and other factors, the forward predicted price-to-earnings ratio is at the moment estimated to be 10.43, which does not look very good compared to the trailing twelve months price-to-earnings ratio of 7.83. However, the most recent price-to-cash flow ratio is about 3.36, and this ratio is often a good estimate of the forward price-to-earnings ratio. This supports our valuation.

Disclosure

The author owns CONN shares at the time of this writing.

A simulation-based valuation of DXC Technology (DXC): May 2021

Summary

- DXC Technology (DXC) is a technology consulting and services company headquartered in Tysons, Virginia ().

- Launched in April of 2017, DXC was created from the merger of Computer Sciences Corporation (CSC) and the Enterprise Services division of Hewlett Packard Enterprise (HPE).

- In this post we provide a simulation-based (sim-based) valuation () of DXC.

- Our results suggest the following fair values – stock price: $70.21, and price-to-earnings ratio: 7.65.

- DXC currently trades at $36.86, so it appears to be undervalued, with a potential upside of 90.48%.

DXC Technology (DXC)

DXC Technology (DXC) is a technology consulting and services company headquartered in Tysons, Virginia. Launched on April 3, 2017, DXC was created from the merger of Computer Sciences Corporation (CSC) and the Enterprise Services division of Hewlett Packard Enterprise (HPE).

The company operates in more than 70 countries, and counts among its customers several federal and regional government agencies. In many ways DXC is similar to Accenture (ACN). In fact, DXC has had since September 2019 a new CEO, Mike Salvino, who previously served as group CEO for Accenture Operations.

Estimating a fair value for the stock

In this post we provide a simulation-based (sim-based) valuation () of DXC.

At the time of this writing the company had a negative net profit margin of -15.67% and a price-to-sales ratio of 0.48. The company has great growth potential, as long as it transitions from legacy technology services to more modern and narrow offerings (e.g., cloud applications, security consulting). This transition seems to be a major focus of the new CEO.

To be somewhat conservative, we will use recent numbers from Accenture to set our sim-based estimated earnings growth rate for the next 5 years (1.24%) and net profit margin (11.95%). We believe this to be a conservative approach because DXC is much smaller than Accenture; e.g., DXC’s revenues are less than half of Accenture’s.

Another reason why we believe the above is a conservative approach is that it is quite possible that in the near future earnings growth will be much higher than it is now. Sales are likely to go up, and so should earnings – the latter at a faster pace, leading to higher margins for many of DXC’s services (the same goes for Accenture).

The table below summarize our sim-based results.

Since our sim-based analysis uses a S&P 500 return as a basis, our results summarized on the table above suggest the following fair values – stock price: $70.21, and price-to-earnings ratio: 7.65. At the time of this writing, DXC trades at $36.86, so it appears to be undervalued, with a potential upside of 90.48%. In fact, the company seems to be quite undervalued at the moment, even though its shares gained more than 100% in value in the last 12 months.

Note that we assumed a positive net profit margin of 11.95% for a company that actually has a net profit margin of -15.67%. This type of assumption is useful in valuing growing companies that have a negative profit margin, which is often the case with companies that have been experiencing problems and are turning around; as well as high-growth companies that have been publicly-traded for only a few years.

Other pluses and minuses

About a year ago, DXC paid an attractive dividend of 5.11%, significantly higher than the average S&P 500 dividend at the time. We thought then that the dividend was relatively safe, but the COVID recession proved us wrong. That dividend was cut to zero in response to the recession, and still no dividend was being paid at the time of this writing.

While somewhat leveraged, DXC has a reasonably attractive balance sheet, with EBITDA in the neighborhood of $2.53 billion. This, added to its cash position of $3.92 billion, is fairly close to its $7.80 billion dollar debt. So, DXC is leveraged, but much less so than many other companies with much higher valuations.

Disclosure

The author owns DXC shares at the time of this writing.

Cash hedging with high-dividend securities: A look at the AGNC, ORC, OXLC and SRET (April 2021)

Summary

- The cash hedging strategy discussed in this post is one in which an investor raises cash, to protect against a severe correction, but maintains a high-dividend allocation that is calculated as a proportion of the cash position.

- Let us assume that the investor has $20,000 and wants to have 50% of her portfolio in cash, as protection against a severe market correction.

- We show that, if the investor wants the equivalent of a 2.50% return on the cash, before taxes, she needs to invest only a fraction of the cash in a high-dividend security.

- Often over 80% of her cash is protected. The portion at risk generates the desired yield.

Cash hedging

The cash hedging strategy discussed in this post is one in which an investor raises cash, to protect against a severe correction, but maintains a high-dividend allocation that is calculated as a proportion of the cash position. Cash is raised as investment gains grow together with the perception that the market is overvalued. We assume that interest on “pure” cash is negligible, as it is at the time of this writing.

The high-dividend allocation is calculated as follows: (desired cash allocation) times (desired yield on cash) divided by (high-dividend security yield). The remainder is the actual cash allocation, which is “safe”. The high-dividend allocation is the portion at risk, which earns the equivalent of the desired yield on the entire desired cash allocation.

Let us assume that the investor has $20,000 in a portfolio and wants to have 50% of that in cash, as protection against a severe market correction. The table below assumes that she wants a 2.50% return on the cash portion, before taxes. For that, she invests $1,785.71 in a high-dividend security with a yield of 14%. In this example, over 82% of her cash is protected. The portion at risk generates the desired yield.

AGNC, ORC, OXLC and SRET

Investors may consider using one or more of the following high-dividend securities to implement our cash hedging strategy. These securities pay dividends regularly, typically on a monthly basis.
- AGNC Investment Corp. (AGNC, ), a mortgage real estate investment trust (REIT) with an 8.59% yield (at the time of this writing).
- Orchid Island Capital, Inc. (ORC, ), another mortgage REIT, this one with a 12.98% yield.
- Oxford Lane Capital Corp. (OXLC, ), a collateralized loan obligation (CLO) fund with a 12.86% yield.
- Global X SuperDividend REIT ETF (SRET, ), a high-turnover fund of REITs with an 8.01% yield.

How much cash at risk?

The table below shows how much money would be needed across various high-dividend yield options ranging from 14% to 8%. They cover all of the funds above, in terms of yield. For example, if one were to use SRET, a little over 30% of the cash would have to be invested (i.e., put at risk) to yield the equivalent of a return of 2.5% on the full $10,000.

Final thoughts

Generally speaking, the higher the yield, the higher the risk. Often this is due to leverage being used by the security to generate the outsized yields. Nevertheless, it tends to be safer for an investor to buy a leveraged security (e.g., the ORC) than to borrow money to implement leverage directly. For example, one could get a return on a 4%-yielding security that is significantly higher than the 4% yield by borrowing to buy more of the security – a debt that has to be paid back, with interest.

Many investors like to employ protection strategies other than increasing their cash allocation. A favorite is the use of “put” options. The reality is that these strategies are highly specialized and require much better timing than holding cash – e.g., “put” options are “timed” bets, since they expire at a certain date. Because of these and other constraints, they tend to be less successful.