Tuesday, May 16, 2006

Whaddya Pay for Foreign Earnings Power- BUCY

Maybe it's from just coming off the Berkshire weekend. Maybe it's re-reading Empire of Debt. Maybe it's too many hits of dailyreckoning.com. Maybe, it's the sinking feeling that I had when I lived in Canada and watched the currency go from an articially high level near 90 cents to 62 cents. Now all the way back as a revitalized petro-currency and a stalwart of fiscal responsibility. Looking for shelter from US dollar weakness is really becoming an important focus as an investment theme.

What to do? Where are the opportunities? I agree with Buffett's views on commodities in general....speculative excess, silly money chasing after it. I was too damned early in getting out of base metals but I still feel comfortable about the decision. Yesterday's thrashing may not have been the end in my view, but certainly demonstrated that ownership of the theme is falling into increasingly weaker hands. Gold as a commodity remains interesting but most gold mining stocks have In my view discounted the hereafter, perhaps even using a negative discount rate. Memories of late 70's and early 80's valuations of gold mining stocks, battles for St. Joe Minerals and Amax are all coming back. The same tape is being re-played. Inco and Falconbridge are referred to as Canadian jewels in the Wall Street Journal.

In my view,foreign earnings power will be an important aspect of investing over the next few years, obviously if Buffett's views about the dollar are correct. The ideal investment target should have costs domiciled largely in the States and revenues elsewhere. This kind of thinking was successful for many Canadian manufacturing businesses when the Canadian dollar was beset with scorn and disdain and traded below 70 cents U.S. But pure dependence on currency weakening and consequent export sales is not a sufficient business strategy. Using the window of opportunity to restructure and re-position will work for businesses that are savvy.

As always, thematic or macro viewpoints seem so obvious, yet successful investing requires some determination of value and margin of safety. I note an upgrade of Bucyrus Erie (BUCY) that occured today.

BUCY fits the macro bill beautifully. Some 75% of its sales are export. The end markets for its products are heavy cyclical businesses such as coal and copper mines. Cash generation has been humongous with debt to capital representing 100% of capital in 2002 down to only 23% currently. trailing twelve month return on invested capital is stellar at 20.5% in sharp contrast to the negative returns of 2002 and 2003.

The sustainability of the business is propped by a large maintenance and replacement parts business which represents about 70% of revenues. This part of the business has grown at about a 17% rate since 2002. The sales of machinery have grown at a stellar CAGR of 56%. The street consensus for sales growth over the next three years is a 25% CAGR. Earnings growth of 35% is the current consensus for earnings growth.

In my view, investors are paying up for a rather cheery consensus. Operating margins which have run on a TTM basis at 13% might not be sustainable over the long run. Other international competitors exist such as Komatsu of Japan, Atlas Copco of Sweden, and United Heavy Machinery of Russia also compete in this business. On an EV/EBIT basis BUCY is trading at 20.6 times TTM EBIT.Komatsu is at 16 times, and Atlas Copco at 13 times.

Great theme, wrong price in my opinion. At least for the margin of safety that I look for.

Disclaimer: Neither I, my family, or clients have a current position in any of the stocks mentioned in this post.


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