Sunday thoughts - catching up after a week off

Kicking thoughts around on CNK, BBWI, TURN, TRTN and BRK

What a week to take a vacation right?

It seems like this past week was up there with December 18’ / March 20’ for “wild swings in sentiment”. As readers know, I try to steer clear of macro thoughts outside of providing competing explanations for selloffs and using sentiment to find attractive entry points.

On the latter point, I wanted to share some thoughts on terminal value that simply summarizes what I learned in corporate finance a long time ago - the value of a company into the “forever” future is:

(FCF * (1 + growth rate)) / (Discount rate - growth rate)

If you set the growth rate to zero, this reduces to:

FCF / Discount rate

One very easy way to think about this is you’ll get a 10% return if you pay $10 for an asset that produces $1 of cash flow every year into infinity. The reason this is true is that the number of periods you measure return grows very large in the future, so once you break even in year 10, your IRR keeps getting closer and closer and evens out at 10% (1/10 → 10%). Given no growth, your return here is your FCF yield at the time of purchase.

Given a little growth, the price you’ll pay to get the same return goes up a lot. As an easy example, no growth here on $1 of FCF is 10%; 5% growth is more than double the starting price at $21, but you still get the same long-run return because the growth bumps up your cash flows so much:

Imagine now if you could buy the same 5% growth asset on $1 of FCF at $10 instead of $21. You now get a 15.5% IRR:

(1 * (1.05))/(0.155 - 0.05) = $10

At the risk of stating the obvious, price paid is an easy way to tack on multiple points to your return.

I think in the last few months many companies are starting to pass the 10% expected return threshold with very conservative assumptions about the future. As the chart above shows, when you get a 30% decline in a stock you think can grow at GDP (let’s say 2+% here), you can start assuming 0% growth and still get a ~10% return. This is maybe the theme in every Stock Talk post, but price sets expectations, and as prices come down, expectations come down with it.

If you believe the future prospects of a business are unchanged, buying at lower prices is like getting an easier professor. You’re the same skill student, but better grades are now easier to come by.

With this idea in mind, I reviewed some earnings for names I own over the break and came out with high conviction that expectations should be much higher:

• Cinemark- CNK has handily outperformed the market this year, but I think the price isn’t moving up as fast as my own expectations are. This was a really great quarter - the company did positive EPS (albeit $0.05) for the first time post pandemic and said it would be FCF positive (management clarified this was after planned capex) for 2022 despite a first quarter that didn’t have any blockbusters. On an adjusted EBITDA basis, the company once again ran positive and did so for the first time with its Latin American theaters. Many analysts seemed impressed w/ LatAm in their questions and management said that region is beginning to catch up with the US in pandemic recovery progress. Newly promoted CEO (and former COO / CFO) Sean Gamble sounded extremely bullish on the theater environment and called out Uncharted and Dog as beating expectations this week. The company’s Movie Club subscription service is within 1% of members from 2019. For Stock Talking readers, most exciting will be that it looks like advertising on the big screen is coming back:

• CNK itself is starting to advertise more:

• We’ll hear from NCMI next week, but as long-time readers know CNK does include NCM results in its filings:

• It looks like full year revenue increased but a wider earnings loss. I’m not reading into this too much as National CineMedia remains a 2022+ story and all signs point to an extremely strong theater environment. It’s amazing to me CNK is telling us it will come in FCF positive this year and is marketing more aggressively. Advertising should follow attendance. A good quote on the 2022 slate to pump up the crowd:

• I would not want to be short theaters the next few years. I expect a slew of positive headlines as attendance goes back to 2019 levels and we see some new box office smash hits with Top Gun and Avatar specifically. And don’t sleep on Batman this weekend.

• I started covering movies in Q3 2020. I can tell you back then there were real bear voices out there saying the following:

  • The theatrical window is dead and streaming is the future

  • The consumer doesn’t want to go to the theater (too expensive, doesn’t feel comfortable)

• CNK clearly stated the 45 day theatrical window is here to stay.

• Ticket prices have actually increased and demand hasn’t leveled off, as evidenced by Spider-Man being the third most successful movie ever in box office $ and second most ever for a single weekend.

• You can tell by reading this call that COVID is no longer really on the minds of analysts or management as a real long-term threat. If there’s something theaters have to worry about, it’s a dearth of good titles like in Q1 or most of 2021. That risk clearly isn’t on the table in 2022; the slate is loaded. At this point in time, it seems obvious the bears were off the mark a few quarters ago. Share prices have outperformed the indices. The movie industry story is a good one and I like the 2022 set-up.

• Bath and Body Works - BBWI came in at $2.30 on EPS after pre-announcing a buyback and dividend bump. They’re forecasting $4.30 - $4.70 for FY 2022, and probably would be coming in higher if not for inflation (they forecast a weak Q1 in part because of inflation, driven by high labor costs and raw materials). With the stock at ~$55, this now trades at about 12.8x earnings (I’m being lazy but let’s use this as a proxy for FCF). I attribute the discount to concern over earnings in the near term, the company as a whole not being understood after the spin off of L-Brands which includes Victoria’s Secret (not as good a business) and the CEO announcing he’s stepping down due to health reasons, which surprised a lot of people (myself included) this quarter. I think long-term BBWI can grow well above GDP+ and should benefit in the next few years from its loyalty program ramping up (crazy right? The Bath & Body Works rewards program is still in pilot mode), improvements in its fulfillment centers and the fact that they can keep raising prices on candles without changes in demand. I also have some nice scuttlebutt on the Wrentham location here. Going back to my previous chart on terminal value, you just have to believe they can grow at 3% or so long term and a 10% IRR is well within reach.

• 180 Degree Capital - I have more thoughts on TURN but the quick summary is they didn’t report current NAV (everything in call this Friday was as of 12/31) presumably because it’s not good. Check out a chart of Quantum (QMCO) if you want to see how one of their top picks has done in the new year:

  

• The market may have TURN right in the short term. I’d bet the public names have cost the stock more than a $1+ of NAV. I remain a happy shareholder since the work on the private portfolio this year has been great - I’ve written about how the D-Wave SPAC and Petra milestone rights announcements are great for shareholders. All that said, when you invest in a closed end fund that is heavily exposed to micro-caps, you get slammed more when the general market gets slammed (welcome to illiquid small companies everyone!). I have no intention of selling any of my 180, but I don’t expect the stock to do anything if we’re in a bear market and there aren’t any private portfolio announcements. All that said…

• AgBiome may be well positioned given the ongoing situation with Russia:

  

• If US agriculture becomes more important, AgBiome should do well. TURN has this marked at $12.4mm, which is about 16% of the market cap. TURN isn’t getting credit for this and it’s very possible AgBiome could SPAC at a higher valuation. I used to work for an agriculture start-up that raised a ton of capital at impressive valuations. There is a lot of interest in the space.

• TURN doesn’t fall nicely into my terminal value musings ideas. This is a “discount to NAV, good stock picker” story and in my opinion more about good people at a misunderstood closed-end fund as opposed to a business growing earnings over time. I like how there was one person who asked questions on TURN’s call. I like how the CEO responded the one time I e-mailed the company. This is so small and under the radar I can’t help but feel I’m getting a popularity-based discount.

• This might be meaningless, but the company is at least aware of the need to market themselves more aggressively and re-did the website, opened a Twitter account and said this on the call:

• Very few people are paying attention here and by extension most people are missing that management has done a spectacular job inheriting a failed BDC. TURN is ~+80% over the last five years (about when Rendino & co. took over), which while trailing SPY at +83% before dividends is nicely outperforming the Russell 2000 (+46%), a much better comp for a fund invested in smallcaps. Overindexing on how the microcaps they own crashed YTD would be missing the forests for the trees.

• Triton - I haven’t published on Triton Q4 earnings yet but I was really happy with the print and think the biggest surprise is they are buying back a significant amount of stock now:

As the peak season ended, we shifted a portion of our strong cash flows to share repurchases. During the fourth quarter, we repurchased 1.1 million shares, and we have repurchased an additional 700,000 shares through last week.

• So that’s 1.8mm shares in the last 4-ish months. There were 66.7mm shares outstanding as of 10/22 and and 65.2 as of 2/11. While a 2.2% buyback may not seem like much, remember 1) TRTN already pays a ~4% dividend and 2) they did a big buyback the second week of February when the stock was in the low to mid 60s. If Triton’s share price does nothing, I expect between buybacks and repurchases I easily get 10% of my capital back (4% dividend + say at least 6%+ buybacks when you annualize). Going back to the terminal value chart above, I’m buying an asset at about <6.5x forward earnings (again not a perfect proxy for FCF, but good enough here IMO) I think can grow at GDP or at least remain flat. I’m getting 10% back this year most likely just in buybacks and dividends.

• One more point here - long-time readers know my favorite Triton slide, here updated for Q4:

• Per the slide, 17.5% FCF yield at $62.46 and per my math at the current price it’s about 16.5% (going off Friday’s close). Let’s assume no growth and go back to our old formula. 1/0.165 = $6. I’m buying $1 of FCF for $6 and my terminal value multiple says I can expect a 16.5% return if Triton doesn’t grow and does $720mm of FCF every year into infinity. Note that assumes the share count stays constant. Triton in reality is buying back shares and paying a dividend you can reinvest in the stock. TRTN comfortably clears my 10% hurdle rate and remains a large position for me.

• Berkshire - Buffett published his annual letter Saturday and I was reminded again that Berkshire remains perpetually underrated. BRK outperformed the S&P last year and is smashing the index so far this year. Since inception, it has been about double the IRR and that all compounds. Many managers would tout that type of performance in the press (you might be able to guess the few I’m thinking about), but we get one letter every year that quietly reminds you how management made amazing purchases like BNSF during the Great Recession (which did a record 2021 in profits) and continues to buy back its own stock more aggressively than most of the S&P. Great things often don’t make that much noise.

That’s all I got for now. I think the start of this year has provided a ton of attractive entry points for buying into high quality companies and I’m excited to keep buying.