Archive for the ‘General’ category

CT Capital Outperforming S&P 500 (TR) and Russell

August 7th, 2019

….from our latest report to clients


That the account is outperforming both S&P 500(TR) and Russell 1000 Value (TR) indexes this year is merely in line with historical trend given the alternation in risk landscape and stage in cycle. Employment of an accurate discount rate guides us to firms in the portfolio as their valuations become faulty due to analysts’ overstatement of entirety of risk profiles.

As risk levels to free cash flows ascend our accounts should continue this outperformance, though any given quarter is subject to the many externalities.  As the period elongates, outperformance should broaden vs. benchmarks as a greater cross-section of investors adjust for previously unaccounted-for risks, including that of outright financial failure.

Just read comments sent to me–sorry haven’t seen before

May 27th, 2019

Didn’t realize how many of you enjoyed our previous works on this site. Just read comments, some of which were years old.


Unfortunately, more recent works are for the benefit of our research clients, all of whom are very high NW or institutional in nature.


We will, from time to time, distill some of our analysis a week or two after client receipt, and post here.


Sorry haven’t kept this up-to date; suggest you look at my twitter account (@credittrends), though there I post on a variety of topics, many baseball related as well as finance—as you will see I am a big Yankee fan


Lastly, I would urge you read my last book, “Security Valuation and Risk Analysis,” after which I am sure you will rarely listen to analysts or other gang of idiots you see on CNBC. They have NO idea of the scores of items behind each line entry in the published financial statements. And in most cases, neither do their CFO’s



Follow us on twitter, @credittrends

May 27th, 2019

Second Quarter Review-Sent Oct 1, 2018

November 4th, 2018

The following is but a small portion of that sent to clients


What conducts of equity direction are observable, logical, and have shown to be determinants of valuation?

Table not shown here

We know though the reporting season has just begun (98 firms reporting) a greater number (76) have ratcheted down their expectations for the coming year.

We know sovereign and trade risks have increased worldwide, driven by the China-US dispute and stiff tariffs, as well as US-Iranian sanctions.

We know the upcoming election cycle given prevalence of political risks could well bring tangible change, some of which can be expected to impact firms cash flows, return on capital as well as other determinants of valuation. Sections of the recent Tax Reform Act could be in jeopardy, and consumer confidence could swoon if impeachment talk gains momentum or economic activity stalls as rates continue its rise.

It is with this backdrop we focus the bulk of this report on risk.

We outline herein why, therefore, account performance has been acceptable though trailing S&P 500, specifically why we believe the portfolio is “set up” to minimize risks of the back-end of the cycle while our firms cash flow generating assets should allow them to continue their histories of solid credit and additions to capital geared to prospective free cash flow, while giving space to flexibility many concerns would need to bypass. No firm wants a credit downgrade under a slowing economy.

Many of the outperforming stocks in the benchmarks this year have been older firms which have primed the earnings pump through reduced pension expense yet will now need to make large cash infusions to their assets, having been beneficiaries of such reduced funding the past three years, boosting reported cash from operations and engaging in large share repurchases. Pension debt and its annual cash outflow effects 326 firms in the S&P 500, or slightly over 65%, so this large liability is certainly nothing to sneer at.

We are sitting in the “catbird’s seat” with these holdings (see highlighted box), a time when equity prices in general could be challenged.

Add to that multi-employer debt (this liability is excluded from balance sheet listing) and overseas pension liabilities, State’s cumulative $1.6 trillion deficit, and the $74 per employee (increases are certainty with new indexing) charge to PBGC, and one can’t help but adjust potential cash flows and credit valuation multiples downward if markets stagnate.

Of general consequence as impacts the portfolio remains the full brunt of the Tax Reform Act, where our holdings will almost certainly see incrementally favorable benefits versus the ever-so popular FANG companies. That investors have in so many instances failed to properly examine and account for future (including compounding of) tax benefits is unremarkable given the proclivity for investors to react in arrears based on the news of the day.

The new GILTI ensures a residual U.S. tax of at least 10.5% when the foreign effective tax rate is less than 13.125% and with the uptake to 100% bonus depreciation and territorial approach the legislation favors the majority of the portfolio, especially with their 21% Fed rate versus the FANGS lowly four-year average cash rate of 12.7%.

Let us not fail to mention the FANG’s are mainly one product consumer tech firms; a major obstacle to our investment decision approval process.

The EC is resolute these mammoth tech-driven firms pay their fair share as opposed to a “negotiated rate.” Ireland and Luxenberg will not enjoy their current tax advantage indefinitely, as seen with Apple having to recently cough up $14.3B.

The GILTI, after exemptions and credits will hit fewer firms than originally thought, though the Treasury and IRS are still issuing clarifications. Undoubtedly, there be an offset to many firms’ previous cash flow expectations and rate of growth, especially with the final chapter not yet written.

Analysts refusing to accept the new tax realities under the guise of a bull market and economic expansion are being foolish.

Of significance, should the 10-year risk-free rate rise another 50 basis points or so we will likely see more leveraged entities having significant debt due within the upcoming three years or reliant levered customers/suppliers see their valuations react rather suddenly. Should such take place, we reason investors will look towards the more consistent firms with wide financial flexibility, including those such gems contained in our portfolio.


2018-Second Quarter Review

July 5th, 2018



The account continued to outpace the Russell 1000 (TR) Value by a very wide margin over the last 5 years, while the so-called tech-based FANG stocks have again propelled the S&P 500 this quarter. The long-term very high correlation between the S&P 500 and Russell Value broke apart in 2015. One would certainly expect they will again converge at which time our performance can be expected to surpass that benchmark as well.

For the portfolio, the Tax Reform Reconciliation Act fundamentally altered the way multi-nationals are taxed, and yet we have found many have not altered their international financial structures which were set to take advantage of a now antiquated tax system. Our firms stand in a relatively stronger position from which the account should benefit in the years ahead.

A US shareholder of one or more controlled foreign corporations must include in gross income its GILTI (Global Intangible Low-Taxed Income). This rule generally subjects a US shareholder to tax on the combined net income of its controlled foreign corporations that is not otherwise taxed in the United States, thus giving many of our holdings a nice domestic advantage, especially when combined with the new 21% statutory rate vis-a vis foreign entities so subject. Much of this will be felt as the years roll by.

Many companies will find they will be subject to the base erosion (BEAT) tax it did not expect.


Consumer tech eventually meets its match and for Apple it may come about from sovereign interference or plain old competition[1] as 5G comes to pass next year or perhaps a residue of its litigation with Qualcomm. As shown in Table 1 Apple’s economic profits as a percentage its market value, using proprietary CT Capital worksheets, has declined the past two years, its first consecutive such decline over the past decade. Economic profits, not return on capital, is the appropriate benchmark for Apple due to declining equity, assets, plant and equipment. Should this trend continue, its shares will very likely drop as well.

[1] See

Many companies will find they will be subject to the base erosion (BEAT) tax it did not expect.

In the 1990’s investors also drove technology shares to unfathomable heights. Yet, no sector undergoes market share alternations more rapidly, with each generation seeing firms thought bullet-proof fold. Anyone know where I can buy Kodak film? A Wang word processor, or a Magnavox TV? Nokia was thought invincible not too long ago as were Lehman and Bear Stearns. We are not suggesting Apple or Google will meet similar fate, yet they too will meet their match.

Restrictive trade policies and actions to be established under CFIUS could bear on free cash flows, employment, and government policy. There is no guessing the extent at this point; sensitivity analysis helps estimate any potential impact on existing and potential investment related to supply chain, segment sales (cash flows) and other expense, including asset relocation if necessary. The discount rate could be impacted as well if expected free cash flows are to become increasingly uncertain.

To be sure, the crystallization of the BEAT (base erosion tax) provides additional expense to non-US firms, in a way forcing Europe’s hand, yet it is prudent not to over-react at this point.


When those FANG investors move on we believe many will indeed gravitate, despite this week’s Amazon announcement, toward our investments in CVS and Walgreens, which have all the characteristic of becoming the next McDonalds or Starbucks.

Upon Amazon’s announcement it would acquire Pillpack, a firm which has been for sale quite a while and has slightly more than $100M in sales (vs CVS almost $200B), the combined market values of CVS and Walgreens market values fell $12B. We have seen Amazon scares too many times to count and remain doubtful they will be able to make large inroads against the physical locations.

The future of health care is “closeness to the consumer” —CVS and Walgreens employ over 600,000 with over 20,000 locations. Amazon has zero locations. Amazon does not enjoy similar advantage in health they have in general retail, such as pricing, delivery, and technology.

Importantly, consumer health hubs—dental to urgent care—is taxiing on the runway and a space where they needn’t worry about Amazon, and both CVS and Walgreens are active and gearing. CVS currently has over 1100 such clinics in 33 states while it is estimated both companies control between 50%-75% of the drugstore market.[1]

Example: Clinics offer a quick means to combat the spread of disease or illness as was seen this month in Ohio where an outbreak of hepatitis A took place. CVS’ MinuteClinics offered Hepatitis A Vaccines statewide following the outbreak of the virus.




And with its expected merger with Aetna, we are confident CVS is primed to become a large winner for the portfolio, ensuring superior return on capital and economic profits for years. Aetna’s insurance is a product Amazon does not offer, bringing additional large cash flows into the firm.

CVS and Walgreens have vast experience in best practices—including real estate management, billing, Medicaid and psychological services— making this indisputable movement of health hubs ferrying considerably lower risk with strong prospective growth. While the hubs could very well be sad news for hospitals and even for Amazon’s health unit, CVS and Walgreen’s are well-primed to benefit while selling at high normalized expected cash yields.

The implications of the Tax Reform and Reconciliation Act will also prove a catalyst to these firms—CVS’ cash rate of 38.6% and Walgreen 26.5%. Amazon is facing large tax bills in Europe. As written last quarter, the compounded effect of the Budget Act has yet to be fully digested by investors, and especially for those firms which make value-adding decisions with regard to said cash. Real return on capital and economic profit/market value is quite likely to remain at least 4 percentage points above their weighted average cost of capital for all our healthcare holdings.


Large share price movements following earnings announcements are typical as investors overstate a single period’s importance to fair value. Investors and firm executives who extrapolate recent events are quite prone to error.

And so, earnings reflex often reverses as events normalize for firms with strong market penetration and growing markets. A shortfall to a single quarter effects fair value to only a minor degree, as a firm is worth the present value of the entirety of its free cash flows plus a terminal value. For instance, at a 7.5% discount rate and free cash flow growth of 15% per year for 10 years, moderating to 2% thereafter, the current year free cash flows can often constitute just 2.6% of its total fair value[2]. For lower initial growth the impact is even smaller. So, when we see a holding’s market value react inappropriately, we exercise patience, all else equal. Such pessimism is most often unwarranted and why shares in fact shrug off the short-term nonsense given sufficient time.

This brings us to Fluor, which dropped this quarter on its announcement. As you know we prefer to write of firms which did not meet their normalized metrics as the winners speak for themselves.

Fluor, a construction and engineering firm, which could have as many as a thousand jobs going in various stages, mis-bid a gas-fired project, the consequence being a write-off and always-present possibility of additional cash outlays. Such action does not reflect well on their bidding teams as fixed price contracts always carry risk. Over the decades such “wins” too often have resulted in losses, yet for shareholders it has paid to stick around.  Other times a single job can sink a company, as was the case with Morrison-Knudson due to its then subway manufacturing division.

Meanwhile, Fluor’s backlog remains satisfactory though subject to many factors, including energy prices and political events. The firm is supported by strong credit and liquidity of $7.5B. As with many firms, they erred in its use of capital, re: share repurchases, for which we penalized its cost of equity.

Given firms like Fluor have a strong tendency towards normality, in this case a rather consistent normalized 15.65% (Table 1) adjusted return on equity, we remain with the position.




As the default rate on high-yield instruments drops, yield spreads collapse, and bonds priced near bankruptcy offer superior returns relative to investment grade. Approaching a default rate nears zero, a firm’s credit rating—for bond investors—become less weighty and the appropriate fixed-income investment strategy is to allocate a higher percentage of the portfolio within firms paying the highest rates of interest. For this reason, CCC rated firms have outperformed investment grades over the recent past.

The same investing logic does not apply to investors in equities.

Yet, have those investors throwing a record volume of capital into lower quality debt again laid the seeds for a credit “event”? Leverage loans (LIBOR 125+) are now greater than the high yield market, exceeding $1.2 trillion according to Fitch, and while maturities have in many cases been stretched out, investors look over the hill in decision-making.

Because funds for acquisitions are abundant and yield spreads tight, we have become increasingly mistrustful of those large-scale technology deals [3] . We would not touch AT&T with a ten-foot pole. And unfortunately, we have seen credit agencies giving acquirors abundant headroom and become too rating-lenient, abundantly trustful of management puff instead of penalizing for the credit build.

As interest rates rise the great corporate debt build will begin to have consequence as rollover time nears.  Over the past decade, according to McKinsey, corporate debt issuance has nearly equaled the rise in government debt.

And furthermore, as refinancing’s become due for roll, it would not be unusual for key metrics to be below peak.

The Tax Reform and Reconciliation Act limits the deduction of interest expense in the US to the sum of business interest income plus 30-percent of adjustable taxable income. Many firms who may now seem far away from the ceiling will certainly run thru it, having an absolute impact on valuation.

Higher rates of interest are more easily tolerated for firms with high return on capital (or economic profit), while for other firms becomes more difficult to grow or even maintain its spread with cost of capital.

Importantly, with interest rates moving up piecemeal, our firms enjoy strong credit rankings by our higher standards. Investees have little to zero exposure to floating rates and about 13% of their debt due the coming 3 years. They enjoy strong flexibility with more than adequate credit facilities.


When comedian Henny Youngman’s was asked: How’s your wife? He responded, “Compared to what?” The same applies to valuations.

Someone should tell analysts at Factset—a firm I was an original client and helped one of the co-founders set up some proprietary financial software—as well as investors and other data providers, single metrics should never be viewed in isolation. Valuations (Figure 2) must be viewed relative to inflation, credit, prospects, consistency of metrics, lawsuits, taxation, etc. and not relative to itself as a measure of value. What good is a free cash flow yield of 12% (8 multiple) if inflation is 15%?


Figure 2 Valuations Must be Viewed Relative to Other Metrics-FIGURE NOT SHOWN

Same is true advice for the St. Louis Fed researcher in making a case between recession and unemployment. High employment is not, in and it itself, a motive for recession but may be a function of imbalances (inventory), excesses (dot -com) or government action (Vietnam War). In 2008, the lower unemployment rate was a function of large scale hiring in real estate and related sectors.


While the high-yield default rate is expected to stay low for the time being allowing valuation multiples to remain lofty, sector and firm-specific valuations can be expected to undergo platonic shifts due to alterations in risk—from trade, location of suppliers and cusitmers, to credit— topics we believe CT Capital has a large competitive advantage.

We do not pretend to have a crystal ball, only our financial statement adjustments and definitions bear a closer reflection of economic reality and have worked well over multiple cycles.


Kenneth S. Hackel, CFA

Eli C. Hackel, CFA

[1] buy-aetna/

[2] Assumes typical CT Capital credit, return on capital and economic profit and cost of capital.

[3] AT&T will have over $180B in debt post its Time Warner acquisition.


Credit Trends to be updated early 2017

December 20th, 2016


June 2nd, 2016

Robust asset growth in passive portfolios is ascribed to active managers’ inability to earn higher post-fee returns. We have long attributed this to benchmark composition which has overcome the placement of valuation in the make-up of the benchmarks: simply, large firms with strong market shares whose products and services drive superiority of credit, cash flow, and return on capital compared to the investment universe at large. Under similar and reasonable logic, the CT Capital portfolio, whose firms are of higher credit, generate stronger (operating and free) cash flows per investment dollar, with higher return on capital than the benchmarks, should consequently outpace this hurdle rate over the cycle

The growth in “smart beta” products, which has so captured investor and consultant imagination deploys naively constructed metrics, is substantially inferior to the CT Capital worksheets, and would never be considered by credit agencies, bankers, and potential financial acquirers as compelling proof of worth or ability to satisfy claims

The December “Games”

December 31st, 2014

It has been estimated that about 90% of investment advisers were under performing their benchmarks going into the final month of the year. To make up lost ground, the smaller stocks would be easiest to push up in price. As evidenced in the following table, there was a perfect positive reverse correlation between December’s returns thru December 30 and index size.


December Games?
Index Mkt Cap-Median Return
S&P 500 (TR) $18.8B 0.79%
S&P 500 (TR) Top 10 $313B -0.57%
S&P 500(TR) Top 25 $251B 0.27%
Russell 1000 $8.1B 1.73%
Russell 2000 $.7B 3.56%

AstraZeneca-Arbitrage Possibilities

May 13th, 2014

The clear rejection by the Board of AstraZeneca to Pfizer may not necessarily mean a permanent end to a deal. This reports reveals what the Board needs to hear and the possibility of such taking place.


This report available to consulting clients of CT Capital LLC. Contact or for information

Retailing–Buggy Whip or High Tech

March 7th, 2014

Retailing is at the crossroads, as seen this week with Staples, Radio Shack, Children’s Place, and ASNA to name just a few. While on-line divisions are generally performing to expectations, as with Bed Bath and Beyond as well, cash cow big box stores are suffering from Amazonitis as well as sluggish consumer spending. In some cases, managements are hiding behind the harsh winter weather, and in several cases, that is true.

Yet, an analysis of the industry’s financial metrics clearly shows that there will be some large losers, as we have seen with JC Penney and the aforementioned Radio Shack.

Yet, there should be some good-sized winners as well, which we show in the tables and outline below.



Apple-Fair Value and Updated Risk Analysis

February 26th, 2014

With so many high profile investors entrenched in the stock, and the accompanying publicity they have drawn to the company, why haven’t shares in Apple performed more admirably. From Icahn to Einhorn………….


Contact or $50,000

Fair Value-Fannie Mae

February 23rd, 2014

An estimate of fair value for Fannie Mae is a complicated issue. In the analysis that follows no account is made for a possible liquidation or change in its current form. Furthermore, large 79,9% dilution, loss of tax carryfowards which would be required……………………


Report is available for $ 150,000. Write or






New PBGC Fees to Have Significant Impact on Many Firms Cash Flows

January 6th, 2014

Fore the $2 trillion in defined benefit plans the raising of fees to $64 per participant will have a significant impact on firm cash flows, while at the same time benefiting selected insurers.

However, some firms, by virtue of both their asset allocation and………………




JCP Update

December 4th, 2013

JCP Update, 12/3/13

There have been a few important developments in the credit of JCP, and equally impacts equity valuation. Yet, as pointed out in our last report, the challenging retail environment, combined with……….



A Hugely Overpriced Stock With Bankruptcy Possibilities

October 29th, 2013

CT Capital, after intense analysis, has identified a company whose share price does not reflect its economic reality.

Their cash flows, using our adjustments, are not what it appears using traditional metrics. They are also very vulnerable due to other factors, any one of them would serve to undermine their prospects of remaining in business.

This is our first short recommendation since JC Penney.


For a copy of the report, please contact The cost is $50,000.



Sovereign Risk

October 23rd, 2013

We have seen changes to cost of equity for various major countries in which US firms derive significant cash flows and have made large capital and financial commitments. In China, we have recently seen…


Report is available for $50,000

CT Capital LLC

September 27th, 2013

Our Investment Philosophy


CT Capital’s methodology is quite simple, when distilled to its underlying elements. We compare an equity investment’s free cash flow yield and cash based return on capital to that of the yield on the risk free rate and cost of capital. We then look at the risks to the firm at least maintaining the above spreads—its cost of capital— with normalized nominal free cash flows growing. When invested capital is low or not meaningful, we look to economic profits.


JCP- Update

August 5th, 2013

Since we last warned about credit conditions at JCP……….


Updated report now available. Price $125,000.

July 2013 Summary Review- Full Review to Clients Only

August 4th, 2013

In the News

I have been reading a number of articles lately on the subject of share buybacks, the works of both highly placed academics and practitioners. Yet, in no analysis have I seen the authors adjust for (1) an upward shift to cost of capital resulting from the equity impact including increased leverage and impaired credit, (2) superior utilization of that cash which could improve return on capital (3) excess tax benefits[1] resulting from share based compensation listed under financing activities in the statement of cash flows that should be moved to operating activities and (4) reduction in financial flexibility.  I have written previously that while buybacks may improve upon GAAP numbers such as return on equity it does not change return on invested capital as it neither improves free cash flow nor adds to capital.

Regarding the trillion or so dollars held by US corporations overseas, an analyst should not assume this cash is available for share buybacks as most of it won’t see the light of day in the US, even given a drop to a 28% tax rate put forward by the administration this week and other credits which could bring the rate down even further. Such cash is, most often,  better used for overseas expansion where the taxes have already been paid and could raise the firms’ return on capital by being deployed in faster growing economies or new acquisitions.

Lastly, Detroit proved that pension liabilities still matter. Even for strong firms, the liability impacts fair value. This month, portfolio holding Lockheed-Martin reported a very strong quarter, and would have reported considerably further strength if their cash contribution was level with last year. Unfortunately, the firm, although not mentioned in its press release, most likely has at least seven such years of stepped-up contributions ahead of them, given the enormity of their unfunded liability. Nonetheless, its shares are trading very near to its all-time high.


In these reports, it is important I comment on a position that has lagged the benchmarks. Several of the holdings of prior comment have been acquired, and almost all have had very strong runs in excess of the benchmarks, such as Google, EBay and Nu Skin (latter two since sold) as well as the entire insurance space.

In March, I illustrated a cash flow worksheet on Bed, Bath and Beyond, which at the time was being heavily sold by investors after reporting a weaker than anticipated quarter. In reality, a single quarter has a quite minimal impact on the actual valuation for most firms with a long history of  generating normalized and adjusted free cash flows with low cost of capital. BBBY shares now trade near its all-time high.

And so, on July 12th, when Domtar (UFS) announced weaker than expected results its shares fell to a 52 week low, and have only modestly rebounded since, down 16.8% for the year.

UFS, under a purchase (accounting) with no retroactive subsequent adjustments and $300MM in goodwill (subsequently written off), acquired the Weyerhaeuser fine paper business in 2006 with shares and debt assumption ($1.6bn), becoming the largest integrated manufacturer and marketer of uncoated paper in North America and the second largest in the world. They own or license 16MM acres.

Table 1 shows why UFS shares have declined, yet even so, continues to produce acceptable free cash over two, three and four year periods. Its free cash flow stability index (shown as its standard deviation/average) of .6 is above average but not unacceptable. For example, International Paper’s free cash flows have a stability index of .41.

Exhibit 1          Stability of Free Cash Flows-Three Year Average



As shown in exhibit 2, there is a strong association between UFS’s 3 year average free cash flows and market value. Free cash flows in the table are not adjusted for tax subsidies related to alternative fuel credits, which biased 2010 results.  In that year UFS received a $368MM cash refund, the impact of which has been somewhat minimized in both the three and four year averages. An additional credit of $198MM remains for 2009 which could be released this year pending audit. No credits were claimed for 2012. SG&A has been influenced by stock based compensation which is adjusted into our models.

For our positive thesis to hold we would need to see a continuation of the growing three year average free cash flow, which will not occur on an adjusted basis until sales begin to improve. The firm could, however, adjust discretionary spending to mitigate further erosion in sales until economic strength reconvenes. Yet, to delay equity investment in a strong credit cyclical firm like UFS until a positive turn is underway when the market value is long term attractive is a common error most responsible for missing the greatest jump in share price.

Exhibit 2           Three Year Average Free Cash Flows versus Market Value




As shown by Exhibits 1 and 3, UFS is unlikely to struggle servicing its debt, with very strong fixed charge cover. Maturity structure is well spread out. Total debt (including leases) has increased just 3 of the past 10 years. Our cost of capital model penalizes firms which require frequent trips to raise capital either to maintain or grow free cash flows.

Funding improvement to pension plans, its one significant credit issue, is taking place despite reporting a $96MM increase in non-funded status. This comes about from the firm’s more realistic actuarial assumptions and $666MM in company contributions over the past 5 years; its discount rate has dropped to 4.8%  (from 6.3% two years earlier), with plan assets growing to $1.7 billion. The 2012 actual return on the plans ($182MM) plus company and employee contributions ($93MM) exceeded actual paid benefits of $97MM. With 41% of their plans in equities and 59% in debt, funding status could, however, be further strained if interest rates continue to rise and equities markets fell. If UFS were to close out part (or all) of its plans, a logical step, it would lower cost of capital by up to 40 basis points in our model. In any event, given the stronger funding status, firm cash flow should be boosted. This year UFS expects to contribute considerably less than last year (again hoping for aid from financial markets) versus the past 5 years average of $133MM; the contribution is being swayed by the lower production volumes.

They are a member of 7 multiemployer plans with unknown member financial status for at least one of the plans. As contributions into these plans have been small ($6MM/year), I presume the risk is not significant in relation to its cash. One of the plans, however, is in Red (less than 65% funded) Status, yet their contribution to that plan was just $3MM last year. Of late, unions in general have been working with employers to improve funding, including the reduction of benefits.

UFS uses derivatives almost primarily as hedges in currency and natural gas (no losses shown in AOCI).

Their rate of increase in healthcare expenses is moderating although the post-retirement liability rose 9.7% to $124MM over 2011.  Remaining litigation risk relates to various actions on hazardous waste clean-up stemming from 1999, having settled one large suit the past quarter. They continue to take remedial action ($32MM in asset retirement obligations) and I believe the 25 basis add-on to cost of capital recognizes the liability. Relations with unions have been generally satisfactory, although testy at times, including strike votes.

Exhibit 3       Debt Summary



UFS has had an unstable tax rate, not uncommon given the cyclicality of the industry. In four of the past 10 years the cash rate has changed by over 10% from the prior year. Stock based compensation has been minimal, including tax benefits.

Capital spending has more than doubled ($106MM to $236MM) over the past 4 years despite flat sales. Resultantly, our worksheet picks up some of the excess as the firm could reduce this budget while maintaining similar sales, especially with their plants running below normal capacity. The last two year step up in capital spending, acquisitions and joint ventures ($974MM) less disposals ($93MM) has been financed by cash from operations and a debt raise, with only minor balance sheet management. Share repurchases, which have totaled $650MM the past two years, has been a poor choice by its Board, given the needed debt raise, lack of sales growth and cloudy near term expectation.


Other metrics which have caused cost of capital to rise include adjusted cash flow from operations which have benefited from the tax refund, growth rate in free cash flows, inventory accumulation, economic profit/sales LFY of 1.9%, capital spending in relation to sales growth, deterioration of working capital to total debt, stability of cash tax rate (average cash payment of $46MM past 6 years), and productivity. Negative metrics point to the needed reduction in headcount.

Despite the above flags, normalizing UFS’s metrics underlie our faith in its shares. Over the past 3, 5 and 8 years, its normalized return on capital has remained in the high teens with strong, although declining, free cash flows. It easily earns its cost of capital for which there is substantial room for improvement in spite of the current sales stagnation.  If and when the world’s economies perk up, its shares should outperform all benchmarks by a very substantial margin due to significant operating leverage. Other large winning positions in the account have come from similarly depressed conditions and playing “the waiting game.”  I believe the risks are known and accounted for.

A buyout is certainly within the realm of possibility given how several other large paper manufacturers shares have held up which could finance a deal.


Kenneth S. Hackel, CFA

[1] When a restricted stock vests or a nonqualified option is exercised, the amount of the employer’s corporate tax deduction is fixed. At that time it is evident whether the amount deductible on the tax return is greater or less than the cumulative compensation cost amortized (using Black-Scholes) over the vesting period.

J.C. Penney Company Inc.(JCP)

June 16th, 2013


Very few investors, including apparently major fund managers truly understand the profound changes that have taken place at JCP over the course of the past year, led by a drastically altered credit. This new landscape has been, and will continue to play out……



June 15th, 2013


Last  month we purchased our first company based in China, coming after greater than normal research and investigation, lasting several years.

Netease (NTES), one of the leading providers of internet services within China, derives 87% of its revenues from online gaming, 10% from online advertising and 3% from email services, the country’s largest with 550 million, and growing, users. Their success with email and gaming is now allowing them to branch out to other services. Total firm revenues are US $1.3 billion with $685MM in adjusted free cash flow against a $7.5 billion market value of equity (36% in cash).  Compared to the US, internet penetration in China is low, estimated at just 42% of the populace.  The firm’s various websites are, according to independent firms, among the most visited in China, if not the world.

The lengthy review time was needed as the company is not audited by a US firm nor is any inspection of its books evaluated by a US firm, although two Board members are CPA’s. Cost of equity capital was raised by 1% due to lack of well-known oversight, reducing fair value by 16%. While the SEC has brought action against five accounting firms in China, NTES is not involved in such proceedings, but may be ultimately impacted if the case against the auditors is lost. It is conceivable, though quite doubtful, they could lose NASDAQ listing, although its shares would continue to trade and be active. I am hopeful an agreement signed last week allowing the US Accounting Oversight Board permission to review Chinese audit records will develop into full scale cooperation, quell the regulatory riff, lift any conceivable financial veil, and bring down the firm’s cost of capital. It appears this is what the Chinese desire given various scam companies and resulting publicity that have taken place. Also, slower growth in China alongside strong need for credit on local levels will require such action.

China has seen its sovereign risk rise over the recent month according to our models, reflecting its economic slowdown. Its  5 year CDS spread over similarly dated US Treasury bonds also rose this month, going from 29 to 58 basis points, and equity cost of capital is raised by this latter  amount over the US risk free rate, still at an historically low 2.15% When all risks are considered, the cost of equity capital hurdle (7.7%)for NTES  is high for a firm with its credit, however has been overcome as a result of products, time in business, independent proofs, lack of significant litigation, stock ownership, joint ventures, as well as the financial metrics.

Their auditor is registered in China. Chinese company law is modeled after that of the UK, yet the firm follows international accounting standards. While foreign exchange rules in China are controlled, the Renminbi is freely convertible for current account items including dividend payments, interest and trade transactions.

On the metrics side, NTES sells at a 9.1% free cash flow yield, a 24.5% return on invested capital, economic profit/sales[1] of 27.2% (GOOG is 18.5%, and AAPL is 21.3%) and has zero bank debt or bonds. Operating leases are for rent, server custody and office machines which are modest in relation to cash, operating cash flows and equity. Their share repurchase program is minor.

Over the past 7 years, free cash flow has grown by 356% and revenues by 475%. The stock is volatile and subject to those risks inherent in any technology firm.  Given its valuation, however, like portfolio holding Google, which I was forced to write on last fall when its shares fell by $100, only to recently rise to all-time highs, NTES appears to offer strong risk-adjusted long-term prospects, taking into account its cost of capital.

[1] Economic profit removes the distortion of firms which by their nature operate with a low capital base. The CT Capital definition is far superior to the general concept employed by the industry as we use adjusted free cash flow, not EBITDA, which is an analytical trap. For a full explanation, please write.

Report on Bed Bath & Beyond (BBBY) Available

March 25th, 2013

There is plenty about BBBY  investors do not understand or account for in their valuation of the firm

Our report is available for the introductory price of $2500. If you are interested, please contact CT Capital LLC

For a Real Edge, Calculate Free Cash Flow Correctly

March 13th, 2013

Free Cash Flow- Must adjust for misclassifications, extraordinary and one-time items and other expenses and events not properly accounted for in either the income statement, statement of cash flows, or footnotes. Examples would be pension over (underfunding), interest, taxes, payment to non-controlling interests, capital leases, moral obligations and overspending in discretionary areas.

If you are unsure how to accomplish this, buy the text to your right

February 2013 Investment Review-Abridged Version

March 3rd, 2013


Sorry, the full version is sent to clients of CT Capital LLC. For information, please see


February 2013 Monthly Review-General Distribution

January 2013 Abridged Review

February 10th, 2013




PDF Jan 2013 reivew=credittrends site