Value Library

The following is an excerpt from the ABC Perspective - July 2003 - Pg. 4-5

Four Undervalued ABC Favourites

We are constantly on a diligent hunt for undervalued company shares to include in our three ABC Funds portfolios. Our research methods involve an ongoing quest incorporating extreme patience and discipline alongside our ABC Funds Ten Commandments of Value Investing. While at times this search process can be painstaking and tedious the end result is normally psychologically and monetarily rewarding. Ultimate success involves a combination of serious investigation, patience and courage of one's convictions.

Over the past several months we have uncovered four undervalued companies, which we subsequently added to our ABC Funds. A brief analysis and commentary on these four securities follows. Most interesting is the fact that three of these four securities are in the consumer retailing industry --- a sector hard hit by SARS, bad winter weather, Iraq-CNN War and uncertain consumer spending patterns.

BON-TON STORES

The Bon-Ton Stores, Inc., is a York, Pennsylvania family controlled business operating 72 quality fashion department stores in small secondary markets where retail competition is sparse. Bon-Ton is not officially followed by any Wall Street investment analysts and trading in the stock can be relatively thin.

Bon-Ton shares have performed well recently increasing 48% above its November low of $3.37. It appears as though the investment community is beginning to take notice of this under-followed company. Even with the recent appreciation in price, we continue to believe that Bon-Ton remains one of the most undervalued companies in the retailing sector. The stock trades at only one third of its book value of $14 and less than 7 times this year's expected earnings, which management believes will be in the range of $0.65 to $0.70 per share. Bon-Ton also pays a $0.025 quarterly dividend which, currently represents a yield of about 2%.

Bon-Ton's depressed share price can be attributed to a slower growing U.S. economy, flattish top line revenue increases over the past several years and its position as a small capitalization, under-followed public department store. With its strong financial position, we believe that when the U.S. economy does recover Bon-Ton will be well-positioned for future revenue growth and increased profitability.

DANIER LEATHER

In operation since 1972, Danier Leather is a vertically integrated company, which designs, manufactures and retails leather and suede products. The company's clothing and accessories are sold exclusively under The Danier label. Currently, Danier operates 97 shopping mall, street-front and power centre stores.

The Canadian retailing market has proven to be challenging over the past year. We have seen large department stores struggle as consumers flock to niche players and superstores. In light of this consumer trend, we feel that Danier Leather is an opportunistic value find. At its current price of $10.00, Danier is trading at approximately its tangible book value and under 7 times 2002 earnings. Further enhancing its low valuation is a solid balance sheet with no debt.

Furthermore, over the last 5 years, Danier has consistently demonstrated positive sales growth. It is expected that further growth will be led with expansion into power centres. The company feels that there is potential for 50 more outlets in Canada. In addition, Danier will continue to slowly increase its presence in the United States.

On another note, with the recent strength of the Canadian dollar, it is also essential to evaluate Danier's exposure to the currency. A stronger Canadian dollar is actually beneficial with 70% of Danier's products purchased and manufactured overseas in US$. Hence, its cost of goods sold will be reduced which will improve its gross margins. While a positive, management has indicated that the benefits of a stronger Canadian dollar will not be realized until sometime in the next fiscal year since the company has proactively purchased its leather ahead of time.

We feel that Danier's strong fundamentals, market niche and business model will support the company's potential growth. As this growth through expansion continues, backed by a solid, debt-free balance sheet, we feel that Danier's share price will improve over time.

JC PENNEY

The JC Penney Company, Inc. operates two distinct divisions: the department stores/catalog division and Eckerd Corporation. The department stores/catalog division comprises over 1000 moderately priced department store chains while the Eckerd drugstore chain operates close to 2700 drugstores located through the Southeast, Sunbelt, and Northeast regions of the U.S.

JC Penney shares reached a high of $80 in June of 1998 after years of strong earnings growth. By that time, however, many of JC Penney's department store customers were starting to flock to off-the-mall retailers such as Kohl's and Target, which offered centralized checkouts, bigger aisles and better signage. At the end 2000 JC Penney shares could be purchased for less than $10 as the once dominant retailer was clearly falling behind the times.

In September of 2000, Allen Questrom was hired as the company's new CEO. Upon arriving at the company, Questrom immediately put together a five-year plan for JC Penney that would see it transition to a centralized operating platform. This included opening 13 centralized distribution warehouses and shifting to centralized buying. The plan also aimed to implement changes in marketing and store operations. By the end of 2001, JC Penney had positive same store sales for the first time in 4 years. In 2002, JC Penney earned $1.37 a share: the first increase in earnings since 1998.

We believe that based on JC Penney's current share price, the market is undervaluing the sum of its parts. Essentially, JC Penney's share price represents a very good deal: buy JC Penney and gets Eckerd for free. Based on comparable market multiples of publicly traded companies, we believe that the department stores alone are worth the price of the shares. In fact, the combined net asset value, or break-up value of JC Penney and Eckerd together is likely worth between $26 and $28 per share. At current levels, JC Penney shares sell at a 38% discount to our net asset value and a 24% discount to its book value of around $22. Downside risk in the stock should be mitigated by its tangible book value of $12 and its 3% dividend yield. We are optimistic that the market will eventually price JC Penney in line with its book and net asset value.

NORTHBRIDGE FINANCIAL

Northbridge Financial Corporation is one of Canada's top commercial property and casualty insurers. The Company operates through four key divisions, Lombard Canada, Markel, Federated Insurance and Commonwealth Insurance Company. Northbridge also provides home and automobile insurance to select demographics, although personal insurance accounted for only 14% of gross written premiums in 2002. Originally a wholly owned subsidiary of Fairfax Financial, 26% of the Company or 13.4 million shares were recently sold through an initial public offering. Northbridge began trading on May 23, 2003 under the symbol NB.

Northbridge's gross written premiums have grown at an annual rate of 20% over the past 4 years and reached $1.8 billion in 2002. Over the past fifteen years, Northbridge's return on equity has averaged 11.9%, which is above the industry average. In 2002, the Company's combined ratio (claims and expenses as a percentage of net premiums earned) was 97.4%, indicating that the business was profitable at the underwriting level. Further, Northbridge's investment portfolio is managed by Hamblin Watsa and has outperformed benchmarks consistently over a ten-year timeframe. The Company has no debt on the balance sheet and claims provisions have been more than adequate to cover actual claims expenses.

At the IPO price of $15, Northbridge Financial was priced at only 1.2 times book value of $12.50. The Company pays a $0.60 dividend, which yielded 4% at the issue price or approximately 3.2% at the current market price. The outlook for earnings growth is good for two main reasons. First, the property and casualty industry is experiencing "hard-markets", characterized by pricing power, underwriting profitability and a rising return on equity. The Company's focus on the commercial sector is important because the business is less susceptible to pricing regulation from the government. Second, the recent equity market rally should improve investment returns and therefore the Company's bottom line. We believe that the hard markets could persist for several years, ensuring solid earnings momentum in the near to mid-term.

Irwin A. Michael, CFA