BON-TON STORES INCORPORATED
Bon-Ton Stores is a York, Pennsylvania based
corporation, which operates 139 department stores and two furniture
stores under the Bon-Ton and Elder-Beerman names. The stores are
situated throughout 16 states from the Northeast to the Midwest and
are positioned in smaller rural cities and towns where competition is
sparse. The stores carry a broad assortment of brand-name fashion
apparel and accessories for women, men and children as well as
cosmetics, furnishings and other miscellaneous goods.
In October 2003, Bon-Ton purchased Elder-Beerman
Stores, which operates 68 department stores in the Midwestern United
States including Ohio, West Virginia, Indiana and Michigan. Bon-Ton
purchased the company for $8 a share which was at a significant
discount to its book value of $14 a share. The purchase made sense
strategically as both companies focused on small to mid-size markets
and offered similar fashion-oriented merchandise and brand name
products. Also, there was virtually no geographic overlap between
them. The acquisition served to provide a much-needed catalyst to
Bon-Ton shares, having received very little attention from Wall
Street. Bon-Ton shares rallied in the months following the
announcement and have settled into a trading range of between $11 and
$14 since July of this year.
For the 2nd quarter of 2004, Bon-Ton recorded
net sales of $284.2 million, an 85.6% increase from last year’s level.
Comparable store sales, which exclude the Elder-Beerman stores,
decreased 0.5% while home, accessories, cosmetics and women’s clothing
recorded positive sale increases. Bon-Ton’s back to school season was
softer than expected however, a robust holiday season could provide a
lift to Bon-Ton’s stock price, which we feel is attractively priced.
The shares are trading 22% below their book value of $14.72 and under
nine times management’s earnings guidance of between $1.20 and $1.40
per share.
DECOMA INTERNATIONAL INCORPORATED
Decoma International Inc. is a major
international auto parts supplier of exterior vehicle appearance
components and systems. The Company designs, engineers and
manufactures fascias (bumpers), front and rear end modules, plastic
body panels, roof modules, exterior trim components, sealing and
greenhouse systems and lighting components. Magna International
maintains effective control over Decoma with an approximately 74%
ownership stake in the Company.
Decoma was spun out from Magna on March 2, 1998
and began trading on the TSX under the symbol DEC.a and on the NASDAQ
under the symbol DECA. The auto parts industry is notoriously cyclical
and is driven primarily by interest rates, consumer confidence and
employment levels. Looking at the historic trading pattern, the shares
have moved from an issue price of $9.50 CDN to a high of $21.10 CDN on
June 4, 2002, and back to roughly $10 CDN today.
Decoma, and most stocks in the auto parts
sector, have come under selling pressure related to several major
issues. As we mentioned, auto parts are cyclical stocks that typically
under perform in a rising rate environment. Further, volatile economic
data, including key consumer confidence and employment growth figures,
have added to the uncertainty. Skyrocketing oil prices have also
negatively impacted the outlook for auto sales, especially sales of
SUVs and light trucks. Tier 1 auto parts manufacturers, such as Decoma,
are also facing demands from the OEMs for price concessions, as they
try to maintain market share and boost their own profitability. On the
manufacturing side, raw material costs have spiked upward with steel
and resin prices rising dramatically. Finally, Decoma has several
facilities and programs ramping up, which hinders profitability until
the product launch is well underway. With all of these influencing
factors, investors have been frightened off; it is no wonder that
Decoma has declined to near six-year lows.
We believe that Decoma is cheap, on an absolute
basis, on an historical basis and relative to its peers. The Company
pays a dividend of $0.28 per share in US dollars, which yields
approximately 3.5% in Canadian dollar terms. Book value is
approximately $7.58 US and it trades roughly at book value. Consensus
earnings estimates are $0.93 US for 2004 and $1.11 US in 2005 with the
stock trading well below 10 times this year’s and next year’s
earnings. Auto parts stocks typically bottom at these valuation
levels. On a relative basis, Decoma trades well below its peers based
on yield, P/BV and P/E metrics. While the Company may experience a
weak quarter or two, we are comfortable that downside risk is limited
at current price levels.
Given the reasonable margin of safety, we would
like to point to several factors that could drive the performance of
the stock over the next 12 to 18 months. First, we believe that the US
Federal Reserve will raise rates at a measured and cautious pace that
will not damage the economy or consumer spending. Next, Decoma has
several major product launches through 2005, as the OEMs revamp and
refresh their model lines. Look for new or restyled cars from Ford
(Cross Trainer, Five Hundred and Montego), Daimler-Chrysler
(Cherokee), GM (Canyon/Colorado) and Mercedes (A Class). So far this
year, Decoma has been a beneficiary of strong sales of Chrysler’s new
300C sedan, available with the ferocious Hemi engine. The earnings
improvement at Decoma coupled with less negative sentiment toward the
auto parts sector should reward investors over the next 12 to 18
months.
GENERAL MOTORS
General Motors Corp. (GM) is the world’s largest
automobile manufacturer. Some of its brands include, Cadillac,
Chevrolet, GMC, Hummer, Oldsmobile, Pontiac, Saab and Saturn. GM has
operations in 32 countries and has 326,000 employees worldwide. In
2003, GM sold nearly 8.6 million cars and trucks, which represented
close to 15% of the global vehicle market with sales of over $185
billion. To complement its automotive division, GM also operates GMAC
Financial Services, which provides a broad range of financial
services, including consumer vehicle financing, automotive dealership
and other commercial financing, residential and commercial mortgage
services, and personal automobile insurance coverage.
We feel GM shares represent an attractive
investment opportunity based on the company’s relatively high dividend
yield, low price to earnings and low price to book multiples. GM pays
an annual dividend to shareholders of $2 per share, which works out to
a yield of about 4.6%. We feel this dividend is safe given the
company’s payout history and high operating cash flow. GM is one of
the 30 stocks that make up the Dow Jones Industrial Average, and as a
result, many Wall Street investment firms closely follow it. Earnings
estimates for 2004 range from $6.35 per share to $7.60 per share,
which implies 6 times forward PE ratio. In addition, GM shares are
trading at a 13% discount to its book value of $49.18 per share.
GM is a cyclical company that appears to be
getting back on track after three tough years. After reaching an all
time high of $93.62 in May 2000, the company was hit by a global
economic slowdown, intense competition from foreign car manufacturers,
and a growing pension deficit. Earnings per share fell from a record
$9.18 in 1999 to just $1.78 in 2001. Consequently, GM’s share price
fell as low as $29.92 in March 2003. Today, with its share price
currently in the low $40s, we are optimistic that better times lie
ahead for the company. A robust global economy, particularly in China,
where GM has shown early success, should lead to an increase in demand
for its vehicles. As for GM’s pension: it is now fully funded and
could return to a surplus as interest rates begin to increase.
Finally, GM is slated to introduce 11 all new and significantly
redesigned models in the second half of this year. These cars have
been well received by GM’s dealers and could be just the spark the
company needs to rejuvenate sales and take back market share.
GM’s financial results for its most recent
quarter are encouraging. On July 21st 2004, the company reported
earnings from continuing operations of $1.3 billion, or $2.36 per
share compared with earnings of $879 million, or $1.57 per share, in
the second quarter of 2003. Revenue rose 7.1 percent to $49.1 billion.
GM Chairman and CEO Rick Wagoner had overall praise for the quarter
but cautioned that competition remained intense and that the company
had a lot of work ahead of it. We feel that if GM can make good on its
initiatives, the stock has the potential for decent capital
appreciation in addition to its excellent yield.
MORGUARD CORPORATION
Morguard Corporation (TSX: MRC) is an integrated
real estate company comprised of four operating divisions. The Company
has a 50% interest in Morguard REIT (TSX: MRT.UN), a publicly traded
real estate investment trust that holds retail, office and industrial
properties across Canada. Morguard Residential, a wholly owned
division, develops, manages and sells multi-unit residential
properties primarily in the Greater Toronto Area. Morguard
Investments, another wholly owned division, acts as a real estate
advisor and manager for Canadian pension funds and institutional
investors. Finally, Morguard has an 80% stake in Revenue Properties
Company (TSX: RPC), which owns, develops and manages a portfolio of
shopping centers, office properties and apartment buildings.
Morguard’s financial performance has been
impressive, especially over the past five years. Revenue has grown to
$369 million from $101 million and funds from operations (FFO), a
standard metric in the real estate industry, have grown to $94
million, or $6.60 per share, from $21 million, or $1.32 per share. On
a proportionately consolidated basis, Morguard reported FFO of $4.69
per share in 2003, after adjusting for the minority interest of
Morguard REIT and Revenue Properties Company compared to $3.13 in
2002, an increase of 50%. Book value at December 31, 2003 totaled
$31.07. At current price levels, Morguard trades at 3.6 times FFO, 5.1
times consolidated FFO, 0.8x book value and pays a $0.56 dividend,
which yields 2.3%.
Our investment thesis is based on the Company’s
significant discount to its net asset value (NAV), in addition to the
attractive financial multiples and dividend yield discussed above.
Essentially, the NAV is calculated by adding the Company’s capitalized
net operating income, the value of the properties under development or
held for sale and the investment portfolio at market prices less net
debt. Following this methodology, we believe that Morguard’s NAV is in
the mid $30 per share range, implying a discount of approximately 30%.
Like many of our Value Favourites, management seems to agree that the
shares are undervalued and have filed for a normal course issuer bid
for 774,508 common shares or about 10% of the public float
outstanding.
Like many of the REITs, Morguard Corporation
declined almost 15% in the first half of 2004. The sell-off was
triggered by the threat of rising interest rates and the potential
fallout on the real estate market. However, we believe that because
Morguard trades at a discount to both its book value and net asset
value, further downside is limited. Even though the shares have since
recovered almost 10%, we still believe that the stock is cheap. In
2004, we expect management to continue to buy back stock, look for
accretive acquisitions, develop and renovate existing assets and
divest non-core properties. Management is building wealth within the
Company, which should eventually be reflected in Morguard’s share
price.
Irwin A. Michael, CFA
