Category: Stocks

• Wendy’s opportunity lies in the International markets 
• Wendy’s Capital Allocation Program dooms the future of Wendy’s performance 
• The domestic market is Competitive, and Wendy will cede market share to smaller more versatile companies 

 

Wendy’s is the sixth largest QSR business in the United States with systemwide sales exceeding nine billion dollars and global systemwide sales of more than ten billion dollars.  Wendy’s International Franchised stores made only a sliver of these sales with 477 million dollars.  In addition, by 2020 the international franchised restaurant industry is expected to be worth $5 trillion. 

 

While there are certainly challenges to overcome in the domestic markets the opportunity international markets provide the company will outweigh the loss of any market share in the domestic arena.  

 

The book Good to great underlines some key aspects a great company needs to have.  Applying these concepts from the book to Wendy’s provides a few key indicators to look for.  One of the themes throughout the book was the idea that management must be superb.  The common thread linking great management is their continued involvement within the corporation and their loyalty towards their company.  These types of leaders are required to improve existing parts of the company or a new endeavor.  Abigail Pringle, the head of international development at Wendy’s, is a long-time company insider 

Ms. Pringle joined the Company in May 2002 and has served as our Chief Development Officer since December 2014. She served as our Senior Vice President of Restaurant Development and Growth Initiatives from July 2013 to December 2014, Senior Vice President of Strategic Initiatives and Planning from April 2012 to June 2013, Vice President of Strategic Initiatives and Planning from November 2008 to March 2012 and Director of Strategic Initiatives and Planning from May 2002 to November 2008. Prior to joining the Company, Ms. Pringle worked from August 1996 to May 2002 for Accenture plc, a global professional services company, where she served as a consultant in the areas of process re-engineering, systems implementations, organizational design, and change management. 

 

With a capable leader at the helm, other factors must be looked at to see how Wendy’s can compete in the international QSR business. Wendy’s management has been doing this recently expanding their international presence.  In Q3 of 2018, Wendy reported: “another impressive quarter of double-digit growth at 13%”.  The idea that management is focused solely on expanding Wendy’s operations brings us to another Good to Great concept.  The book Good to Great states every “great” company has had a strong strategic concept and focused solely on it called the “Hedgehog” concept.  

 

If management acknowledges this truth and works towards utilizing cash flows towards expanding in the international environment Wendy will recognize large growth.  For management to more effectively compete in the international marketplace more cash must be retained in the company.  If we recognize that Wendy must retain more cash to reinvest in its international operation to expand then its capital allocation program seems foolish at best.   

 

In a hypercompetitive domestic marketplace, the largely underinvested international markets offer Wendy’s new opportunities in redefining its position in the QSR industry.  While they contend with Restaurant Brands International (parent of Burger King) and McDonald’s with burgers Wendy has an opportunity to redefine this relationship.  By focusing on higher margin, healthier products Wendy can change the battlefield.  

 

With changing consumer trends, the continued perception of Mc Donald’s and Burger King as unhealthy allow Wendy’s to rebrand themselves more aggressively and dominate a larger portion of market share.  However, if Wendy does not adapt quickly enough substantial market share will be controlled by smaller enterprises such as Chic-fil-a. 

 

But if Wendy is not able to change the conditions on which this game is played the future looks bleak. It seems very unlikely Wendy will be able to do this with its capital allocation plan. This idea of giving excess cash back to investors goes against the hedgehog concept of focusing on international growth.  By not retaining its earnings and adapting to the hypercompetitive domestic market and ceding market share to smaller companies Wendy seems doomed to mediocre performance. 

 

 

Berkshire Hathaway an Enduring Investment

• The economy is about to go into a recession and cash is king 
• Berkshire Hathaway is well positioned with the companies it owns to power through a recession 
• Warren Buffett has a 100 Billion to buy equities when the recession hits and its primary business will continue to perform even in an economic contraction.

Introduction: 

The Federal Reserve has been tightening monetary policies and raising interest rates.  In addition to the Fed’s tightening policies, the 3-year and 5-year yield curves have inverted.  These changes come at a time when global economic growth has been slowing and after the longest economic expansion in history.  It is clear we are within two to three years of a major economic recession. As legendary hedge fund manager Ray Dalio said, “we are in the 7th inning of the current economic cycle.” Thus, with the looming recession, investors must look for securities that perform well in times of economic contractions. Berkshire Hathway is well positioned to not only survive but perform exceedingly well in the upcoming recession. 

 

Breakdown of Berkshire Hathway: 

There are two main components of Berkshire Hathaway.  The first is the investment side of Berkshire.  I define this side as the minority holdings in publicly traded companies and the income created from investing with the insurance float.  The second component of Berkshire is the fully owned subsidiaries.  I term this side of Berkshire “Physical Berkshire”.  Each component offers a path for Berkshire to succeed in the upcoming recession.  

Physical Berkshire: 

This component comprising of the wholly-owned subsidiaries is imperative to the success of the company and accounts for slightly more than 10 billion dollars about half of Berkshire’s net earnings (Earning not including Tax Cut).   

Net earnings                                                                                                 2017     2016      2015 

Insurance – underwriting …………………………………………………$(2,219) $ 1,370 $ 1,162 

Railroad …………………………………………………………………………………3,959     3,569    4,248  

Utilities and energy …………………………………………………………… 2,083      2,287   2,132  

Manufacturing, service and retailing ………………………………6,208      5,631   4,683 

Physical Berkshire, during times of high interest rates, benefits greatly from the cash it can borrow cheaply from the investment side.  This free flow of capital is great for capital-intensive activities like railroad and manufacturing.  As the Fed continues to increase interest rates, Berkshire will be more successful than the broader market.  While this company will be more competitive relative to its peers, it too will suffer during an economic contraction.  

The manufacturing, service and retailing portion of Berkshire Hathway will suffer significantly during a recession.  This portion of Berkshire accounts for about half of Physical Berkshires’ net income.  While the recession will hurt Berkshire in this area it will be more than made up for by its investment arm.  Physical Berkshire also includes its insurance underwriting segment.  The underwriting segment will begin to incur increasing losses due to climate change.  As major catastrophes begin to become more common the underwriting portion of Berkshire will see material adverse changes.  We have already begun to see this with the loss incurred from Hurricane Harvey in 2017.  However, the fully damaging effects of climate change will not need to be considered within the next decade.  Thus, in the near future, we can expect the net income from the underwriting segment to be positive. 

Each portion of Physical Berkshire save manufacturing, service, and retail are recession proof.  Insurance, energy, and railroad are all necessities in the face of an economic slowdown.  These industries will continue to produce large returns even in a recession something many other companies will struggle with.  This makes Berkshire Hathway a sound long-term investment especially with a recession on the way.  

Investment Berkshire: 

The investment portion of Berkshire contains Insurance – investment income, Finance, and Financial products, as well as investments.  These investments account for a significant portion of Berkshire Hathaway’s net earnings. 

 

Net earnings                                                                                         2017     2016     2015 

Insurance – investment income ………………………………………………..$ 3,917   $3,636   $3,725 

Finance and financial products …………………………………………………..1,335    1,427    1,378 

Investment and derivative gains/losses ……………………………………1,377    6,497    6,725 

Right now, Warren Buffets portfolio is split between equities and cash.  Cash currently accounts for 34% of Berkshire Hathaway’s portfolio. 

 

 

 

Having such a large cash position before entering the recession will position Berkshire strategically to succeed in the economic contraction.  This large position in cash is a testament of Warren Buffets belief the economy is headed into a recession.  In 2008, after Lehman’s Brother’s collapse, Buffett took advantage of the financial meltdown and profited handsomely.  If history is any predictor of the future, Berkshire will be well positioned again to succeed in the next recession. Thus, Warren Buffet is ensuring Berkshire Hathway’s success through this economic slowdown by having a large position of capital. 

 Having such a large cash position before entering the recession will position Berkshire strategically to succeed in the economic contraction.  This large position in cash is a testament of Warren Buffets belief the economy is headed into a recession.  In 2008, after Lehman’s Brother’s collapse, Buffett took advantage of the financial meltdown and profited handsomely.  If history is any predictor of the future, Berkshire will be well positioned again to succeed in the next recession. Thus, Warren Buffet is ensuring Berkshire Hathway’s success through this economic slowdown by having a large position of capital. 

Conclusion: 

Berkshire’s cheap capital allows for Berkshire to perform well even with increasing restrictions on credit.  Berkshire Hathway is also poised to utilize its capital to make strategic acquisitions to further its competitive edge in its physical segment.  These factors make Berkshire Hathway a solid long-term investment even in the face of an economic recession. 

 

 

 

• Synchrony has close to a 6 – 6.8% of Total Loans Receivable as Provisions.
• Industry Standard for Loan Loss provisions is 2 – 2.5% of Total Loans Receivable.
• What does this mean to quality of assets listed on their balance sheet.

 

Synchrony financial (SYF) deals in the private credit line for business.  They have a very unique position in the health care sector compared to other banks. After buying Citi Corps portfolio of consumer credit debt in healthcare, Synchrony has become a dominant player in that arena.

 

While the company enjoys the “moat” of competitive advantages, analysts worry about asset quality especially after the last earning release in Q1.

 

Even with earnings beating the Streets expectations by close to 9%, the share price remained relatively unchanged. This primarily has to do with the quality of loans in Synchrony Financials portfolio. In the chart below, it is evident how the relative percentage of coverage for loan loss stacks up to its competitors.  

Two of the largest banks, Citi and Wells Fargo, have had decreasing percentages of loan loss provisions. In addition to lower percentages in subsequent years, they are also significantly lower than Synchrony Financial and Capital One.

 

Seeing how high the provisions are for these losses, warrants a special look at the quality of these loans. The graph below, from Synchrony’s 2017 annual report, shows the breakdown of the loans they have been amassing.

 

Seventy percent of all Loan receivables come from their Retail Credit line. It also demonstrates the significant amount of 20% from their payment solutions.

 

The annual report does not show what percentage of loan loss provisions are tied to each operating sector.  However, any increases in allowance for Payment Solutions through the fiscal year (2018) can be accounted for through the acquisition of the PayPal portfolio.  This is evident in the following quote from their 10-k, which says:

 

“In addition, we also expect increases to our allowance for loan losses in the second half of 2018 to establish appropriate loan loss reserves for the PayPal transaction, which we expect to close in the third quarter of 2018.”

 

The acquisition of this debt explains the huge uptick in Loan Loss percentage between Q’4 of 2017 and Q’1 of 2018, which was given a larger allowance.  Even with the PayPal acquisition, there is no explanation for the 26% increase between 2016 – 2017.

 

In addition, the acquisition of PayPal debt portfolio can only explain an increase in Q’3 and Q’4 of this year.  So naturally any increase in the loan loss provisions between 2017 and 2018 Q’1 & 2 must be explained.

 

In examining the first earnings release this year, things get even uglier with provisions for loan loss increasing tremendously y/oy from  6.37% to 7.37%. Not only is the allowance for these delinquent debts increasing year-over-year, but it is expected to get worse as the quote below will demonstrate.

 

“We also experience a seasonal increase in delinquency rates and delinquent loan receivables balances during the third and fourth quarters of each year.”

 

This is due to the latter quarters including many holidays and is known to be a huge time for consumer spending.  But this means continued coverage of these through the allotment of capital.

 

With these huge increases of capital to cover these potential loses comes a great opportunity cost. Keeping this capital secure and away from investments means that it will be hard for management to put this capital to work.

 

Not only is this huge allowance for loss hindering future growth, it is also hindering current performance. At the end of fiscal year 2017, Synchrony Reported the following:

 

“Net earnings decreased 14.0% to $1,935 million for the year ended December 31, 2017, primarily driven by increases in provision for loan losses and other expenses.”

 

Although Synchrony enjoys being the largest private credit line in the world and has an unique position in the healthcare sector to provide credit, it is hindered by the allotment of capital to loan loss provisions. Synchrony is in a position to reap the benefits of its position in the healthcare industry to capture huge revenues by becoming the sole provider of consumer credit in that arena.  

 

While Synchrony is on a strong footing in its private credit line business, it has some major obstacles to overcome in the future which investors need to continually monitor.