Sample Report – Melcor

THIS IS AN EXAMPLE REPORT FROM 2003 – We rated MELCOR a Speculative Strong Buy at that time.

This Sample Shows you the content of the reports and you can see there is a lot of analysis and thought that goes into our ratings.

Report Author: Shawn Allen
Author’s disclosure of share ownership: I hold shares
Based on financials from: Dec ’02 Y.E. +Q2
Last updated: 15-Aug-03
Share Price At Date of Last Update: $37.75
Currency: Canadian $
Current Rating (Company Rating does not consider the circumstances of any individual investor and is therefore not a recommendation and is not Investment Advice): THIS RATING IS FOR EXAMPLE ONLY AS IT IS NOW COMPLETELY OUT OF DATE. Rating per this old report was: Speculative Strong Buy
DESCRIPTION OF BUSINESS: Primarily a residential land developer. Also develops some commercial properties. Owns and leases some commercial property. Owns and operates two golf courses. Operates almost exclusively in or near the major cities of Alberta.
RATING: Here we have a company with a long history of profit and growth and it is selling slightly under book value. The assets consist of receivables, land and buildings , which means that the book value is quite real (unless the economy turned down very sharply driving down land prices). Profit is expected to decline in 2003 after an exceptional 2002. But the stock price seems to assume that profit will not recover. Their history suggests that profits will grow over the long term. Based on the strong value ratios and the strong history, I rate this a Strong Buy. It is somewhat speculative particularly in the short term due to cyclic nature. Trading liquidity is unfortunately quite thin, with a wide bid-ask spread. Therefore the stock is not suitable for fast trading and caution should be exercised in buying and selling due to the wide spread. Overall Rating – Speculative Strong Buy.
RISKS: The primary risk is the state of the Alberta economy and the demand for new housing. also, this public company has a majority controlling owner. In most cases this will benefit outside shareholders as compared to hired-help type management. But there is a risk that the controlling shareholder will use his position to award large bonuses and stock option grants to himself and the family and not act strictly in the best interest of out-siders. To date, this may not have occurred and outside shareholders have done very well. This family control feature does tend to hold the share price down some-what.
INSIDER TRADING: I have no convenient access to this information, but as a family controlled company it seems unlikely that insiders would be selling.
WARREN BUFFETT’s TENETS: Seems to arguably pass all of Buffett’s tenets (see Robert Hagstrom’s book – The Warren Buffett Way) – simple to understand (pass),good profit history (pass), favorable prospects for above average returns (marginal pass), apparently candid ethical management (pass), reasonably high ROE (pass), high profits on sales (pass) , low debt ratio (pass), little chance of permanent loss of capital (pass) low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) and arguably selling at a discount to intrinsic value (pass).
VALUE AND GROWTH RATIOS: The Price to book value ratio is very attractive at 0.92. (However, note that the company has a history of trading at an average 76% of book value). The dividend yield is fair at 2.9% and is indicative of a more mature operation. The P/E based on the latest 12 months earnings is highly attractive at 5.1. But 2003 earnings are expected to drop, the 2001 level however the P/E based on 2001 earnings is also very attractive at about 7.5. Return on Equity is recently exceptional at 20% but has historically been closer to 14%. The 5 year compounded growth in revenue per share is strong at 17%. The 5 year compounded growth in earnings per share is strong at 23%. The share price is currently implicitly assuming that earnings will fall to the 2001 level and grow very slowly from there. If earnings grow at 8% from 2001 level, the intrinsic value is calculated as $54.82. Overall these value ratios (in isolation) point to a Strong Buy.
Symbol and Exchange: MRD, Toronto
Currency: Canadian $
Category: Growth with income
Latest four quarters annual sales $ millions: $95.8
Latest four quarters annual earnings $ millions: $20.4
P/E ratio based on latest four quarters earnings: 5.8
Latest four quarters annual earnings, adjusted, $ millions: $20.4
BASIS OR SOURCE OF ADJUSTED EARNINGS: No adjustments made, but note that earnings are cyclical and heavily dependent on economic activity.
Quality of Earnings Measurement: High, Earnings result mostly from sale of developed lots at a profit. There is little in the way of estimated costs such as depreciation. Builders often have 1 year to pay for the lots and so there is some risk of bad debt. However earnings are cyclic and expected to decline in 2003 so they are not very predictable.
P/E ratio based on latest four quarters earnings, adjusted 5.8
Latest fiscal year annual earnings: $23.1
P/E ratio based on latest fiscal year earnings: 5.1
Fiscal earnings adjusted: $23.1
P/E ratio for fiscal earnings adjusted: 5.1
Latest four quarters profit as percent of sales 21.3%
Dividend Yield: 2.9%
Price / Sales Ratio 1.23
Price to book value ratio: 0.92
Quality of assets measurement: Very high, and this is particularly important in this case since the shares trade near book value. Assets consist primarily of receivables, land and buildings. While a recession could lower their values, there is no reason at this time to believe that these assets are not worth the book value amount, net of liabilities.
Number of Diluted common shares in millions: 3.2
Controlling Shareholder: T.C Melton, the executive chairman of the company, together with his family, controls just over 50% of the shares.
Market Capitalization $ millions: $119.2
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 58%
Current assets / current liabilities: not available
Liquidity and capital structure: Good liquidity, the company does use debt to finance their lands and buildings but the debt is not excessive and was 66% of the equity at the end of 2001. The debt ratio has been declining in recent years.
Latest four quarters adjusted (if applicable) net income return on ending equity: 15.7%
Latest fiscal year adjusted (if applicable) net income return on average equity: 19.8%
Adjusted (if applicable) latest four quarters return on market capitalization: 17.1%
5 years compounded growth in sales/share 17.4%
Volatility of sales growth per share: Strong growth with some volatility. Expect higher volatility in future
5 Years compounded growth in earnings/share 22.6%
5 years compounded growth in adjusted earnings per share 22.6%
Volatility of earnings growth: Strong growth with some volatility. Expect higher volatility in future
Projected current year earnings $millions: $16.3
Projected price to earnings ratio: 7.3
Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? Yes, it appears to be, but volatility is expected in the long run
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 16.8%
Conservative estimate of compounded growth in earnings per share over the forecast period: 4.0%
Optimistic estimate of compounded growth in earnings per share over the forecast period: 8.0%
GROWTH OUTLOOK: The Alberta economy continues to be strong. The company should continue to grow through profits on its larger asset base. However any recession in Alberta could lead to lower earnings. Kyoto is a concern.
Estimated present value per share: I calculate $37.56 if adjusted earnings per share grow for 5 years at the more conservative rate of 5% per year and the shares are then sold at a P/E of 8 and $54.82 if earnings per share grow at the more optimistic rate of 8% for 5 years and the shares are then sold at a P/E of 10. Both estimates use a 9% required rate of return. This company is quite cyclical and therefore the growth is unpredictable.
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry rather than any particular company.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. The development industry has limited barriers to entry (fail). There are no issues with powerful suppliers (pass). No issues with excessive dependence on powerful customers (pass), No viable substitute products(pass), Probably at least some tendency to compete excessively on the basis of price (pass). Overall this industry appears to be only neutral in attractiveness.
COMPETITIVE ADVANTAGE: Established presence in the market place and knowledge.
RECENT EVENTS: Sales and earnings in 2003 are running well below 2002 levels as predicted by management. Earnings are expected to approximate the 2001 level. The dividend was recently increased by 10%.
ACCOUNTING AND DISCLOSURE ISSUES: Good disclosure. Candid discussion of the risks and the high dependency on the state of the economy in Alberta. See comments under quality of earnings and quality of assets.
COMMON SHARE STRUCTURE USED: Normal, 1 vote per share
MANAGEMENT QUALITY: High quality with a long record of profitability. I am disappointed by their choice of not directly expensing stock options.
EXECUTIVE COMPENSATION: Salaries are not at all excessive. Bonuses were quite huge in 2002 but presumably would be cut well back in lean years. I am a little bothered by the 80,000 stock options granted to the Chairman. He is not the CEO and I can’t understand why he needed to be granted such a huge number of options. Furthermore, I believe that the pro-forma calculation of options compensation that is provided grossly under-states the true impact of this option grant. (But I have no doubt that their calculation follows the letter of the law).
BOARD OF DIRECTORS: A strong small board. Key members own large stock holdings which aligns their interests with that of outside shareholders. It is however disappointing that several members own no or very few shares.

DISCLAIMER: The information presented is not a recommendation to buy or sell any security. The author is not a registered investment advisor and the information presented is not to be considered investment advice. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision.

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