Boring Portfolio

Done with Tenets
Now on to the holdings
by Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (Nov. 4, 1998) -- Alex and I have pretty much finished up the Boring portfolio tenets -- for now, at least. As we go forward, we'll add to those every week as we learn things and our views on the world evolve. The listing of the tenets is there pretty much for people who come in wondering what the heck this is all about, anyway. Before we put them together, we'll polish them up and add some clarifying remarks and so forth.

So, next up for us will be a look at what we have and what we will buy or sell. We have buying power, so a sell is not necessary at this time if we want to get into the buying ring. We're going to get into the current portfolio holdings, then. First, what is interesting is that, for the most part, companies in the portfolio are all very good return on invested capital performers. Even near its low, Andrew Corp. (Nasdaq: ANDW) is good-looking in that department. And the company has done the right thing with buybacks. If we do part company with Andrew, it won't be because it's a poorly-run outfit.

One thing I did look at briefly over the weekend was Atlas Air (NYSE: CGO), since "Inbloom" asked about it on the message boards. His or her post:

"It's been a while since I've seen any commentary on Atlas air, which has experienced serious volatility (from 42 to 23 back to 36) in just a few months. Any Foolish thoughts on the company's progress?

"I think the company is doing very well. Net margins are moving back towards 12%, which is about 2x any of its competitors. Revenues are increasing, and the company has announced several important new ACMI contracts.

"Any thoughts on the potential impact of a pilot's union forming? Do you think the company has too much debt on its books?"

My response follows:

"Well, I'll just say this. I don't think we really have a future with Atlas Air. How can you build that much value in a business like this? There's lots of capital in this world, there are lots of aircraft, there are lots of good air transport executives out there, and there are lots of good pilots out there. The company's basic business doesn't even offer it many opportunities to form serious competitive advantages. You can see that in the return on invested capital of this business. It's a little less than 10%, being generous and taking out excess cash equal to 95% of revenues. That estimate of excess cash is probably low because the company has earmarked the cash for something, but the ROIC [Return on Invested Capital] as calculated reflects the company's operating profile.

"In a record quarter, performance should probably be above that. I just don't see how the company can add that much value, but that may be because I don't know the business as well as I will when we make the decision to hold onto it or get out of it. However, at about 1.75 times invested capital and a pretty average ROIC, ROE [Return on Equity] of 12.5%, and ROA [Return on Assets] of 2.11% (through six months, annualized results) I personally don't see too much value here at 3.2 times book and 50% of assets."

Earlier today, Inbloom replied:

"I disagree about Atlas not having any competitive advantages.

"First, you don't have to disagree about Atlas not having any competitive advantages... I challenge you to find one competitor of Atlas that has even 1/2 of Atlas' 12% net margins. Further, Atlas has demonstrated that there is great demand for its product, even though the world is full of planes and money. It has announced commitments for new planes with new and old customers that should sustain double-digit growth for at least another 1.5 years. The demand for its product and the profitability of its operations is proof positive that it currently has a strong competitive position that is sustainable into the future.

"Further, demand for its service will continue to increase as international trade barriers come down.

"Value doesn't always fit into a formula. The bottom line is how much money will the enterprise generate going forward and how much does the investor have to pay for those monies.

"I look forward to seeing a more thorough analysis from the Fool when you re-evaluate Atlas' position in your Boring Port. If you like, I can break down how I see Atlas' earnings taking shape in the next two years."

And we will remit a more thorough-going analysis of things. But here's the thing. Net margin doesn't mean you're a desirable company. We like some companies with single-digit net margins. Net margin to us doesn't mean anything unless it's combined with asset turns. When you look at a bank, you see gigantic net margins of more than 20%. Their asset turnover, however, is usually 6% to 8%. That means that a dollar of assets turns into a dollar of revenues something on the order of every 12 1/2 to 16 years. That's fine for a bank where assets are pretty stable, but not for an industry as notoriously volatile as the air transport business.

If Atlas generates 12% net margin and a 2.11% ROA, then its asset turnover is 0.176. Just to test that, let's see what the actual turnover was from the more recent 10-Q: Revenues of $167.584 through six months and average assets of $1.463 billion. That's annualized turnover of 0.229, or 22.9%. It takes the company roughly 4.4 years to turn a dollar of assets into a dollar of earnings. And as I calculate it, I see net margin of 9.2% through the first six months of the year. This asset turnover is just not desirable for us.

When things turn down and you're not operating at peak capacity, then your return to shareholders will be sub-optimal. Let's make the unrealistic assumption that asset turnover hangs at 22% in a downturn. But let's say margin gets to 7%. That's a 1.4% return on assets. We don't like that kind of business. Just to generate a satisfying return on equity, you've got to leverage up this business pretty hard. With all the great businesses out there, there are many other dynamic companies that can provide us with far better returns. So, preliminarily, this one is not too high up on our dance card.

Later tonight, we'll take a look at Cisco on the message boards.

Bore on,


10/01/98: The New Boring Port Transitions Facts

FoolWatch -- It's what's going on at the Fool today.

11/04/98 Close

Stock  Change    Bid 
 ANDW  -  7/16  16.75 
 CGO   +  7/16  36.63 
 BGP   +1 3/8   28.00 
 CSL   +1 5/16  40.38 
 CSCO  +2 3/16  65.56 
 FCH   -  1/8   23.63 
 PNR   +  5/16  38.50 
 TBY   -  1/16  6.94 
                    Day   Month    Year  History 
         BORING   +2.15%   4.21%  -4.68%  19.94% 
         S&P:     +0.70%   1.82%  15.28%  79.96% 
         NASDAQ:  +1.96%   2.95%  16.12%  75.18% 
     Rec'd   #  Security     In At       Now    Change 
   6/26/96  225 Cisco Syst    23.96     65.56   173.68% 
   2/28/96  400 Borders Gr    11.26     28.00   148.75% 
    3/5/97  150 Atlas Air     23.06     36.63    58.84% 
   8/13/96  200 Carlisle C    26.32     40.38    53.37% 
   4/14/98  100 Pentair       43.74     38.50   -11.98% 
   5/20/98  400 TCBY Enter    10.05      6.94   -30.94% 
   1/21/98  200 Andrew Cor    26.09     16.75   -35.80% 
   11/6/97  200 FelCor Sui    37.59     23.63   -37.15% 
     Rec'd   #  Security     In At     Value    Change 
   6/26/96  225 Cisco Syst  5389.99  14751.56  $9361.57 
   2/28/96  400 Borders Gr  4502.49  11200.00  $6697.51 
   8/13/96  200 Carlisle C  5264.99   8075.00  $2810.01 
    3/5/97  150 Atlas Air   3458.74   5493.75  $2035.01 
   4/14/98  100 Pentair     4374.25   3850.00  -$524.25 
   5/20/98  400 TCBY Enter  4018.00   2775.00 -$1243.00 
   1/21/98  200 Andrew Cor  5218.00   3350.00 -$1868.00 
   11/6/97  200 FelCor Sui  7518.00   4725.00 -$2793.00 
                              CASH   $5750.59 
                             TOTAL  $59970.90