Beating the Street (47 page)

Authors: Peter Lynch

Sun Distributors had been working to maximize the value of the B shares by reducing debt and reducing costs. Several months before the company announced that it was putting itself up for potential sale, it completed a deal to refinance its long-term debt. Because the company's debt problem was a potential overhang, this was exciting news, and you could have read about it in the annual report. Moreover, its annual earnings had increased steadily, even during the recession, and it continued to bring in $1 per share per year in free cash flow. Theoretically, this meant $1 per year was added to the intrinsic value of each share of Class B.

This was another case of the company doing well and the share price going nowhere. Class B had been selling in the $2.50-$3 range for more than two years, and then it jumped to $4.40 in September 1993, the month when the possible sale was announced. The stock market can test your patience, but if you believe in a company, you hold on until your patience is rewarded.

The Class B shares might have fetched $8 a share or even more if the company had stayed intact until 1997. I feel the same way about the potential sale as I felt about Taco Bell being acquired by PepsiCo in the late 1970s. Taco Bell shareholders made a quick profit, but the ongoing enterprise had the potential to be 10 times as rewarding.

Tenera
, my limited partnership in recovery, has not fully recovered. If it weren't for the debt-free balance sheet, Tenera would have been a goner long ago. Before you invest in a company that's clinging to life, make sure it has the cash to pay the medical bills.

The stock price rose and then fell, and as of this writing the price is about half of what it was when I recommended the stock in January 1992, and about the same as it was in January 1993 when I recommended the stock again. The company has a new COO and $2 million in the bank, which it has used to buy back some of its own shares. It has attracted new clients for its utility management services, and its problem projects are reduced from six to two. The contract dispute with the government is not yet resolved, but the company has set aside enough money to cover itself if it loses. A win would be a bonus.

The way I see it, if the company never recovers, the liquidation value is $1 per share, and if it does recover, the stock goes to $4.

Table PS-2. LYNCH'S 1992
BARRON'S
PORTFOLIO: 24-MONTH UPDATE

Two other master limited partnerships I continue to follow but didn't recommend in 1992 are worth mentioning.
Cedar Fair
, the amusement park company, has continued to thrive after its acquisition of the Dorney Park amusement complex near Philadelphia, which I visited with my family in 1993. It has one of the highest splash rides in the world. More to the point, the stock has a 6 percent yield with certain tax advantages until 1997, and the company continues to grow by adding new rides and making acquisitions. It could become an acquisition target itself. I can think of a lot of buyers out there, particularly the entertainment giants, which might want their own amusement parks with Bart Simpson rides or Arsenio Hall of Fame rides or whatever. Disney has already bought a hockey team and named it the Mighty Ducks, so imagine how well it might do if it bought an amusement it knew something about. It could turn Dorney Park into Buena Vista World.

EQK Green Acres
, the partnership that owns the shopping center on Long Island, completed a refinancing of most of the debt that was hanging over the company. Two other bits of positive news were reported in 1993: (1) Home Depot's acquisition of a piece of EQK property, which helped reduce debt; and (2) the purchase by the principal shareholder and CEO of 56,000 additional shares for himself, as noted in a quarterly message to shareholders.

The stock price of EQK rose after the announcement of the refinancing, but not right away. This is another example of how investors don't need inside information to profit from good news. Even after good news is made public, Wall Street can be slow to react.

EQK also has announced that it may convert to a real-estate investment trust (REIT). This will strengthen the balance sheet and enable the company to borrow money at lower rates. In the conversion, the company would have to compensate its major partner, the Equitable, by giving it shares in the new REIT. But the new structure would allow EQK to use its financial clout to buy additional shopping centers, the way Cedar Fair has bought other amusement parks.

Supercuts
has made a startling announcement: It will open 200 additional outlets in New York, to be owned by the company in a joint venture with another partner. The company is borrowing money to pay for this expansion, and this will penalize its 1993â94 earnings. Whereas analysts expected Supercuts to earn 80 cents in 1994, it is likely to earn less.

For the longer term, the new stores will accelerate the growth rate
of the company. The stock continues at a p/e ratio that's below the market multiple. In today's market, investors are paying a lot more for companies that are growing more slowly and aren't industry leaders, which is what Supercuts has become. Customers continue to line up for the Supercuts shampoo and trim. The all-important same-store sales increased 4â5 percent over the past year, without any increase in prices.

A recent quarterly report includes a coupon good for a $3 discount on a haircut, which may be another reason to own the stock, but after my shearing in Boston, I'm declining the offer.

Sun Television & Appliances
, the Ohio retailer, has had a memorable year. In 1993, same-store sales were up 15.2 percent and the company had opened 11 new stores in the past two years. After its triumph in local markets, Sun TV is on the march to Pittsburgh, Cleveland, and Rochester and soon it will enter Buffalo and Syracuse. By deploying its forces from one end of the Great Lakes to the other, Sun TV makes it more difficult for competitors to establish themselves in between. The company is growing at 20 percent and selling at less than 20 times 1994 earnings, and the stock price has more than doubled in 24 months. If the price gets hit in a stock-market correction, I'd be inclined to buy more.

General Motors
has been the least-admired of the Big Three, but it may be the best performer over the next few years. Although I recommended all three automakers at the beginning of 1993, and Chrysler has had a great year to date, a reason to like GM is that it sells a lot of cars overseas. GM will benefit when Europe comes out of its recession.

Before the end of the current upswing in car buying in the U.S. (there's still a pent-up demand, as described on pages 241â242), GM also has a decent shot at turning a profit on its domestic car business. With a 30 percent share of the market, it ought to be able to make a profitâFord makes money with 20 percent and Chrysler with 10. GM has already turned the corner on trucks, and its non-automotive divisions are doing well, so even if the company only manages to break even on cars in the U.S., it could earn $10 or more per share.

This is a different sort of turnaround from, say, IBM's. For IBM to recover, it has to make money in the U.S. computer market, but GM can recover without making money in the U.S. auto market.

Fannie Mae
is still underappreciated on Wall Street, and undervalued
as well. This company is as close to a sure winner as you'll find. It has a growing share of a booming business. At the end of 1993, the stock price was only slightly higher for the year, despite the company's three strong quarters.

Fannie Mae has only 3,000 employees and it makes $2 billion in profits. Few businesses are more predictable or measurable. Wall Street is always looking for predictable, consistent growersâwhat's the matter with this one?

The lastest worry about Fannie Mae is that low interest rates will clobber the earnings as millions of homeowners refinance their mortgages. A few years ago, people were worried about high interest rates. Fannie Mae doesn't care what the interest rates are. Because much of its debt is “callable,” when interest rates decline Fannie Mae can reduce the cost of its borrowing. The savings on the debt will offset the losses in revenue from the refinanced mortgages. The profits are locked in.

A second worry is that Fannie Mae will be undone by the recession in California, because 25 percent of the mortgages it owns or guarantees are on California real estate. Fannie Mae did get hurt by the Texas recession a few years ago, but that's old news. It has tightened its underwriting standards. The average Fannie Mae mortgage is for $100,000 or less, and in California its mortgages have a loan-to-value ratio of 68 percent, the highest of any lender in the state. Its loan delinquency rate has fallen for seven years in a row, even during the national recession, and currently stands at .6 percent, a historic low. This is not inside information. Fannie Mae mails it out to any shareholder who asks for it.

A third worry is that Fannie Mae is related to Sallie Mae, the company that handles student loans. Sallie Mae got blasted by President Clinton and by Congress, both of whom said the government could do a better job. This is a doubtful assertion, given the record of the post office, but no matter. The politicians were determined to set up a government competitor to Sallie Mae, and they are getting their wish.

Nevertheless, Fannie Mae has nothing to do with Sallie Mae. Last year, Congress passed a bill redefining government-sponsored corporations, and Fannie Mae was left intact. Earnings were up nearly 15 percent in 1993 and projected to be up another 10â15 percent in 1994. Give Fannie Mae a normal valuation in today's market, and it's a $120 stock.

I've already brought you up-to-date on the S&Lsâ
Eagle, Glacier, First Essex, Germantown, Lawrence, People's Savings Financial
, and
Sovereign.
About the wisdom of investing in mutual savings banks as they come public, I couldn't be more emphatic.

There are 1,372 mutual savings banks and thrifts that may yet convert to public ownership. If there is one in your neighborhood, open a savings account there. If you have $50,000 and deposit $1,000 in 50 different thrifts that aren't yet public, you will improve your chances for participating in a conversion. As the number of lending institutions continues to be reduced by takeovers and buyouts, it's a good bet that all the mutual savings banks and S&Ls will eventually convert.

NEWS FLASH!

As we put this edition to bed, the government's Office of Thrift Supervision has slapped a moratorium on savings bank conversions. The problem is that some officers and directors have been taking advantage of these deals by giving themselves options to buy shares at reduced prices. A few have gotten shares for free. The government wants to stop this profiteering by insiders. Hearings are underway in Congress, and the whole process is being reviewed.

I'm all for that. Meanwhile, only two percent of the depositors nationwide have taken advantage of their opportunity to buy shares at the favorable initial prices. So 98 percent have turned their backs on these superb deals at their own local thrifts in their own neighborhoods. My guess is that once the rules are changed so that insiders can't reward themselves with freebies, the conversions will be allowed to proceed. This is one case where it will pay to keep up with current events.

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