Portfolio manager’s Letter December 2006
In spite of our skepticism in relation to the overall market, Losch Management Company has recently been able to find a few interesting new investment stocks. These are companies with strong earnings, and very solid balance sheets. These are new investment stocks that will benefit from weakness in the dollar, either because they are basic materials stocks, or because they are companies that manufacture things in the United States. They are small companies with market capitalization that runs from $100 million (Core Molding) to $3.5 billion (Mechel OAO and Minas Buenaventura SA).
First from new investment stocks is Steel Dynamics. This is a steel manufacturing company that owns and operates three steel producing mini-mills in Indiana with an estimated combined annual production capacity of 4.2 million tons. The company will probably earn between $7.20 and $7.30 this year and is currently selling for $35. Long-term debt is 400 million, which is about what the company earned this year. Steel Dynamics will benefit from a weak dollar, because it will make imported steel (the competition), more expensive. Steel Dynamics declared a dividend of $.30 per share for the third quarter. The company produces its steel principally from steel scrap, using electric arc furnaces, continuous casting and automated rolling mills.
Its operations comprise three primary steel making facilities: Flat Roll Division, Structural and Rail Division and Bar Products Division. Steel Dynamics also has other operations, which include a scrap substitute manufacturing facility, referred to as Iron Dynamics; two steel fabrication facilities, which produce trusses, girders, steel joists and steel decking, referred to as New Millennium Building Systems, and a 50%-owned trading and processing facility. On October 18, 2005, SDI announced the execution of a definitive agreement to acquire the steel making and fabricating businesses of Roanoke Electric Steel Corporation. In April 2006, SDI acquired Roanoke Electric Steel.
For the nine months ended 30 September 2006, Steel Dynamics, Inc.’s revenues rose 49% to $2.4B. Net income rose 86% to $291.6M. Revenues reflect an increase in sales from the flat roll division shipments, higher structural and rail division production and increased sales from the Roanoke Electric Steel Corporation. Net income also reflects improved operating margins, decreased interest expense and increased net other income.
Second from new investment stocks is Core Molding Technologies. Company will earn about $1.00 per share this year and is selling for about $10 which makes it easy to figure the PE. They have $11.6 million in cash will earn about $10 million this year; and they have $11 million in long term debt. The company is a compounder of sheet molding composite (SMC) and molder of fiberglass reinforced plastics. The Company produces fiberglass reinforced molded products and SMC materials for various markets, including light, medium and heavy-duty trucks, automobiles and automotive after markets, personal watercraft, and other commercial products.
For the US truck market (International, Freightliner, and PACCAR the company produces hoods, fenders, air defectors, roofs, and splash panels. These products are fabricated using techniques that include SMC Compound, Glass Mat Thermoplastic (GMT) Compound, Closed Molded Products and Open Molded Products. In August 2005, Core Molding Technologies acquired Cincinnati Fiberglass Division of Diversified Glass, Inc., a manufacturer and distributor of fiberglass reinforced plastic components supplied primarily to the heavy-duty truck market.
This is another company that will benefit from a lower dollar because it will raise the prices of the products of its foreign competitors. For the nine months ended 30 September 2006, Core Molding Technologies, Inc.’s revenues rose 27% to $124.1M. Net income rose 48% to $7.7M. Revenues reflect an increase in international & PACCAR sales, higher revenues from tooling project, an increase in demand for medium & heavy duty trucks and acquisition of the Batavia, Ohio operations. Net income also reflects higher gross margins, an increase in interest income and lower interest expense.
Third from new investment stocks is Mechel. Mechel’s nine months came in at $2.76 per share if the 4th quarter is anywhere near as strong as the 3rd they could earn $4.00 this year with the stock selling at $26.00 the price would appear cheap. On its balance sheet the company has $184 million in cash $755 million in long term investment while its long term debt is $349 million. The Company is an integrated mining and steel company. Its mining business is focused on mining products used in the production of steel, primarily coking coal, iron ore and nickel. Mechel OAO also produces a significant amount of steam coal. Its business consists of two segments: mining and steel.
During the year ended December 31, 2005, the Company acquired a blocking minority stake of 25% plus one share in Yakutugol, located in eastern Siberia, which produced 5 million tons of coking coal and 3.9 million tons of steam coal in 2005. Mechel OAO also acquired Port Kambarka; two subsoil licenses for the Raspadsky open-pit mine area of the Raspadsky coal deposit and Berezovsky-2 area of the Berezovsky and Olzherassky coal deposits; two subsoil licenses for the Erunakov-1 and Erunakov-3 coal mines near Kemerovo, and three subsoil licenses for the Sorokinsky, Razvedochny and Olzherassk coal fields in Kemerovo. In April 2006, the Company acquired Metals Recycling OOO.
For the nine months ended 30 September 2006, Mechel OAO’s revenues increased 8% to $3.14B. Net income from continuing operations increased 18% to $372.2M. Revenues reflect growth in selling prices for all major product groups. Net income also reflects lower selling & distribution expense, decreased provision for doubtful accounts, lower interest expense and the presence of foreign exchange gain vs. a loss in comparable prior period.
Fourth from new investment stocks is Breakwater Resources. Breakwater’s trailing PE based the last 12 months is 7.2; it has 71.6 million in cash and short term investments, and 1.1 million in long term debt. Breakwater is a base metals mining company that produces zinc, lead, copper and gold concentrates. During 2005, the Company’s concentrate production was derived from two mines located in Canada, one each in British Columbia and Quebec, and a mine located each in Chile, Honduras and Tunisia. The mine in Quebec, the Bouchard-Hebert mine, was closed in February 2005 and the mine in Tunisia was closed in September 2005, both due to depletion of mineral reserves.
Breakwater Resources also owns base metal and gold exploration properties in Canada, Honduras, Tunisia and Chile. In addition, it is developing its Langlois mine located in Lebel-Sur-Quevillon, Quebec with commercial production expected by mid-2007. The Company’s Caribou mine has been held by Breakwater on a care and maintenance basis since August 1998. In July 2005, Breakwater signed a letter of intent relating to a possible sale with Blue Note Metals Inc. and Forest Gate Resources Inc.
For the six months ended 30 June 2006, Breakwater Resources Ltd.’s revenues rose 11% to C$131.5M. Net income totaled C$68.3M, up from C$6.5M. Revenues reflect higher metal prices and an increase in treatment charges & marketing costs per ton of concentrate sold. Net income also reflects lower depreciation & depletion, higher investment & other income and the presence of other foreign exchange gain, vs. a loss.
Our fifth new investment stocks is Minas Buenaventura SA. Company’s trailing PE is 7.6 as of September 30. The Minas Buenaventura SA’s balance sheet shows $294 million in cash and short term investments, and $.2 million in long term debt. Buenaventura Mining Company Inc. is engaged in the mining, processing, development and exploration of gold, silver, and, to a lesser extent, other metals, in Peru. As on December 31, 2005, the Company operates four mines: Julcani, Recuperada, Uchucchacua and Orcopampa. It has controlling interests in three other mining companies, which have controlling interests in the Antapite, Colquijirca, Ishihuinca, Shila-Paula mines.
In addition, as of January 1, 2005, the operating data from the Paula mine has been consolidated with the operating data from the Shila mine and after such date is referred to herein as the Shila-Paula mine. The Company also owns an electric power transmission company and engineering services consulting company, and has minority interests in several other mining companies, including an ownership interest in Yanacocha. On September 5, 2006, the Company’s subsidiary, Inversiones Mineras Del Sur S.A., acquired Brandon Properties S.A.
For the nine months ended 30 September 2006, Compania de Minas Buenaventura SA’s revenues increased 78% to $451 million. Net income increased 80% to $350 million. Revenues reflect an increase in both the volume and average price of most of the metals which the company mines, especially lead. Net income benefited from higher operating margins, as well as substantially increased shares in affiliates’ investments.
Together these companies will make a nice basket of new investment stocks that provide hedge to protect our portfolios against a rapid decline in the dollar.
For Berkshire Hathaway the fourth quarter usually shows the strongest underwriting profit. This is because Berkshire Hathaway does not book their profit from CAT coverage until the coverage has expired. Underwriting profit is usually 40 to 50% higher in the fourth quarter than in the third quarter. So my guess at the fourth quarter looks like this.
Pretax underwriting profit $1.4 billion. Dividend and interest income $1.1 billion. Operating companies, pretax $1.6 billion. Realized gains $.8 billion (I am guessing realized gains higher than third quarter, because of sale of 9.1 million more shares of Ameriprize in November). Total pretax $4.9 billion. Tax at 35% $1.7 billion. Total fourth-quarter after-tax $3.2 billion. Total income 2006 $10.6 billion.
Net income per “A” share $6,883. Undistributed investee earnings (Look-Thru earnings) per share $1,010, per share Grand Total 2006 $7,893, per share Last year’s undistributed investee earnings amounted to $918.00 per “A” share. It seems reasonable to me to assume that this will increase by at least 10% this year in view of the fact that the value of the portfolio is currently up about 19% from the end of last year. The above figures are much more of a guess than an estimate and they assume no catastrophes, between now and December 31.