Every quarter the Mastermind Group from The Investor’s Podcast gets together to discusses their latest investment ideas. In this episode, each member of the group recommends a stock pick that might outperform the S&P 500.  After each stock pick, the remaining members of the group pick-apart the idea.  After talking about the 4 different stock picks, the group transitions into a discussion about cryptocurrencies.

In this episode, you’ll learn:

  • Which stocks the TIP mastermind group might acquire this quarter
  • Why you should go straight to the numbers before analyzing a stock pick in detail
  • Why the airline industry might be worth investing
  • What Bitcoin Cash is and if should you own it?

Tweet your comments about this episode directly to Preston, Stig, and the rest of The Investor’s Podcast Community using #TIPMoney.

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Podcast Transcript and Summary

Tobias: [00:01:55] I’ll give it a bash. I don’t mind. My pick is Gilead Sciences GILD is the ticker it’s one that I’ve picked before and it’s fun I get lots of questions about it. So I thought I’d go back to what I think when I first picked it was sort of in the high 60s ran up as high as 85. It’s run back now to around 70 71 seventy-two dollars. So people are asking me that the father asked me again and I’ll just talk about something that I still hold. I still think it’s cheap it hasn’t really moved that much from where I bought it originally that six months ago. For those who don’t know the stock, it’s one of the stocks that two years ago it was a hugely popular stock. And if you go to any of the message boards at the time it was one of the ones that everybody was kind of riding to victory. It was trading at around 120 bucks 120 bucks plus of last two years. It’s had this sort of terrible trajectory straight into the ground and it’s basically halved over two years and now it’s one of those stocks that everybody hates because it’s one of those stocks that everybody held a couple of years ago and I remember how badly they’ve all been burnt on the reason for buying two years ago was that it had this kind of stellar earnings growth that fat toad and the earnings have basically been falling since then that looks like they got to continue to fall for another 12 months two years.

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Tobias: [00:03:18] So basically it’s a buyer pharmaceutical company. Their specialty is anti-viral drugs so that means that treat to hepatitis B hepatitis C flu HIV. The problem for them has been that they’ve treated the hepatitis C which was a big moneymaker so successfully that they’ve cured everybody who they’ve treated with it rather than sort of drip feeding them this over a long period of time and building a really good business. So that’s a great thing for the people who have received the treatment not so great for the shareholders in the company right now. My sympathies are with the people who are receiving the treatment rather than the shareholders from. So they’re looking for new revenues for growth. The things that I like about the stock it’s at ninety four billion dollar market capitalization as of today and a prospect values about $95 billion a net debt of about a billion dollars. But it’s got 40 billion dollars in cash. Kind of balancing that off. So it’s very very liquid. It’s hugely cash flow positive because it they’ve got this drug that’s basically in run off they’re trying to find new sources of revenue but they are generating cash flow in the mean time so the chances of this going away as a business is very very low. If I look at any of the statistical measures of distress or any manipulation or fraud or any of those things there’s nothing there is no indication the return on invested capital which is not a measure that I think is particularly useful most of the time.
Tobias: [00:04:44] But in something like this where it’s patents it’s got various other protections. It is a kind of a useful metric. It’s incredibly high. It sits around 73 percent return on invested capital free cash flow yields around 15 percent. So when the return on invested capital is that much higher than the free cash flow yield that’s sort of an indication that the stock is probably way too cheap. And so I think favorably for the stock probably around 100 to $105 sort of at the low end and with the stock trading around $70 I think is a fairly wide margin of safety. I think potentially it could be worth more than the next few years. But the issue is going to be declining revenues for these sort of immediate future. So anybody who buys this you know next quarter are you going to see revenues a little bit lower quarter after that revenue is going to be a little bit lower. The only thing that you have going for you in this is that it’s incredibly cheap and it’s generating huge amounts of cash flow and it’s generating this incredibly high return on invested capital. So for me this is exactly the kind of stock that I’d like. It might take a few years to work its way out but by the time that the future is going to look a little bit brighter it’s going to be a much more expensive stock.
Stig: [00:05:55] I’m so happy you brought up this pick Toby I’ve been asked about this for at least a year and I want to say it’s been on my radar for yet 2 or something like what you are also saying because it has been a very light stock and then it became a cheap stock and for me I guess it always comes back to I don’t know how to value patterns. For me it’s too complicated when I read through the financial statements and also look into the business model in terms of figuring out how sustainable to do so. Toby could you talk to us about your process in terms of evaluating patents.
Stig: [00:06:30] Sometimes I’ll take a slightly different approach to these sort of stocks. The future is difficult for me to foresee I think a lot of other people have much better crystal balls than I did. I have no idea what it looks like to me I sort of have to look at the immediate past and for this stock it doesn’t look right. The revenues have been falling with her. She thinks that I should have mentioned one of them is that they’ve used some of that enormous cash pile to buy another company for about 12 billion dollars. They will start generating and things in income in some time next year I think. And then it’s not going to replace the HCV income but it’s going to come in at about a quarter of what the HCV income is which is about the closest thing I think gets to one or two over the next few years and then it continues to grow. I think that it’s one of those things the cash flows very strong. The company’s got a lot of cash on its balance sheet it has bought some stock. All of those are things that indicate to me that it’s got longevity and the potential for something good to happen and I’m just sort of at this price I think it’s cheap that I had to sort of wait and see if something good can happen when it happens.
Tobias: [00:07:36] Discussion about ratings is in danger. That when you hear from the JD portfolio business. The reason I’m asking is that the Dems or I would like to start explaining starting 17 to 20 21. What are your concerns and how can they compensate those expectations.
Tobias: [00:07:58] The earnings are falling because they’re negotiating the contracts for the sales of this into the future for me. I don’t know what’s going to happen I don’t know how to replace it but they are looking for ways to do it and they have the firepower to do it. They’re generating lots of free cash already from the existing portfolio. So I sort of think it’s one of those things that revenues continue to fall. But as a Deepali guy out I don’t really mind that so much because the balance sheet is pretty strong free cash flows they’re still running box on its existing portfolio and very very cheap.
Preston: [00:08:32] So Toby I know nothing about technical analysis so I’m just going to throw that out there. But whenever I’m looking at this and I’m looking at the top line that we’re all talking about and how it’s contracting and it’s going down and you kind of take a look at the chart and you’re seeing the price chart which I think this is the first time I’ve ever talked about a price chart on the show 165 episode. When you look at the price chart I guess the pattern of the prices just keeps going down and you’re not seeing much volume trying to stop that from happening. And so whenever I’m looking at a business like this that’s really big and has to do a lot of R&D. A billion dollars in R&D to create a new product and then they have to go through all the marketing and then they have to go through everything to try to make it a successful drug to potentially start growing that top line again. I think they’ve got a tough road ahead of themselves before you’re going to see the price of normalized and start taking off again. There could be something there could be a breakthrough in some type of R&D that they’re doing right now that could make it pop on on a whim.
Stig: [00:09:36] But for me I guess I love the price and I love the valuation on this. I’m not going to lie whenever I did the intrinsic value on this I got a very high number double digit number but my concerns are more on the technical side of their performance on their income statement and my expectation of what it’s going to look like a year from now I think it’s going to continue to contract and I don’t see anything in the volume of people buying that’s going to maybe reverse that anytime soon. So I guess for me I wouldn’t buy this even though it looks really juicy from a return standpoint from a value investing standpoint it looks really juicy. But I guess I’m going to continue to watch it and if I feel like I see a large spike in the volume I might miss out on a little bit but I think it has more to go. I think it has more to fall before you’re going to start to see the price return. That’s my personal opinion.
Tobias: [00:10:25] Drifts are definitely going to be low this time next year. Almost certainly. The thing is that by that time this sort of gets when you can see the runway for this thing the price is going to be a lot higher it’s lower than it was a few months ago but it’s higher than it was sort of six months ago. So I don’t know if that means anything to the ticket because it has it can shoot me a tweet told me.
Preston: [00:10:46] I’m pretty sure no matter what comes out of the technical side it probably won’t be. Yeah I just need to be quiet because I don’t know anything about that.
Tobias: [00:10:53] Well one of the reasons is you can have a look at the price shot from Italy this year Johnny Hopkins who writes the acquirer’s multiple blog posts. He wrote a post of Gilliat because he was excited about it and he said I want to post this up and I wanted to wait until the earnings data got populated into the spreadsheet from the data providers. And in that sort of period of time it when it bounced really quickly from 64 which Johnny had found a kind of up to 67 and then it looked like it was going to get away. And I felt really bad for Johnny because I had picked it really well and it didn’t look like it had taken off. As it happens as often happens with these stocks you do get another chance to buy them. But it’s one of those things that I think I’ve just discovered over a long time trying to buy and sell stocks if you like the process. You got to do it today because you might not get it tomorrow. They can take off really really quickly.
Preston: [00:11:45] So I agree with everything you just said. Let me ask you this then. Are you buying a small volume at this point and slowly working your way into it or are you just taking it a decent sized position right now.
Tobias: [00:11:57] I put a chunk of it and I bought some leaps when I six months ago. So it was it wasn’t the bottom it was it was in the high 60s I think at the time that I did it and it got a little bit cheaper after that and had sort of taken off since I have had a pretty full portfolio until today. So I’m going to revisit it again it’s probably something I’ll buy some more of.
Stig: [00:12:17] I guess what I’m getting from Tobias’s point of view is that the price is so low and there are a lot of upside including acquisitions which we didn’t talk about but they can be a potential target for acquisition and actually they are from that aspect as well. That’s a good point.
Preston: [00:12:35] All right. So I think that concludes Toby’s stock pick and the stock ticker is G I L D. And we’re just going to go around the horn here so why do you want to go next. Great. So Harry you’re up.
Hari: [00:12:49] Always fun to sit around and chat with you guys and I’m ready to be beaten up my pick today is Union Pacific which is a railroad company that has a lot of talk about tariff and restrictions on imports from Mexico and whatnot. And Union Pacific does a lot of business with Mexico in the sense that a lot of companies especially automobile manufacturers that transport lot of their cars through railroads and Union Pacific can be in for the two big railroads on the West and for those of you who are not familiar with railroads in the U.S. there are different classes of railroads. And back in the days that is before 1980 there were many railroads because of lot of regulations against consolidation. All things change and from then on it started as a stylus. And from then on the consolidation started happening and a lot of synergies were realized. And the number of railroads also started in music. So today there are only a handful of last one railroads on the west. We have to get big. And the NSA which is now a real Berkshire-Hathaway. And on the east it is CSX and not so different. Of course there is a Kansas City railroad as well which is a small player. And some of the interesting facts of what railroads is that about 40 percent of all the inner city. While you are transported by rail. Today and railroad employees are on one hundred and eighty five thousand jobs. It used to be 1.5 million 100 years back so they definitely work a lot on productivity and efficiency. And one trade the blazes around 250 trucks on the highway and also some of the other interesting facts about railroads in terms of their efficiency is that if freight can be moved four hundred and seventy nine miles on one gallon of fuel.
Hari: [00:15:05] So that’s much more efficient and also a safer way to transport freight than trucks in those of what they carry around 19 percent this school so coal is a major contributor to the revenue and chemicals grains and food and then assembly parts water weight. And then finish goods and miscellaneous. So that’s kind of the we’re all contributors to revenue. Union Pacific specifically operates mostly in the western region. As I said most of their Walham comes under course also for entry. We got it on Los Angeles Long Beach on the west coast and then BNSF pretty much are neck to neck. If you look at their revenue number of miles of tracks BNSF and you won’t be having to actually on the West Coast. One of the interesting facts about railroads is obviously there are more. It’s really hard to create another rail road because of all the regulations in terms of land acquisitions and building up their infrastructure is concerned you and B has been expanding quite a bit in the last couple of years. And also it has increased its overall efficiency. And the reason I think that is there are some uncertainties going ahead in the next couple of months. And based on how the policies on imports are shaped it might impact railroads and specifically Union Pacific and BNSF. So this will be a stock to watch. It will be good for us as I understand a lot of the different sources of revenue for this railroad. And if there is a I think about this particular stock and if people are ready to throw the baby with the board it might be investing back for some of us.
Preston: [00:16:57] So sorry for me when I’m looking through this I go straight to the numbers and although I think that the competitive advantage piece of it I completely agree with everything you said. I don’t see the revenues really contracting at all. I think they’re going to continue to be able to produce decent cash flow but the premium that people are paying to own it today for me is not a buy. I’m kind of curious what you think the intrinsic value through like an IRR is. For me I’m coming up with I think I’m being very liberal in my assessment as to what I think they’re able to do in the future. Basically saying I am giving them much more a benefit of the doubt than being conservative with my numbers and I’m still coming up with like about a three and a half percent return at the current price. So basically saying what they’ve got today they can continue to sustain into the future. That’s my worst case my best case is saying that they’re going to grow at 7 percent. And those are the numbers that I’m using as my projections into the future and I’m still coming up with three and a half percent. And so I guess my question back to you is if that’s a true statement let’s just assume that that’s a true three and a half percent. Why not just buy an S&P 500. Because I think you’re going to get the same return and you’re going to have less risk.
Hari: [00:18:07] That’s a good point. I’m not recommending a buy at these levels as I’m sure also that this is not a stock that I would buy hoping that they will get all that revenue at a faster pace from here. In fact I’m not even assuming any growth in revenue. I’m looking at them as a place to borrow my cash I some do it and it’s more like a gun generating opportunity but not at this price. I would be interested in the stock when it is in the lower 70s. That’s when it becomes much more compelling and interesting. But however it’s it’s good to study this now because I’m expecting that there will be a lot of rumors and news around banning Mexican imports or some Mexican reports that can drastically impact the revenue of Union Pacific because they’re already low on their revenues from coal which is slowly. And that is being compensated by the revenue from imports from Mexico. So there is definitely some headaches.
Preston: [00:19:14] So it’s your number that you that you quoted there. You’re looking for something in the $70 price range. And whenever I put that number into my intrinsic value assessment I get around an 8 percent return if you can buy it for like 70 bucks. But the problem is it’s it’s not 70 bucks it’s $115 right now so I’m with you. As far as wait until around that price range. But you know by the time it gets to $70 there might be some other deals in the market that are way better than a 8 or 9 percent return. I also want the audience to know that right now the dividend on this has given you a 2 percent yield at the current price so that’s not a bad dividend. And I think all the money that you’re going to make on this. Now moving forward at that price is really going to be that difficult.
Hari: [00:19:57] I was just going through some thoughts at you on this one. If I look at it on the trustee Altman finish rich Remine statistical measures to determine if it’s in any financial distress if it’s financially strong if there’s any sort of manipulation. So there’s none of that which is always a good sign. Market caps around 91 billion enterprise value was at a hundred and six billion which means that it’s carrying sort of 15 billion dollars in net debt net obligations which aren’t typically love. If I look at on an acquirer’s multiple basis it’s trading a little bit of 10 times which for a good business or really good business that could be about fair value. I think for this business I think it’s either just at face value or it’s just a little bit below to say that the way that I would calculate it turning on invested capital around nonperson and the return that’s available is about 3 percent. So it’s a little bit of value for me but there are some things that are nice. One of them is got a very stable earnings trajectory. So it is one of those things that if you could get it at the right price which $70 is probably the limit of the right price but that’s well within the possibility of something that you would do. It’s probably something that you can buy there and then let it sit for a long time and you can’t just sort of accumulate and grow. So I think it’s a really nice fundamental stock a little bit worried about the level of debt that’s carrying just not something I think. I’m not certain I should say I’m worried about it’s just not something that I like to see. Otherwise I think it’s a good fundamental business just a little bit expensive.
Stig: [00:21:26] Yes. So for me I don’t have too many things to add. I also read through our intrinsic value calculator and when I look at it we probably around called 3 or 4 percent so there are similar results as Preston in terms of debt that Toby just mentioned. I don’t think I’m as concerned so you get have different types of obligations that might be more burdensome for the company and others and if you look at the interest bearing debt. It’s not too bad you still have a coverage ratio above 10 was basically just means that you can pay the interest expenses but the operating income of these 10 times and even though that debt has slightly increased I don’t think it’s it it’s a huge issue. So I think that that feedback is really just summed up is. Great business. Not a lot to say about that. You bring up a lot of great points about local monopolies and perhaps pricing power to some extent even though it’s regulated. But really the valuation is really the big red flag here.
Hari: [00:22:25] Yeah I think I definitely agree with you. And one piece of information for the audience is that the previous month in October us last on railroads together or more intermodal containers were than during any previous month in the history of returns. So obviously the valuations are basically letting the recent trends and the recent numbers come in go to all the railroads all the railroads are really valuable. They are really as Toby was alluding to are a little bit higher than their value.
Hari: [00:23:02] So it’s definitely not something that I would buy right now but I will definitely watch the well never look at the revenue and I guess you can say that but a lot of the utility companies see that it’s more last less. And you also said before that you don’t expect perhaps growth at all. Is it even possible in this business to grow your top line being as a local monopoly as a Union Pacific operation.
Tobias: [00:23:31] Yes if you look at the revenue growth it pretty much tracks the GDP and also tracks the important explore dynamics between US and Mexico. If I were charged in my analysis which essentially tracks the dollar amount of U.S. and Mexico import export and the U.N. peace Holligan their revenue from that particular well. And another interesting aspect of you and B is they own a significant percentage in Mexico’s biggest rating. So they have some growth coming in from Mexico. But again right now everybody recognizes these facts. So everything is big into the stock price.
Preston: [00:24:21] Ok. So Stig go ahead and talk about your pick because I didn’t know what your pick was until just a couple minutes before when I was doing a little bit of research on your pick and I had to smile because we almost have identical picks with. This was not planned in any way. But go ahead. Let’s let’s hear yours first. So my pick is Southwest Airlines and the stock ticker is LUV. So what’s not to like about that. It’s a major airline and together with Delta United and American they control 70 percent of the U.S. market. They’re the biggest at least measured in originated passengers audit and they provide schedule extra potations throughout US and also in the international markets. One thing to mention just before we talk about the industry is that they have 44 consecutive years off of his ability. And that’s almost unheard off especially if you talk about the industry like the airline industry. Some of the key industry ratio ratios so look at that. First of all the load factor. That’s basically how they fill their seats per mile. And if you look across the board we are looking at something slightly above 80 percent in North America Japan 7 to be exact. LTV was one of the best airlines out there with eighty three point six.
Stig: [00:25:47]. That’s the class where Southwest Airlines really makes his mark is on customer satisfaction and if you look at the airlines that’s its top ranked all the major airlines. Number two and three JetBlue and Alaska and then for my at Delta US number four. But very interesting. And people are probably not surprised when I say that United Airlines they’re not doing that great in their customer satisfaction survey here. The oil price is very important and it’s a high percentage of the operating expenses. So it fluctuates a lot if you look at the past 15 years for Southwest It has been everything from sixteen point five. Back in 2003 up almost thirty eight percent of the operating expenses in 2011. Today it’s hovering around the low 20s because of the relative oil price that you see. That’s another interesting factor to consider. So if you think the oil price will stay on for a long time it might be more appealing. And if you have a different opinion. You might come up with a different expected yield rotation for the industry is really not good. I don’t know if people remember Warren Buffett buying into the airlines a few decades ago and he has continuously said almost ever since I did say almost because he actually just popped into airlines.
Stig: [00:27:20] But he used to say that he has an 800 number that he used to call and say hey my name is Warren and I’m an air-aholic because he just loves buying an airline at least at that time and it didn’t pan out for him as well in the 80s as yet. Typically it’s also a hated industry because the labor is unionized so it’s a it’s a tricky business to be and definitely need to put that out there. They’ve been caught a few changes in the airline industry over the few decades though which is probably also one of the reasons why you see investors like Warren Buffett and other investors too going into the industry. Why. It’s still a very competitive business. There are fewer airlines today than they used to be. Provides more monopoly and they’re also pricing power in different regions like if you are in Dallas area you might primarily be flying American or if you’re in New Jersey you might be flying United. So you do have some pricing power but even more importantly the last batch or the past 15 years has gone from 70 above 80 percent. That’s been very important that you see in this consolidation in the industry.
Preston: [00:28:35] If I look specifically at LUV I see almost no death almost no dividend either. But that’s really not that important a thing that they the way they are looking at the capital this is really good. You see a share buyback around 5 percent. But perhaps the thing I’d really like to highlight is the moat. If you look at the Competitive advantage of LUV I think it is the culture and even though it’s very hard to quantify the importance of culture I think that is one of the very reasons why you see this customer satisfaction being so high for this company. This is probably an anecdote more than anything but the company does not allow any type of art on the walls of the headquarters. Instead they only allow pictures of employees friends and family. We spoke to just pop right months ago about this pig and he talked about how the annual meeting people would give each others Hock’s which is typically something you don’t see unless you team up with our crew in Omaha I guess. But I’m curious to hear what the group has to say before we talk about the potential growth and the catalyst for the stock.
Tobias: [00:29:52] I’m a big fan of the airlines. They’ve all come into the acquirer’s multiple screener Delta and LGV Levy is just sitting slightly outside of the screen. I’ll tell you a few things are the reasons that are that are like in market cap said it’s a billion enterprise value that it’s a billion almost no debt on the core is multiple of non-points six times so that the most expensive stock in the screener at the moment is Nonpoint to time so that tells you how close it is to appearing in the screener of all the airlines is probably the best run airline and that’s reflected in a few things. It’s got excellent returns in the capital. It’s among the best companies out there. On that basis I think the price is excellent to where it is the only two concerns that I have. Free cash flow yield is very low. So it’s generating a little bit under 5 percent. Our free cash flow basis. And if I look at my statistical measures my Petroski Altmann Benish witcha financial distress financial strength and it’s really palatial fraud et cetera. It’s fine on financial distress it’s fun it’s not manipulative but Petroski it scores fall out of a possible nine so that’s sort of towards the low end I’d have to dig into that and find out exactly why that is but it’s just just an observation. Otherwise I think it’s a good pick.
Preston: [00:31:13] So stig this one also I agree I think it’s a decent pick but I’m curious what you got for the intrinsic value as far as what you think the yield is based off ramp rates. Yeah. So whenever I did that and I think it was conservative. Now we haven’t talked too much about the growth opportunities a put 7 percent as my rubber band or with a 25 percent probability of 3 percent as my most likely growth rate 60 percent. The reason Mike came up with 3 percent is that the expectations offer until I think it’s 2013 or that’s around 3.3 which is it is hard to predict and yet it’s not this has to do with immigration has to do with GDP growth. And it would not be unreasonable to expect 3 percent whether or not Southwest could capture that. That’s always of discussion. And then I have a minus two in my little band because it’s just we’re pessimistic I guess and I come up with an internal rate of return or expected rate of return of 7.2 percent which is not great. It’s not something I’m super excited about but I think a 7.2 percent in times like this I think that might be if you have some sort of certainty for that might not be too bad. Luckily you have the chance to speak with my good friend Toby about this just last week we talked about whether or not actually 7 percent was the upper limit given how the market is right now.
Stig: [00:32:45] I don’t know. It is very modest but it seems to me to be good if you’re paying the opportunity cost of the market. I’m curious to hear your thoughts about your intrinsic value escalation price. I had very similar numbers to you as far as the bands and adjustment that I made. I think that their free cash flow that they had this past year coming in at 2 billion what I had for this past year seemed like it was a little uncharacteristic of the previous period of time and so I felt like that was a little high. So I just sat down and whenever I did that I ended up getting around a five to six percent return for the IRR on the company so I mean if we split the difference we just say it’s somewhere in between you know five and seven percent we’re at 6 percent. So you know if the markets priced that three and we think we can get six with this double the return of this five hundred that becomes a hard decision to go into an individual stock because especially something that I highly regulated highly unionized very susceptible to commodity prices as they fluctuate. Jean I don’t I would probably buy a little bit of it but I would not be a big position.
Tobias: [00:33:56] I guess Preston is the abominable no man.
Preston: [00:33:58] No I’m not. I’m not. I’m just a little hesitant because the returns aren’t really like extremely fat and it is a great business I’m not going to lie this is probably the best airline company out there. But yeah it all comes down to the valuation. That’s basically what you’re saying. Just to provide you comments to the discussion about free cash flow. I actually think I was conservative when I used the current number as a benchmark. I don’t think it’s necessarily a low number. When I see of the possibilities moving ahead and we could talk about that later. But I also want to say that is if you look at the age of the Leitz or southwest on massive capital investments and the average age is eleven point eight years west for let’s say Delta this is all the four major They have the oldest fleet of seventeen point two. Now it is actually part of Delta strength. He offered to have an older fleet and then pay more maintenance costs. And not as much in terms of the cost of some of the acquisitions. But it’s something that I guess is my way of saying that if I look at numbers I don’t think at the current level we’re seeing now is high.
Hari: [00:35:08] I just wanted to bring get to the point what’s the downside from here. I was just looking at it during the 2007 2008 recession. I don’t see any revenue during that time. Yeah. It’s really hard to believe that the airline is going to do during the data that this is going to be good.
Preston: [00:35:26] When you look at the numbers I know at least for the Delta numbers when you go back and you look at 2008 2009 the revenues were not impacted at all in fact the revenues went up from 2007 2008. They went up again from 2008 to 2009 which I was blown away by that. But their bottom line suffered tremendously. And most of that was because of the oil prices went up to $150 a barrel during the 2008 period of time. So I’m with you I thought the exact same thing here. But the numbers were telling me a different story so I guess the expectation moving forward is that if you have another credit contraction that the revenues probably wouldn’t be impacted too much with the airlines which is surprising but who knows. We’ll see what happens. Yeah and the thing is I’m very excited to see what’s going to happen next. So Southwest only just started to grow outside of of us a few years ago and it still only accounts for 4 percent of top line. And that’s really the focus now. Typically the margins are not as good also because the load factor is not as high. French international flights but there is much more room to roll for Southwest and for the other airlines so even though I always like to be conservative in terms of my estimates that’s something I do put the emphasis on. Now keep in mind that I did say that my Auber band was just 7 percent and I want to get that 25 percent probability. Analysts and Wall Street they expect consensus around 10 percent growth this company growth rate is pretty strong last 10 years.
Stig: [00:36:56] It’s done. The data here I think it looks like it’s more than 20 percent which is another thing that often it’s often difficult to believe on a single point on an annual basis.
Preston: [00:37:08] Wasn’t it when he said it was it. I guess for me when I’m just looking because on our total here we plot the free cash flow so we can like see graphically what they look like and then we kind of interpret that line into the future with another line that we can graphically see. And I mean if I put in 10 percent if you put in 20 percent it be it would not look right. I can tell you that much. No. So if you look at it like the 10 year average here the revenue just last year would be around 8 and a half percent. But then the operating income we around like 15 percent I mean. So it might not be 20 percent but it’s definitely I guess a lot more than most people give you credit or so you know. Again yes it does come down to the valuation. Is this a great airline company. It is. And we should probably have bought whenever Warren Buffet did and he acquired his things 7 8 percent stake in both Delta and Southwest. If I might add. But the price isn’t too much different from whatever he got it. I mean it’s a little bit. It’s definitely higher than whenever he got it. It’s not a lot higher. You know in the summer both of these picks went way higher and they’ve come back quite a bit. I know for mine for Delta it was as high as $55. Now it’s back down to 48. So I mean it’s contracted quite a bit and I think opportunities there.
Preston: [00:38:26] I’m curious let’s transition over to my airline but I promise you I had no idea Stig was coming to the table with an airline tonight. I was I really laughed whenever I saw that and I was actually coming with an airline as well. So Stig I’m curious what did you get for your intrinsic value. Delta before I even start my pitch I want to hear what you got. Yes so I didn’t know that you would take Delta if I pick LV I could came in a little higher for Delta and I did with the Lovi. I think I came around eight eight and a half. Stuff like that. I don’t think the airline is as good. But the valuation is definitely more interesting yeah. So I’m getting a higher valuation than you and I think I’m looking at it with the same conservative guy as you know whenever I was looking at the last one and I’m getting 10 percent on that. So when you go from 6 to 10 percent you know I mean I think that’s a significant jump in the return. And you know when I’m thinking about a person that’s booking their airline I don’t think that a person if they can save a hundred bucks by going on Delta opposed to going on Southwest I think they’re going to go on Delta every day of the week for the most part especially when you get into some of the more expensive tickets. I think people are looking to save money way over the brand of the airline.
Preston: [00:39:50] I might be wrong. So for me when I’m thinking through that the competitive advantage of the brand and all the quality that we talk about with Southwest I don’t know that I’m necessarily willing to take a cut in the yield that I expect to get that to happen simply because I don’t think that it’s a competitive advantage. I mean it’s definitely a competitive advantage. Let me go to the extreme here but I don’t think it’s a strong of a competitive advantage as some people might give to some other type of industry. So that’s why I think this is probably a better pick than yours a lot better. But I do think that the returns a little bit fatter I could get into some of the numbers something that I think has caused the airlines to maybe pull back a little bit from where they were at in the summer is when you start looking at the revenue. When you look at the revenue for Delta from 2001 up until the year 2016 the revenues had increased every single year during that period of time which I find just amazing. 2016 was the first year that you had the revenues actually contract. Just a touch looking at the trend for this year in 2017 it looks like the revenues are going to go higher than they were last year which I think is good but I think that maybe that’s why you’ve been seeing the price maybe not pop as much as what we probably expected a year ago.
Preston: [00:41:13] Just to kind of put some context on this for people so the price of Delta right now is forty nine dollars a share. The earnings are the profit you get for each one of those shares is $5 and 79 cents. So good luck finding anything like that on the U.S. stock market as far as I’m concerned. I think you’re going to have a very challenging time trying to find a company that’s giving you that much profit for the price that you’re paying especially for something that’s this large and this stable that debt to equity on Delta is a point five when the rest of the industry is a 1.3. So their competitors are more than double the leverage in Delta. So in general I think that those are all positive. This is something that I’m definitely taking a position in. That’s not a very sizable position but it’s a position and I think that the negatives here the free cash flow seems to be building pretty strong. It’s growing but it’s not growing at a rapid clip and I think already mentioned whenever Steve was talking I’m not a real big fan of how regulated this industry is but I am a fan of how much it’s been consolidating recently. And I think that that’s one of the reasons why you’re seeing it as a decent place to be based on the prices and in the profits that you’re seeing. So that’s my pitch. I’m curious what everyone else thinks.
Tobias: [00:42:27] I was just going to run through the numbers very quickly. So the market cap fifty five billion enterprise value forty one and a half so it’s carrying a little bit of net debt. But as Preston points out still very low equity I calculated to point six acquirers multiple on the seven tell him so it’s slightly cheaper and Southwest patristic. So I think on valuation I smoked a little bit weaker. I still think it’s too cheap so it’s I think the DCF around 60 65 dollars. The growth rates haven’t been a strong southwest. I think that that makes it a slightly more interesting Petroski score is around 5 out of 9 which is slightly better than average. So that’s that’s not too bad. One thing that’s worth raising the Monsey school which is the measures financial distress it has it into distress. It could be sometimes it’s just that the nature of the business model slightly confounds these statistical models so it’s not something that’s necessarily a concern it’s just when I see something like that it just tells me that I have to dig into a little bit more. I haven’t had the time to do that at the moment. It’s just something to bear in mind and if it continues to deteriorate to understand why it. When I look at the other metrics it doesn’t automate the pretty good return on invested capital doing much better than its free cash flow yield so it’s undervalued.
Stig: [00:43:47] So just to sum up Toby if I put you in this ungrateful situation of deciding what to invest in giving the current valuation would you pick Delta in that case.
Tobias: [00:43:58] Warren Buffett greatest investor alive probably greatest investors the last five generations. And as far back as anybody can tell he took a pass on that and he bought a basket of them. So this notion that I’m going to pick one I have the other.
Hari: [00:44:24] I think behind Buffett I think we question actually like we are talking about the consolidation everything growing. Why is the market not seeing it. Is it something that folks are seeing in the sense that it has been historically prone to competition and international participants. What are the odds that it will not happen again.
Preston: [00:44:50] I think it’s just been known as such a hated sector. I think everyone latches onto the narratives that we’re saying about the unions about government regulation and all that stuff that even as the price becomes attractive a lot of people like yeah. No one ever makes money on airlines. And then they just stop their analysis there. So that’s what I think it is horrible. But who knows. I don’t know.
Tobias: [00:45:12] Part of the problem is that they have this massive operating leverage and that they leave it to the oil price which is currently low. And I’m surprised it’s not as to the economy as then maybe that’s maybe that’s not a bias of mine. I do think that oil moves up it might be a different complection Plus you can see when you fly a lot when I fly the plane is full every single time I fly. So this is good.
Stig: [00:45:37] One thing about the culture that I do want to point out and also just to make sure that it’s not I guess misinterpreted is that I think that the culture is the most important thing to any organization. And I guess Preston had a good point when they were he was saying you know if I can say call 100 bucks or whatever and tell her why wouldn’t I fly with them. Obviously you would. I don’t see culture like that. I mean it’s kind of like the same reasons why Bridgeport a successful I don’t think people are necessarily willing to pay higher fees to Bridgeport to handle the money because the culture is strong. I think it’s all the way around. I think you are building a stronger company whether it’s in how you train your company well that’s how efficient you grow. If you have the right culture in place and it’s more like a trickle down to the customer rather than the other way around. And I think that’s something I want to pay a premium for and I know this probably. I don’t know if that makes sense when we talk about the calculator and we talk about whether or not we should adjust our growth rates and if we have high growth if you have a stronger culture. I just think at the end of the day giving that we know how important it is with taxes and moving around in your portfolio that if you want to hold something for the long run it’s very very difficult not to hold a company like alove or Bridgwater or whatever you want to call it because the culture is so strong. Yes. So you have a point.
Tobias: [00:47:02] Just to follow on your point good work culture. And so is that for a. I think it can have a tangible benefit if it reduces the search cost for customers based on my experience and a lot of folks I interact with here in the West especially in Northern California most of us don’t even think about other lights than we are buying tickets to L.A. for example or any place there is the Interbike because we haven’t got enough prizes. Usually there are but they do. So that goes to the bank what Stuart was mentioning that culture in itself in itself will not win customers but the price point is also parking. So the customers in the airline industry are very nice. So whatever you do should be on top of the price. You cannot compromise the price so the culture will not do you crazy. I don’t think any of the airlines are crazy or all right.
Hari: [00:48:12] I wanted to throw it to you a couple of points so just get your reaction. Number one is Bitcoin Cash. I see a lot of folks in the valley are really excited about it. The second thing I wanted to do is talk about Ray Dalio taking a position in gold. What do you guys think of this.
Preston: [00:48:43] So you just turned this into another hour episode. Well I’ve got some hardcore opinions about the first one. So Bitcoin cash versus Bitcoin. So let’s just give a little context to people if they’re not familiar with this so we’re obviously talking about crypto currencies. Back in August there was a hard fork that occurred between Bitcoin cash and Bitcoin and a gentleman by the name of Roger vair was behind the Bitcoin cash. And the big debate goes down to why it ended up working is because there’s one camp of people that think that Bitcoin should be for everyday purchases so that you should be able to go out and buy a cup of coffee with bitcoin with your smartphone. There’s another camp of people that say Bitcoin should replace gold and it should be what central banks ultimately store instead of gold itself and it should be the new monetary baseline on a global level. I fall into the latter. I think that when you think about what Bitcoin is trying to do it’s trying to fix the monetary base line so that these central banks cannot continue to print. So I guess this is the question I often ask people What is Bitcoin What’s the purpose or what’s the problem that it’s trying to solve. I don’t think that it’s necessarily trying to solve everyday coffee purchases. I don’t think that most people would say that there’s an issue there as far as they’re being taxed too much on the purchase of the currency itself.
Preston: [00:50:13] So I don’t see a fundamental issue there where I do see a fundamental issue is that right now every developed country around the world has a fiat currency that’s pegged to nothing. And these governments can continue to rent at ridiculous levels and since the currency is not pegged to anything. Bitcoin solves that fundamental problem. And so we could go into this a whole lot more but we’d get into block sizes. And when you’re talking Bitcoin cash in the way that they’re scaling this within eight make a big block that in the end creates a very big and chunky block chain 10 20 30 years from now if there are solution descaling is to just increase the size of the blocks that are produced every 10 minutes. In the end individual people can’t mind that or can’t keep the actual block chain on their computer. And so then that becomes a security concern because now you’re not having something that’s going to be centralized in the end you’ll have something that’s centralized which actually doesn’t solve the initial problem with the central banking part that I’m talking about. So I’m a big coin fan but I am not a big point cash fan at all so I’m curious what you’re hearing out in the valley are you on this one.
Hari: [00:51:22] One of the speculations in the valley is folks in Asia are behind bitcoin cash and it’s almost like a cryptocurrency or Ishita and Bitcoin is to look at and see whether euro.
Preston: [00:51:36] Well what it’s really coming down to is a miners versus individual people in a money that will fix the monetary base. So think about it. All these mining pools that are over in China. What do they want. They want more power and control over the currency so what they’re trying to do and you look at one of the guys who’s behind this is one of the biggest mining operations there is in the world. And so that’s why he’s trying to make it bigger blocks because what does that do that centralize the power into his hands and not into the greater good of people. You know if something stick and I read about in the Dalio book and there’s another book that I read called The Selfish Gene and it talks about how when something is good for the masses for everybody that’s the direction that things will move naturally that whenever things are only good for the individual the universe works in ways to always destroy that initiative. So you know whenever I’m looking at this debate through centralization through greater power for the miners versus distributed power for everybody and for the greater good of the world I think that they’re swimming against the current With bitcoin cash and I think that the regular block chain Bitcoin is actually swimming with it. But that’s my that’s my point. And just as a word of caution to anybody hearing this stuff I think crypto currencies are extremely dangerous and we have no idea what this stuff is or what this is going to become. And if you’re actually investing in this stuff I hope you’re not allocating a large portion of your cash flow to it because there’s just ridiculous amounts of inherent risk associated with it. But I also believe that with that inherent risk there is actual enormous upsides with the market caps that a global currency could potentially arise to dilute the gold.
Tobias: [00:53:22] I don’t have any particular view on it other than I think it’s a little bit of a hedge. I don’t have any Bitcoin. I just have the cycles to kind of figure it out. I wish I had bought some a few years ago I had a client who put $10000 into the CEO of him because he likes Bitcoin and he met the kid he was in San Francisco he met the kid he came up with this theory and what you call him the kid to get the young guy he came up with a serum. You put $10000 in in the Kickstarter which is what they described it as this was before it was kind of called an initial calling offering and that was with like 10 million dollars. A few months ago when it was at the stage where he was thinking about the influence of the moon on the tides and how he was going to try it. So I think it sort of lost his mind so he sold out the $10000 into 10 million dollars that actually happened.
Preston: [00:54:06] Yeah. Now there’s a lot of stories. I mean there’s a ton of stories out there like that. In fact trace Mayer is a guy that I follow very closely in this space because I think that he has some of the best information out there on it. And Trace was an early adopter you know 2010 kind of guy. I think he was buying it at a quarter and I saw some crazy stuff on Twitter where this guy they were talking about this as 2 x 4. That didn’t happen. By the way what trace may or said something like hey you know Roger I’ll bet you something like 30000 Bitcoins whatever it was I can’t remember what the number of bitcoins were that he had that he won the bet him. And this is just what he was willing to bet so I don’t know what else he had on the side. But the amount came out to be 100 million dollars. And so like these some of these early adopters and these guys that have bought this back whenever it was a couple. And he’s you know and under a dollar now it’s trading at 72 hundred dollars.
Preston: [00:55:07] They are extraordinarily wealthy. And I can only imagine if we’re talking about when you look at the market cap on this thing and this is so crazy when you’re looking at the market cap on Bitcoin right now it’s around I think 100 and $120 million or something like that. If this thing actually becomes a real currency a global currency we’re talking trillions of dollars here for the market cap because you look at what gold is as far as market cap. I want to say it’s around four to six trillion dollars in market cap for gold alone. You start talking about the riveting markets. There is one thousand six hundred trillion dollars in derivatives just to kind of give you an idea of how big this is in bitcoins just at $120. So if this thing actually matures and goes to some of these levels these guys that have those kind of positions today and they’re already worth $100 million plus they’ll be some pretty wealthy people in the world.
Tobias: [00:56:01] They won’t be excited about your Delta pick at all at all. It will be like it’s not 6 percent it’s 10. Well and that would be yeah you know I just met next year over the past few years.
Preston: [00:56:13] So I’m looking at the price of bitcoin at the 10 percent today. Like literally right now it might do negative. It might do negative 30 percent tomorrow. But I did 10 percent today which is what we were talking about the whole time about Delta potentially giving us on an annual basis so completely different. Like I said if you want to invest some money in this stuff go ahead and do it. But I wouldn’t use a large substantial portion of your free cash flow. But if this thing turns out to be something you might be able to pay for your house with a very small sum of money invested to the stock com bubble this housing bubble bubble. And you know I might go down in the books is being criticized heavily for this comment but I don’t see bitcoin as being anything remotely close to the tool meaning whatsoever. I think that there’s actually something here. I think it’s yet to be seen which block chain might emerge as the as the currency. Right now it sure looks like it’s going to be bitcoin.
Stig: [00:57:09] Yeah my last comment is I believe in technology and if you are going to see a very interesting Oliver it’s very similar to the only. There are many companies coming and want to. I mean we had to that it would have been very hard. So that makes it very hard to act on any cryptocurrency right now. And I’ve been trying to understand this technology and that’s why I’m still not it is that I’m confident enough to invest in it. I love Buffett’s line where he says he didn’t have to know which car company was going to win. It’s not that you wanted to be short a horse.
Preston: [00:57:53] Yeah but he doesn’t short anything. That’s a catchy quote. I guess my point for you. First of all would be I don’t necessarily buy into that narrative. Pairing it to car companies because when you’re dealing with this I think there’s really strong network effects that take hold when you’re dealing with a cryptocurrency that don’t exist when you’re dealing with like an individual business with cars like there’s no major I don’t want to say there’s no there’s some network effects associated with cars. But as far as picking the right brand of car I don’t see there being network effects associated with that. When you’re dealing with a currency on a global scale I think you start getting into some of these network effects. You know I can name some of them mossel like speculation and adoption consumer adoption security developer mindshare where you’re getting the smartest people involved in some of the stuff. And there’s there’s plenty more. So I think that that’s a consideration to maybe move away from that narrative and think of it maybe a little bit differently just because of the influence of those network effects that could take place anyway. All right so guys the thing that concludes our mastermind discussion about stock picks last kind cash and if you want to go first Hari What can people learn more about what you are currently up to see him grow the stock. All right.

Books and Resources Mentioned in this Podcast

Tobias Carlisle’s new book, The Acquirer’s Multiple – read reviews of this book

Tobias Carlisle’s Acquirer’s Multiple stock screener: AcquirersMultiple.com

Tweet directly to Tobias Carlisle

Hari’s Blog: BitsBusiness.com

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