Asmus Puhl Finance Blog

Certainly, Colfax future earning’s power does not only depend on cost savings and on the solution of the asbestos problem.

Will orders of the oil and gas industry pick up in the second half of 2009 and in 2010?

This could happen if the price of crude oil continues to strengthen.

Will the „Global Navy and Commercial Marine End Market” remain strong?

As always in investing there is no guarantee but one thing is assured:

Colfax has a disciplined management. They are positioning the company for better times.

We just don’t know exactly when that will be!

So the stock is up but how do the numbers look like?

What could one expect given the current economic environment?

Colfax posted net income of $4.4 mil (0.10 $ /share basic and diluted) in Q2 2009

Adjusted net income (which backs out restructuring charges and asbestos related costs) was $8.5 mil ($ 0.20 / share), a decrease of 38.8%. This includes a negative currency effect of 4 cts/share.

Net sales were $ 129.2 mil, a decrease of 20% year over year.

Only in the segment „Global Navy and Commercial Marine End Markets” sales were up.

Orders in the second quarter were $ 104.1 mil, a decrease of 44.9%

Brutal numbers indeed!

But the CEO was rather upbeat on the conference call given the current environment.

Colfax Corp. rapidly started a cost reduction program of $ 13 mil until the end of 2009 and if necessary further cost reductions can be implemented.

He points to the healthy balance sheet: the debt/EBITDA ratio is 1.

As acquisitions are part of Colfax’s business model they also mention an improving „acquisitions pipeline”.

Perhaps the best news are – if all goes well – that the legacy asbestos problem goes to trial in october and Colfax awaits a definitive solution at the end of this year.

…….  continues  …..

Today Colfax Corp.  (NYSE: CFX) reached $ 12.10 in an overall positive market.

This blog first discussed Colfax on May16th of this year. Then the price was $ 7.27

Until today this means a performance of 66%, by far outperforming the overall market!

……… Dear Reader, I hope you were invested!

On this blog we will have a look at the latest Q2 2009 results of Colfax published recently and we will discuss whether they justify this performance!

Stay tuned!

They invest obviously in what they know best and so they have a high percentage invested in insurance companies.

As their equity investment criteria are very similar to those of Berkshire it certainly does not come as a surprise that their biggest investment is in Berkshire stock itself.

For more details on their holdings watch their latest SEC 13F Filing (date May 2009).

As Markel’s general goal is „to earn consistent underwriting profits and superior investment returns to build shareholder value” (Markel Annual Report 2008) they aim for an average annual return of at least 15% on their equity portfolio over the long term.

But obviously this all didn’t work well in 2008. As most of us they did not expect a market decline of this magnitude.

Markel’s return on its equity investment portfolio was – 34%. They went heavely down but still managed to outperform the S&P 500 index.

As they put it in their Annual Report: „The best thing we can say about 2008 is that it is over!”

But they believe that the insurance markets will improve beginning in 2009. „Unprofitable companies have to go out of business some day (with government help or without)”.

And they are rather bullish for the equity markets for the next decade seen the performance of the last ten years!

They know that the average historical performance of the S&P 500 index over the last 100 years was 11% (dividends reinvested) and there were always extended periods of flat or negative markets. So simply put stocks will not stay flat forever.

…. continues ….

When we recently discussed Colfax Corp. (NYSE: CFX) on this blog we pointed out that Tom Gayner, chief investment officer of Markel Corporation (NYSE: MKL), is one of its board members.

So why not take the opportunity and have a look at Markel itself?

Markel was founded by Sam Markel in the 1920’s as an insurance broker catering to the transportation industry. He organized the first mutual insurance company for operators of “jitney buses“ in the US.

You can read more about the interesting history of Markel here:

http://www.markelcorp.com/AboutMarkel/History/Pages/History2.aspx

The company remained mainly an insurance broker until going public in 1986.

By then Markel was convinced it had so much underwriting expertise in insuring unusual risks that the strategic focus of the company began to shift from insurance brokerage and services to underwriting.

Markel expanded rapidly as a speciality insurer in a variety of niche markets and with its Terra Nova acquisition in 2000 it entered the international market.

Two grandsons of Sam Markel still serve as vice chairmans of the board.

Markel’s underwriting business is subdivided in 3 categories:

DIVISIONS	GROSS PREMIUMS in FY 2008	EARNED PREMIUMS in FY 2008
US Excess & Surplus	1,164 $ mil	1,029 $ mil
Speciality Admitted	355 $ mil	321 $ mil
International Markets	693 $ mil	618 $ mil

(source: MKL – 10K 2008)

As we can see more than half of Markel’s business falls into the  “US Excess & Surplus“ category.  It provides additional coverage in excess of standard insurance contracts which the larger insurance companies are not willing to provide.

This requires exactly the specialized underwriting knowledge and experience in niche markets which Markel built up for years.

“Speciality admitted“:  In this category Markel operates as a licensed insurer for hard-to-place insurance as mobile homes, health and fitness facilities, horse farms etc.

“Markel International” operates in the London market and covers hard-to-place insurance on an international level.

… continues …

Colfax is intensifying its presence in the middle east oil production market:

http://ir.colfaxcorp.com/releasedetail.cfm?ReleaseID=389586

… this is just another little step in positioning itself in a growth region. It is done by its already strong Allweiler division.

I am curious in what sector they will do the next acquisition!

Yesterday Colfax’s stock (NYSE: CFX) traded at $ 8.35

Shares outstanding are 43.21 mil which translates into a market capitalization of $ 362 mil.

Analysts expect Colfax to grow 7% over the next years.

Danaher’s growth rate over the past 10 years was 17.5%

I think that after a difficult year 2009 we can be slighty more optimistic than analysts and expect Colfax to grow at an 10% annual rate.

I would expect Colfax to acquire at least one company per year.

They have a strong balance sheet and with the economy in recession smaller companies will certainly be available at good prices. This should make acquisitions immediately accretive to earnings.

And don’t forget that Colfax’s earnings are still impacted by asbestos liabilities. It costs them about 40% of their earnings power this year.

But those costs should rapidly decline over the next years.

Management expects EPS this year in the range of $ 1.00 – 1.07 excluding the asbestos liabilities and costs.

So with a 10% annual growth rate the company should at least earn $ 1.61 / share within 5 years.

At a conservative p/e ratio of 10 this means the share price should roughly double to $16.10 (I don’t expect a significant dilution of shareholders given the strong insider holdings).

I think at today’s prices we are able to invest in a very promising company with a significant margin of safety!

……..this blog will continue to keep an eye on Colfax!

Colfax Corporation published a new investor presentation on its website:

http://ir.colfaxcorp.com/events.cfm

It gives a comprehensive and detailed view of the company.

It’s worth reading!

Let’s start right away with a very interesting and still rather unknown small cap

(only 7 analysts are following this company at the moment / source yahoo finance):

Colfax Corporation  ( NYSE: CFX )

Website: www.colfaxcorp.com

Colfax was founded in 1995 in Richmond, VA, USA, and went public in May 2008.

It makes pumps, fluid handling systems, speciality valves for industrial, marine, oil and gas, and power generation markets, and for the Navy.

It has some of the best and most recognized brands in the industry worldwide and extensive engineering expertise. It works in some very attractive industrial markets. Just think of the future energy infrastructure needs especially in Asia.

Their net sales reached 605 mil $ in FY 2008.

Colfax is globally diversified:

51% of sales were in Europe, 25% in the US and Canada, and 15% in Asia and Australia, up from only 2.3% in FY 2007.

The current market capitalization is 311 $ mil.

Business Model:

Colfax works with a business model they call the Colfax Business System.

To understand this we have to look at the business model of another very successful company: Danaher Corporation (NYSE: DHR) website:www.danaher.com

Danaher was founded by Steven and Mitchell Rales in 1983. They started to acquire industrial businesses to form a conglomerate. By applying the principles of „kaizen“ the Japanese word for continuous improvement, they made the acquired companies much more efficient and profitable than they were before.

Exceed customer expectations, defining delivery performance, improvements in costs, innovation in products and services are the goals.

And they called it the Danaher Business System. They implemented this business model so well that they delivered an impressive annual return of 22% to shareholders since 1991.

Colfax follows this model and calls it the Colfax Business System. They are a serial acquirer of small complementary industrial businesses like Danaher.

Mitch Rales founded Colfax together with the actual CEO John Young in 1995.

He and his brother Steven today hold each 21% of Colfax stock.

Mitchell Rales serves as chairman of the board. Also board members are Patrick Allender, the longtime CFO of Danaher and Thomas Gayner, the chief investment officer of Markel Corp., one of the best investors in the US. Some talked of him even as a successor of Berkshire Chairman Warren Buffet.

So Colfax could evolve as a strong core business together with the implementation of its acquisition strategy, backed by the excellent expertise to value these acquisitions among their officers and board members

….continues with the financials….

This blog favors stock picking of small and midcap companies.

… so good….

but what are the criteria to evaluate a company?

For me four criterias are the most important:

Strong balance sheet, earnings power and cash flow

I would not invest in companies which have a debt loaden balance sheet or which even in good times do not generate strong cash flow. They would be too vulnerable in difficult times (as we can experience right now…..)

Certainly, a dividend can add nicely to the investment return over time but if a small fast growing company has better use internally for the money it should reinvest it in the business.

A sustainable competitive advantage:

The best companies to invest in are surrounded by a wide moat filled with crocodiles as Berkshire Chairman Warren Buffet puts it.

Those competitive advantages can be strong brands, patents, de facto standards, or low cost production processes which can not easily be duplicated by competitors.

Long standing good relationships with important clients belong here too.

These factors normally lead to above average earnings and cash flow power.

Honest Management:

This is perhaps the most difficult criteria to assess but the most important too!

I do like intelligent capital allocation (and not risky and exaggerated M&A activity), reasonable executive compensation (and not exaggerated option grant).

The perfect match is certainly when founders and/or executives are still large shareholders so the interests of them are more aligned with outside shareholders.

The share price is cheap

which can happen when p.e.

– the company already is a great business but so small that it is unknown and does not have the attention of many analysts,

– the company faces a temporary setback caused by bad news from its business or caused by a general negative stock market sentiment.