Buffett Book Thoughts; Italian Markets (Buongourno)
I finally got around to reading Buffett’s Early Investments by Brett Gardner. I really enjoyed it and the amount of research that went into the book was incredible. The book highlighted some of the investments made during the Buffett Partnership years and pre-partnership years that aren’t often talked about (excluding AMEX & Disney).
I made some notes and just thought I’d share some takeways from the book regarding some continuous themes of the investments Buffett made.
Balance Sheet Focused
Obviously this won’t come as a surprise to anyone but each company profiled had a strong balance sheet. Even the Disney investment at the time had a net cash balance sheet with other assets like the film library, Florida land and Disneyland rides. All of the companies had next to little amounts of debt.
These types of investments with strong asset backing and little debt helps explain why he hasn’t really lost much money over the span of his 70+ year investing career. This makes sense as he recently stated at the Berkshire AGM that he focuses first on the balance sheet over an 8 or 10 year span before even looking at the income statement. A company can’t really be zeroed if it doesn’t have debt. The balance sheet focus provides downside protection should the business falter, and some of them did as they weren’t great businesses.
Cheap Entry Price
All of the companies in the book had extremely cheap entry multiples whether it be from a P/NCAV, P/TBV or on an earnings basis. I put together all the multiples paid (excluding British Columbia Power because that was an arbitrage):
Marshall-Wells: Bought at 0.46x P/TB, 0.60x P/NCAV, 1.93x EV/EBIT, 5.5x P/E. Didnt make anything on it though and sold at a 1% loss.
The Greif Bros.: Bought at 1.52x EV/EBIT, 3.74x P/E, large discount to TBV. The company was buying back lots of stock and it was a decent winner at 20% CAGR for his holding period.
Cleveland Worsted Mills: Bought at EV/EBIT of 1.91x, P/E of 5x. Dividend cut so Buffett lost money (but it liquidated after and it would have made money had he held. See below)
Union Street Railway: Market cap of $643K and EV of -$327K. You could buy it at a significant discount to the net cash on it’s balance sheet (stock price of $30-$35 a share vs $48.13 of net cash) and it had barely any debt. Although not profitable at the time, it was repurchasing a large amount of its stock and had a return of capital distribution multiples of the stock price due to a strong balance sheet. He earned a 30% IRR.
Philadelphia & Reading: Stock price was $13.38 with NCAV of $9.16. It had a hidden culm bank inventory value which put adjusted NCAV at $17/share and TBV at $31.33. Because of the strong asset value of the balance sheet, Micky Newman (the son of Jerome Newman of Graham-Newman) completely changed the direction of the company by liquidating excess inventory and purchased profitable businesses unrelated to the coal operations. This allowed P&R to use up the valuable operating losses and shield taxes. The change in capital allocation in using cash to acquire profitable businesses one at a time is what really made the stock go from $10 to $200 in 14 years.
American Express: 2.5x EV/EBIT 3 years out from time of purchase
Studebaker: 1.39x TBV, 6.43x P/E
Hochschild, Kohn & Co.: 0.77x P/TB, 5.73x EV/EBIT, 10x P/E, 9.7% after-tax FCF yield. Was technically a “loser” for Buffett and Munger.
Disney: 3.51x EV/EBIT, 7.11x P/E
The vast majority of these investments worked out really well but for 2. And even the two that didn’t work out, the loss was mitigated or would have worked had he held on a bit longer (see below).
Hidden Assets
In some of the investments there were some off-balance sheet assets that weren’t reflected in the numbers.
Philadelphia and Reading traded around a $18.8m market cap, or $13.38/share, with a NCAV just below that but because it had what are known as culm banks that weren’t visible on the balance sheet, the value was hidden. Culm banks are a waste material from anthracite mining which can be used as an alternative fuel source. This asset would have fetched approximately $17/share based on Buffett’s estimate. More than the market cap of the company. It also had valuable operating losses from mine abandonments.
Studebaker had 10 segments and they didn’t disclose numbers for the segments. The fast growing STP segment would only later be revealed when Studebaker IPO’d STP. It grew revenues from $13m in 1964 to $44m in 1968. It also had $30m of large tax loss carryforwards that only would have showed up in the notes to the financials, not the actual balance sheet figures.
Hochschild, Kohn & Co had assets that the balance sheet didn’t account for: 1) the LIFO reserve meant that if the company used FIFO, inventory would be 5% higher and 2) the real estate carrying value was greater than what it was marked at on the balance sheet for.
When Buffett bought Disney, it had a market cap of $80m. The total film library cost was $205m but just $9m of it was on the balance sheet due to being amortized over time. One of the films was Mary Poppins which had just done $30m in sales and Cinderella did $2.5m in rentals. Plus you got over hundreds of short films, 21 animated features and other film and TV shows for that $9m on balance sheet. And every few years you could recycle these movies to generate income because a new generation of children would watch them. Clearly worth more than the $9m it was marked at.
The Greif Bros. Cooperage balance sheet had understated it’s inventory as well because it used LIFO accounting in a rising price environment.
Union Street Railway operated buses and sold tickets in advance. Every sold ticket that went unused was a liability on the balance sheet as deferred revenue. Not only did the company get access to this “float” from unused ticket purchases, but because the liability barely changed year over year, it was highly likely that the tickets wouldn’t be used and therefore the liability could be written down to zero, adding some extra asset value to the business.
Scuttlebutt
When the salad oil scandal occurred, Buffett compiled “a foot-high worth of material” on the company that came from bank tellers, bank officers, restaurants, hotels and credit card holders that all showed the scandal didn’t affect the underlying business. He even went to restaurants in Omaha to be sure customers were still using their Amex cards. It was still growing at a tremendous clip during this period and allowed Buffett to purchase the business at 2.5x EV/EBIT a few years out from when he bought it. A crazy cheap price for AMEX’s franchise quality.
There’s a story of Buffett going to a Kansas City railroad yard for a month to count tank cars in the yard in order to gauge how fast Studebaker’s STP segment was growing.
Even when he went to Disneyland, he was trying to calculate the profitability of the rides and park.
The Losers
Cleveland Worsted Mills - I wouldn’t even say this was a real “loser” but for Buffett it was. He bought just prior to the company cutting the dividend because it was a declining business and sold just after that. But they ended up just liquidating a year or two after he sold and if you bought after that you would have made 21% - 50% annual returns due to the liquidation distributions. The cheap earnings multiples weren’t actually as cheap because the business deteriorated but he had protection through the balance sheet.
Hochschild, Kohn & Co. - Buffett’s purchase of this Baltimore department store seems like a bit of a head scratcher to me. Not only is retail an extremely tough business to be in and predict the future of, but the price paid didn’t seem that attractive as well. You can look up all the multiples in the above section but 10x earnings for a low growth, low ROIC business doesn’t compare to the earnings multiples paid on the other investments profiled. Buffett and Munger would end up selling the business for $11m vs a $12m purchase price but because they received $3.5m in dividends, it technically wasn’t a loss.
Overall Takeaway
Buffett is more value agnostic than people associate him with. He’s known for “buying wonderful companies at fair prices” but even back in the early days, it seems like he was just looking for mispriced bets. Whether it was from net-nets, companies on the proverbial “operating table” or arbitrages, if his downside was protected and the price paid made sense, it could be a potential investment.
A test I noticed that Buffett likes to use is the private market test. What would the company go for in a private transaction? He did it with Disney and said it was worth multiples of what he bought it for. He’s also quoted saying something similar with his Washington Post investment.
Extremely strong balance sheets, with none/small amounts of debt and low entry multiples are what has protected his downside in the event that his analysis of the business was wrong.
Having earnings stability and some kind of capital allocation taking place (whether it be agitating for a change in capital allocation through his control positions or someone who knows how to allocate capital) is where he made a lot of money.
Borso Italiana
I’ve looked at some stocks on the Italian exchange before but with Italy being one of the top tourist destinations in the world I thought I’d go through and take a look at each one. There are some unique companies as usual. Like Avio SpA that could be a play on the potential increase in European defense spend or SOL Spa that seems like it could be the Air Products of Italy.
The Italian Borso has three segments to their market:
The MTA (which stands for Mercato Telematico Azionario) is where their large and mid cap stocks trade.
The Euronext Growth segment is for medium to small companies
The Euronext STAR segment is for small companies
All in there is about 353 publicly traded stocks. I’m sure I missed some and there are others I have highlighted on my excel document that I’m watching but for now I figured I’d write a few up that are interesting.
Cairo Communications – CAI.MI. They operate several divisions that produce periodicals/books, an advertising arm for their print division, and they own the TV network La7, which is one of the top 10 TV channels in Italy. On top of that, they have a 60% stake in RCS Media. This stake can make the underlying accounting a bit confusing as Cairo consolidates RCS onto their financials. They recently just tendered for 18% of their shares, and only 11% was subscribed, which leads me to think that management sees their stock as undervalued. The owner, Urbano Cairo, owns a tad over 50% of Cairo, and 100% of the Serie A team Torino FC, although that doesn’t come with the company unfortunately.
Health Italia - HI.MI. Undergoing a mandatory takeover bid currently with a premium at 157% to the unaffected price. With the stock at €280/share and the bid to come in at €300, there is a nice little spread if arbitrage is your thing.
F.I.L.A. - FILA.MI. You can read my Q2 Letter to get my thoughts on it. It remains deeply undervalued and might be the cheapest stock in Italy.
Lindbergh - LDB.MI. Providing MRO parts has historically been a great business and that’s the line Lindbergh is in. They provide ordered parts to technicians overnight (while they’re sleeping) and other ancillary services. Lindbergh is also looking to roll up the Thermodydraulic service market, which is highly fragmented with 5K companies. It is mandated that Italians must perform yearly maintenance on their heating systems and Lindbergh has started to acquire some small companies that have technicians that services these homes. There is a really good VIC writeup from last year too that covers this well!
Caltagirone Editore - CED.MI. This ones an interesting one. It owns several leading local papers in Naples, Rome, Venice, etc. and a top 5 national one called Il Messaggero. It’s owned and controlled by Francesco Caltagirone’s holding company at 61%. The good news is that with a market cap of €760m, it’s backed by 51% of net cash and investments for an enterprise value of €373m. The bad news is is that the papers don’t make money and are subsidized by the income earned from the investments. It will be interesting to see how long this will go on for! Oh, it also has €51m in tax losses and what is most likely undervalued land carried at €60m.
Brunello Cucinelli - BC.MI. Apparently there are people who like to spend thousands of dollars on a t-shirt or a pair of shoes. The value investor in me could never. Up 900% since going public 13 years ago and trading at 49x earnings and 19x EV/EBITDA, there was a recent article in the FT about the founder Brunello Cucinelli that was interesting. What started in 1978 with €550 is now worth €7B.
RCS MediaGroup - RCS.MI. If you owned FIAT a decade ago you would have received shares of RCS that FIAT owned and were spun off to shareholders (not an actual spinoff, just FIAT’s stake). They own the #1 and #2 Italian and Spanish newspaper, Corriere della Sera and El Mundo. And in sports they own the largest Italian and Spanish newspapers, La Gazzetta dello Sport and Marca. They also put together large sporting events like Giro d’Italia. Their Newspaper segment is their most profitable and just did €50m in EBIT out of the overall company’s EBIT of €93m, which is quite impressive as most paper companies operate at a loss. Now, RCS itself announced at the end of 2024 that they will be doing their own spinoff and separating their Sports and Events division. I’ll be watching to see if shareholders vote for the spinoff and potential spin dynamics at play.
NewPrinces - NWL.MI. The original company was a small milk business in Salerno that has grown to a large €2.8B European food behemoth. They are an acquisitive company and have done about 15 acquisitions in the past 20 years to grow their business. Their brands include Ragu (pasta sauces), Matese (dairy), Pezzullo (pastas) amongst many others in similar categories. They also just announced a few weeks ago that they are buying Carrefour’s Italy business for €1B and might be listing their manufacturing assets on the London exchange. The stock is up almost 100% YTD as investors are excited about integrating these acquisitions as well as future ones.
Racing Force - RFG.MI. Last year I rented a car and drove from Rapallo to Stressa. Little did I know I would have driven right past this company. If you’ve seen the new F1 movie with Brad Pitt, you would’ve saw their brands in the movie. Their OMP segment produces racing equipment that the racers wear (suits, boots, gloves) as well as safety equipment in the vehicle like the seat or seat belts. Their Bell Helmets are worn by 70% of F1 racecar drivers, which seems like a pretty good niche moat to own. They’ve grown sales at a 12% CAGR since 2021 and 14% the last 10 years to €65M last year and earn a decent profit of just under €6m. It will be interesting to watch their growth drivers in the future like their Skier’s Eye application in the defense industry.
As I said I’m sure I missed some so if you can think of any interesting ones just let me know.