Graham-Style Security Comparison - BPL vs. BKI

[buffett]

Here's an Old School assignment for anyone interested in pitching in. Ben Graham used to randomly pick a pair of companies which were usually very closely related alphabetically but in no other way, then he'd ask his class to determine which one presented the better investment opportunity.

I'll throw out a pair of companies, and then anyone who wants to can post their analysis in this thread.

<u>This is an investment thread, not a trading thread.</u> I don't want us to figure out which stock will go up tomorrow, I want us to figure out:
(1) which stock presents a better investment,
(2) why, and
(3) what would be the appropriate conditions to eventually sell it?

Strangely enough, neither of these companies is located in Ohio:

Buckeye Partners (BPL), in Pennsylvania, engaged in oil services
Buckeye Technologies (BKI), in Tennessee, makes paper products

[adios]

I'll have to look at the charts to tell you [img]/images/graemlins/smile.gif[/img].

[Ed Miller]

Bumping for myself. [img]/images/graemlins/smile.gif[/img]

[DesertCat]

BPL - Buckeye Partners, L.P. (Buckeye Partners) is engaged principally in the business of transportation, terminalling and storage of refined petroleum products for integrated oil companies, refined product marketing companies and end users of petroleum products.

Recent Price: $43.15
Book Value: $20.00
Trailing 12m EPS: $2.63
PE Ratio: 16.6

Commentary: On the surface this is a great business because it's an oil pipeline busines. This means limited competition, and locked in profitability. Note it's ROE, which is 12.5%, and margins are 23.7%, which point to being relatively sheltered from price competition.

Normally I ignore energy companies because I have no predictive ability for energy prices. But is BPL's value really related to the price of oil, or not? It actually looks like oil prices have only minor influence on their sales and profitability. Earnings have flunctuated between $96.4M (in 2000 due to discontinued operation) and $30.2M (due to writeoff) the last five years. But throwing out the writeoff and operating earnings from continuing operations were $64.5M, $69.4M, $71.9M, $75.7M, 83M, showing regular growth the last five years.

That's 5% annualized growth. I'm going to stop here because it's not screaming cheap (16.6 PE for 5.5% growth and 2x book), so I typically wouldn't go to the next step, reading it's reports, figuring out what the charges were, and more about the risks and problems in the business. It's also a little leveraged, and one question I would ask is why isn't ROE even higher if they are using more debt than equity?

BKI - Buckeye Technologies Inc. manufactures and distributes value-added, cellulose-based specialty products used in various applications, including disposable diapers, personal hygiene products, engine air and oil filters, food casings, rayon filament, acetate plastics, thickeners and papers.

Recent Price: $7.53
Book Value: $7.38
Trailing 12m EPS: .42
PE Ratio: 17.9

Commentary: Small loss on lower sales last quarter. Low ROE, 5.6%. Profit margins only 2.2%. Looks like it's in a tough business. I smell a textile company.

Looking at net income over the last five years is ugly, only two profitable years, and losing money over all. So what's happened recently, and has it changed the value equation on a permanent basis here?

They had a similar downswing in sales in the year ago quarter. That looks like seasonality. They also shut down a plant and blamed Katrina for higher costs. They've had restructing costs in the last two quarters as well as the year ago quarter. Book value is almost all Accounts Recivable, Invenetories, and Plant/Equipment, very little cash, yuck. My guess is they are a commodity supplier with no strong competitive advantages in their industry.

Since I don't see any hidden value here (and I have to take a shower) I'll again stop before reading any of their reports. Hope I didn't miss a gem here, but this is how I roll, I skim, skim, get a sense of the business and move on to the next one if it doesn't perk my interest.

If I had to buy one of these, easily the pipeline company. It's performance isn't outstanding, and it's not super cheap, but it's in a much, much easier business than textiles. I think you can count on the pipeline company for steadily increasing earnings for a long time while the other company swings from good years to bad.

[DesertCat]

I need to point out of my facts and figures were from MSN, which probably gets them from the same sources as Yahoo. It's great for quickly sizing up a stock, but the numbers can frequently be wrong or distorted based on one-time events. I want to caution anyone reading this, before making a buy decision on any stock, you should read the SEC reports in detail to understand the real financials, the business and the risk factors.

And if it still looks good, then read it's competitors reports, you might find out the competitors are better, or find out some risks your original company didn't mention. And if possible, go out into the "real world" and investigate it, i.e. if it's retailer, go to it's stores. Google for articles on the company. Always double check the biggest risks if you can before you commit too much of your portfolio to it.

[xtravistx]

BPL - Buckeye Partners LP's GP is owned by Carlyle/Riverstone (private equity), if that changes things at all.

[buffett]

I finally got around to digging a tiny bit into these cos....

I like DC's rough analysis, and I totally agree with him that BPL is a better business to be in than BKI. But my conclusion is different than his because if I had to buy one of these two, I'd go with BKI at current prices. Here's why....

<u>BPL</u>
They bought 5 pipelines &amp; 24 terminals from Shell in late '04 for $517M. I wish we had disclosure (or could just figure out) the cash flows associated with this deal, in order to get a sense of the M&amp;A multiples of this space. Without that, though, I'll hazard a couple of wild guesses of a ballpark value for BPL: EV/EBIT of 15 and 15x FCF. For public U.S. companies of just about any size, I think an EV/EBIT or FCF multiple of 10 would be a minimum valuation. For great businesses with enduring competitive advantages I'd go as high as 20xFCF for good retailers and 25xFCF for branded every-day consumer products (JNJ, KO, BUD, etc.). I think of pipelines as a sort of toll road-type business. There are other alternatives of transferring the fuel, but the price they charge represents a good value for the consumer. In other words, dang I wish I owned a toll road. But this is a fairly small player, and I'm not exactly sure what kind of competition they face so I'll start out with a ballpark of 15x and see where that gets me. I say EBIT is around $140M and net debt is around $850M, so 15x implies the equity is worth about $1.275B. I say FCF is around $85M, and 15x that is $1.25B. Coincidentally, these are very close to each other (this is a very rare occurence for me, usually my first two stabs at a value are significantly different). The current market cap is $1.65B, or 30% higher than this, or a FCF multiple of 19x and EV/EBIT of about 18. Seems a bit rich for my blood.

<u>BKI</u>
This thing looks boring.
The income statement is a mess, with impairment charges and all kinds of other "leaks."
Lots of debt...about 2x book value.
The gross margin is low, which means sales aren't much different than COGS, but A/R is way bigger than A/P, which suggests to me that these guys don't have much power in either pricing or selling their products. They just take what they can get.

[We interrupt this analysis to mention that, at this point, I mentally apply the label "cigar butt" to BKI. With most businesses, I either label it a "cigar butt," a "good business," or just vaguely think of it as somewhere in between. I much prefer to buy good businesses, because I can hold on to them practically forever, not pay a lot of taxes, not do a lot of work, and play more golf. But I will invest in cigar butts, with the intention of buying the stock when it sells from a big discount (usually at least 30% for me) from its intrinsic value and then selling it above 90%. This gets me a return of 50% if I'm right, and the margin of safety limits my loss if I'm wrong. Now back to the valuation.]

Cashflow statement actually looks halfway decent, with OCF growing from $55M to $79M over the last 3 years. 3-year avg. OCF is $66M, D&amp;A is $46M, so 3-year avg. FCF is $20M. Current market cap is a little less than 15x that. But it seems like earnings should be picking up over the next couple of years (I don't normally like to look to the sell side, but a quick look at the 4 analysts' who cover this thing estimate for FY07 EPS seems to confirm this). So perhaps current FCF would be a better thing to value it on than 3-year avg. FCF. Current FCF is about $30M, and 15x that is around $13.50 per share. So I'm willing to hold my nose and buy this below $8, with the intention of selling as soon as it hits $12. My annual rate of return depends on how long it takes for this to happen, but if it happens in 3 years or less I should be OK. I would really prefer to have a dividend to tide me over while I wait, but you can't always get what you want.

<u>Recap</u>
Of these two, I think BPL will be a much better buy-and-hold investment. A dividend of almost 7% and a tollbooth style business model make it much more attractive. But I'm a cheapskate, and I wouldn't pay $43.50 for it (if it was selling for something more like $35, I might be tempted), so I'm going to roll the dice on BKI and hope for a quick-ish 50%-er. I would not at all be surprised if this was the wrong decision, but I'm comforted by 2 things: (1) judging between BPL &amp; BKI is fortunately much more difficult than most decisions I make each day (like choosing between Avon &amp; Waste Management, say), and (2) even if I were forced to choose between these two, my assumption going into this exercise that my choice would just be 1 stock of many going into my portfolio, so I would have the cushion of diversification on my side. (If I just had to pick one of these 2 for my entire net worth, I would probably go with BPL instead. How's that for equivocation?)

[buffett]

[ QUOTE ]
I'm going to roll the dice on BKI

[/ QUOTE ]
Just to be clear...I'm not actually going to buy this stock in real life, and I wouldn't recommend anyone to do it. The statement above is just for the hypothetical purpose of this little exercise.