Value Investing Forum

He has a third post (http://longtermvalue.wordpress…..vor-child/). There is some nice discussion of the pension liabilities in the comment section and one of the poster concludes along the same lines that I am, it's not as attractive as it appears. (See in particular El Flaneur's comments from Dec 16-17). The poster TC suggests looking at EV/EBIT with the underfunded liabilities factored in to the debt. That results in about an 11% EBIT/EV yield.

Think about it this way. To make up $2.2B in present unfunded liabilities (assuming nothing changes in their assumptions and plan assets perform as expected) then it would take between 8-10 years to catch up alotting say $350M per year. That will mean the company will have next to nothing in FCF for the next 8-10 years. That's why it looks undervalued by, say, looking at forward P/E or some other figure.

There are a lot of uncertainties with respect to pension liabilities. This article does a pretty good job of explaining some of it. Unfortunatley it didn't answer my question regarding when the "discount rate" is used and when "expected rate of return" is used in the calculations.(My 8-10 years was a result of plugging in a 9% and 5% discount rate for the $350M per year to arive at a $2.2B present value.)

When you think that the company has about $4B in plan assets and $6B in plan liabilities and you factor in that the $6B is determined by actuarial models with a number of assumptions (which might be dubious) and that half of the plan assets are valued via models (the Level 3 accounting) that adds a huge layer of uncertainty. And here's a company that has operating assets of about $5B ($2B of which is goodwill) and FCF of only about $300M. That level of uncertainty means there's lots of ways that this good go wrong.

On that note, I did find an article which claimed that private equity outperformed the S&P by about 3% per year (here - I only skimmed it). Initially I was assuming that the companies pension assets looked more like an insurance portfolio (which has a lot fixed income assets).

So I don't know. I just don't feel it's really all that undervalued. It could turn out to be a good investment. But I think there's a lot of uncertainty here (much of it not good uncertainty) and a lot of ways that this could go wrong and no margin of safety. So I guess I'm still a pass on this one.

So XLS came out with a 10-k. I'm not sure if I'm going to read it or not. I did glance through at some of the pension figures.

They anticipate contributing between $320-370M to the fund.

They have $6.2B in projected obligations and $4.0B in assets being underfunded by $2.2B.

Their assets include $1.7B in equitities, $1.3B in private equity, $0.6B in hedge funds and $0.4B in fixed income, etc.

Out of this $4B, $2B is valued in the "Level 3" category which under my understanding is more or less "mark-to-model" (sometimes referred as "mark-to-myth"). A lot of that is due to the funds in private equity which requires the use of estimates to value the assets.

Also of particular note about some of their assumptions:

The discount rate is now 4.75% though return on investments is expected at 9% still.

They also decreased their expectations of future compensation rate of increase from 4% to 3.75% which results in a lower present value of future obligations.

FCF came in at $239M (I was using $385M in my estimates) and book value dropped to $893M from $2.6B (which seems largely due to the fact that they added underfunded status to their liabilities.)

So unless there's something missing, I'm going to say that it's still about fair value (perhaps even overpriced given the recent run-up of the stock). But I haven't given their annual that much look as of yet.

Post edited 6:41 am – December 31, 2011 by somrh

(I updated this new table again since I can't successfully do one of these without some error.)

I'm not sure if I'm going to hold yet or not. I may hold until the 10-K comes out and reevaulate my position then but I haven't decided. On the plus side, the CEO purchase plus the dividend may help keep a floor under the price for the short term.

In particular, I want to know what "conservative" assumptions they use for their pension fund. Using a 6% discount rate doesn't seem all that conservative but they did claim to update the assumptions.

I decided to subtract off an additional $.84 per share (corresponding to the $950M difference adjusted for the tax benefit in the underfunded status) for the first 4 years and updated the three scenarios I used earlier (I assume $0 in cash earnings for scenario C):

So obviously this doesn't look as pretty as it intially did. The current price reflects about a 13%, 14% and 10% discount rate for Scenarios A, B and C respectively.

I may have to scrap all of this. It looks like the pension liabilities are unfunded by $2150M. So I'm off by about $1B with their underfunded status.

It looks like part of this is due to changes in actuarial assumptions. Per the 2010 10-K ITT was assuming a discount rate of about 6% and expected rate of return of about 9%. I couldn't find a disclosure for what the numbers were changed to but see Note 15 of ITT's 10-Q where they claim that part of the increase of the unfunded status is due to those changes as well as losses due to declining asset values.

So is there any reason to look into XYL or ITT? I've ignored them for the mostpart because XLS looks like the one nobody wants. I don't want to be missing something here though.

FWIW I remember reading about spinoffs that often times when they do spinoff there is a pretty significant sell off because the new companies don't fit into an investing thesis of the holder, so they sell regardless of business fundamentals. Think of mutual funds that only hold things above a certain market cap, or the new dividends went below a threshold. That could account for the current under book price. 

Regarding dividend: whether they pay 0.41 or 0.25, if their EPS is in the $1.90 range like you think either is a pretty good payout ratio. I wouldn't let that be the tipping point factor for not buying. If they do cut it, it'll drop and that could be a good time to pick up more. 

So I'm actually thinking XLS looks interesting. According to Market News Video (and I don't like that they confused XLS with Exelixis or EXEL) David Melcher bought shares under $9 yesterday.

The stock is selling below book value. It was a high of $13.50 which means the price is around 2/3 the high. The company paid a dividend of $.103 which annualized reflects a yield of about 4.5%.

There are certainly some risk factors such as the high debt levels and the pension liabilities. And the government could get themselves out of the war business (who are we kidding? that isn't going to happen) which could affect future revenues and cash flows. But all of that is already priced in.

FWIW, The Arb Fund's "Event Driven Fund" (AEDFX) largest position was ITT as of Sept 30, 2011. Apparently they bought that one pre-split.

See here.

Question. So ITT split into three companies: a company that deals with their water, a company that deals with their bullets (geeze, sounds like a prepper) and The New ITT which deals with what's left over. Namely aerospace stuff. The split was that if you owned 10 shares of ITT, you now owned 10 shares of Water, 10 of Bullets and 5 of new ITT. To me that says that the value the water and bullet section of their business at 50% and the other stuff at 50%. 

If you were trying to value the company now by looking at EPS or FCF/Share, could you just do your valuations by cutting those numbers in half? If that's the case, then my valuations have ITT at a pretty good discount to intrinsic value with a decent dividend too (about 1.8%). Quick and dirty valuation puts it in around $36.

Can you do that when there are spinoffs? Or do you have to go through everything manually and try to assertain what the earnings and fcf was for just the aerospace section of ITT pre-spinoff. Cuz…that sucks to do…