In the summer of 2008, I started accumulating shares of Ingersoll-Rand (IR). At that time, American economy had shown plenty of uneasy signs, while I identified IR as one of the stocks with the potential to thrive through the possible upcoming downturn. I had three reasons to back up my beliefs, first, Warren Buffet's stake in the company, second, IR's move to acquire Trane, and third, its global footprint - the Asian market would provide immense growth opportunities.
Then the unfolding of the financial turmoil later the same year proved my timing was not right. IR was hit way harder than I had figured, primarily due to their exposure to the construction (both commercial and residential) market, and the increased debt level - as a result of Trane acquisition. However, I held onto my positions and haven't changed my long-term views on the company. Now we started seeing some positive signs of the economic trend, and I think it is a good time to revisit my thoughts on IR.
A Company in Transition
First of all, a simple description of IR's business from their 10K.
"Ingersoll-Rand Company Limited (IR-Limited), a Bermuda company, and its consolidated subsidiaries (we, our, the Company) is a diversified, global company that provides products, services and solutions to enhance the quality and comfort of air in homes and buildings, transport and protect food and perishables, secure homes and commercial properties, and increase industrial productivity and efficiency. Our business segments consist of Air Conditioning Systems and Services, Climate Control Technologies, Industrial Technologies and Security Technologies, each with strong brands and leading positions within their respective markets. We generate revenue and cash primarily through the design, manufacture, sale and service of a diverse portfolio of industrial and commercial products that include well recognized, premium brand names such as Club Car, Hussmann, Ingersoll-Rand, Schlage, Thermo King and
Trane."
Here are some key points from reading their 10K, 10Q and other financial presentations.
- On June 5, 2008, for $9.6 billion, IR completed the acquisition of Trane Inc, one of the top HVAC (heating, ventilation and air conditioning) companies, previously known as American Standard Companies Inc.
- On November 30, 2007, IR completed the sale of Bobcat, Utility Equipment and Attachments business units (collectively, Compact Equipment) to Doosan Infracore for cash proceeds of approximately $4.9 billion.
- On April 30, 2007, IR completed the sale of the Road Development business unit to AB Volvo for cash proceeds of approximately $1.3 billion.
- The international share of IR's revenue has been growing at fast pace, and the trend will continue. For example, for Climate Control, in 2001, 39% of the revenue is from outside North America, and in 2008, 47%. Overall in 2008, 34% of its revenue is from outside North America.
- IR's revenue is across multiple markets, including Parts & Service (25%), Commercial Construction (23%), Residential Construction (12%), International Construction (11%), Industrial/Process (9%), Supermarkets – Cases / Install (8%), Truck and Trailer (6%), Bus, Container & Other (3%), Golf & Utility Vehicles (3%). It seems to be very well balanced, not tying to any single market.
- The parts & service revenue, as mentioned above, is 25%, a very healthy number. It represents the recurring revenue, the very type that every company seeks with greatest effort. Its increase indicates the deepened independence of the customer upon the service/parts provider, which translates into guaranteed revenue. IR continues to put high priority on developing the capabilities to deliver recurring revenue.
- IR has been using Lean Six Sigma for years, and will continue to rely on it to achieve operational excellence, which reflects IR's clear and constant awareness of efficiency and cost.
So clearly, IR is a company in transition, from a traditional asset intensive American company, towards a light-weight, international company with good margin, steady stream of revenue and maximized immunity to American economic cycle. In other words, IR has been constantly recalibrating itself to remain as a GROWTH company.
Growth
1) Both high energy cost and environmental regulations will boost the demand for energy efficient solutions for HVAC and Climate Control technologies, which is the key to IR's growth in matured market.
The combination of HVAC and Climate Control accounts for 67% of IR's total revenue. Though IR is reasonably internationalized, North America still contributes more than 60% of the revenue in both segments, especially the residential HVAC, is very much like a typical American business.
Basically both businesses are tightly linked to the economic infrastructure. HVAC services the commercial market and residential market. The commercial market can be further divided into commercial (offices, retail, lodging, etc), institutional (health care, education, government, etc) and industrial (process manufacturing, life sciences, data centers, etc). The climate control mainly serves food transport and grocery stores.
In North America, these markets have been very mature. The population and the overall economy will continue to grow, the HVAC and Climate Market should follow, but I don't see the overall demand outpaces the overall economy. Here I believe the surging energy price and stricter environmental regulation will play a significant role in IR's future. They will force the customers to seek solutions with higher energy efficiency, or green enough to meet the legal standards. This is a process to consolidate the fragmented market, where the companies with superior technology, larger market share, better management and higher productivity win. Today's IR is well positioned to take advantage of this trend.
2) IR's international footprint creates itself golden opportunities to profit from the emerging markets.
More than 30% of IR's total revenue comes from outside North America and its international appearance is very impressive. For all the four businesses, IR has manufacturing & distribution sites, sales consultant offices, and integration & service offices virtually across the entire world.
In the emerging markets, notably China and India, the bottleneck of their economic growth is the infrastructure. As a result, we see both countries put high priority, accordingly high investment into this area. For better understanding, let's paint a simplified picture here.
Combining the population of the two countries, the number we get is 2 billion. Now the 2 billion people need to live (residential development, which creates demand for IR's residential HVAC and security technologies), eat (cold chain and grocery store development, which creates demand for IR's Climate Control technology), work (commercial/institutional/industrial development, which creates demand for IR's commercial HVAC and Industrial Technology products) and move around (transportation development, which creates demand for IR's Industrial Technology products). The key here is that the demand is driven by this gigantic population, and both countries are struggling to keep up with it. Therefore, IR is presented virtually unlimited growth space.
One extra point to note. Both countries have very limited farm land but are experiencing rapid urbanization, which actually creates an exceptional demand for the cold chain technologies. Currently the Climate Control contributes around 20% of IR's total revenue. I see high chance this business becomes a key driver of IR's growth in the next 5 to 10 years.
3) IR's leading market position will continue to generate revenue from parts & services
As mentioned above, currently more than 25% of IR's total revenue is from parts and services. This is a very healthy number.
In today's business world, especially the manufacturing section, we see more and more companies sacrificing the margin to win the customer's initial adoption of their solution. The logic is simple. Once the dependency of the customer on the solution provider is established, the parts & service revenue will eventually follow, which normally has higher margin, and recurring. IR's leading market position and technology advantage means they have stronger leverage to win the customer, in turn, the increased market share will consolidate such leverage and make IR even stronger. I am expecting the parts & service revenue continue to grow at a faster pace than the overall growth rate of the entire company.
Conclusion
IR operates in a traditional industry, where we won't see explosive growth, but a steady one. We see opportunities to be created by both the recovering American economy, and the unabated emerging markets. To certain extent, IR meets the definition as a 'boring' company as defined by Peter Lynch, which makes it an even better long-term stock. At the micro level, I liked the direction that the management is driving IR towards. Normally when we analyze a company, the most tricky part would be the evaluation of the management. Since IR is Warren Buffet's pick, things get easy - there is no need to question the capability of its management. While I'd like to point out that I was impressed from reading the IR related material. I see a management team with clear vision, sound mindset and a long term strategy that is constant, simple and well defined.
One more point to add. I believe IR has the option to combine its four businesses and acts as a solution package provider, which may be an important competitive edge that IR has been enjoying, and will continue to enjoy. In IR's presentation, it frequently used the grocery store to showcase its high performance solutions, where products from all its four businesses are employed and IR is very much like a one-stop service provider for the grocery operators/builders. For the customer, the benefit in cost, efficiency and maintenance to use service from this type of 'package provider' is apparent. And for IR, its four businesses should be able to continue to create opportunities for each other and bring in more and more organic growth opportunities.
Monday, May 25, 2009
Wednesday, May 6, 2009
Thoughts on Recent Earning Reports from Visa and MasterCard
Last week, both Visa (V) and MasterCard (MA) released their quarterly earning results. Here are some thoughts on their reports and the conference calls.
1) Economic Indicator
For a long time, consumer spending has been the driving force of American economy. Albeit the arguments that now finally comes the end of such an era, it is fair to say the consumer spending remains as the most accurate indicator of the economy. Many researchers publish reports, articles, statistics, etc. to track the economic activities, looking for all sorts of signs of the economic trend. But as a matter of facts, no indicators are more accurate than the financial results from Visa and MasterCard. Actually in my opinion, both companies themselves are the indicators.
There are two aspects of the consumer spending, the number of transactions and the total spending volume. I believe there are no entities capable of tracking these numbers as accurate as V and MA. The reasons? these numbers are their business and they simply occur on the information systems owned by the big two. On the other hand, Visa and MasterCard dominate the electronic payment market, which has been widely adopted across all industries. Listening to their conference call, you will hear them talk about virtually everything, the gas, the grocery stores, the fall of CircuitCity, the restaurants, the overseas travel, etc, somewhat their business represents the overall economic picture.
Then what does this mean for the investors in both companies? In my first article on my blog (read it here), I mentioned in the bear market, we pick companies capable of holding up well during the economic downturn, and benefiting the most from the economic upturn. At that time, I listed both MA and V as my favorites. Economic recovery means more consumer spending transactions and higher spending volume, which translate directly into the improved financial results from both companies. When observers read these numbers and conclude the economy is back to life, both companies have already harvested the fruits. From this perspective, we say both companies proceed the economic upturn, and not in a speculative manner, but in a concrete and logical manner. So if you believe the American economy will come back, these two stocks will be the ones definitely flying earlier and very probably, higher.
2) Visa's Advantage Over MasterCard
In my previous discussion about MA (here), we mentioned that the Visa's dominant market position gives it the competitive edge over MA. Since MA can't produce anything with real or perceived difference from Visa's products, the competition pattern somewhat mimics that between Intel and AMD. Now based on the recent reports, it seems the Visa's dominance in the debit market gives it another layer of advantage over MA.
When we look back, the logic seems to be really simple. We are experiencing the credit crisis. Consumers cut back in credit card usage, and resort more to debit cards. This simply is a big positive for Visa. Visa saw the growth in debit card revenue offset the negative results from credit cards, but MA doesn't have such a luxury. In addition,talking about the future growth in the international market, especially in the developing countries, we all know that the credit system is a lot more complex and sophisticated than the debit system. It requires a series of setups, establishments, regulations, etc, which normally take long time to mature. But the debit card system, basically only requires the card holders have cash in their bank accounts. Therefore, the debit card's growth usually proceed the credit card. On one hand, compared to MA, Visa's dominance in the debit card market will position it better to take advantage of these growth opportunities. On the other hand, not everything is so negative for MA. Visa's advantage is mostly in the developed countries, while in the emerging markets, the opportunities presented to both are equal.
One noteworthy interesting point. In MA's 2008 10K, they quoted the recent bank consolidations as one potential risk, but in Visa's earning conference, they confirm that they expect to be the beneficiary of such consolidations. This certainly reflects Visa's dominant position, but also servers as a sign of Visa's long-term, established, strong relationships with big banks, which is intangible, but might very well be another advantage over MA.
3) International Growth
Both companies posted strong growth in the international market. Their strong performance outside the US helped offset the weak US market, guaranteeing their stock will recover at a faster pace than the US economy. Actually the global diversification is another rule I proposed to apply to pick stocks during the recession.
4) Energy Play
Both companies noted the dropping gas price negatively affected their results.
Actually MA and Visa are all good candidates for energy play.
Many believe the future era will be featured by high energy price, in that case, both companies will be benefited from this trend. After more than 100 years, the human world has been built to be relying on energy. There is no short term solutions to change this fact. High gas price may reduce several trips to Florida, but the enormous basic need will still be there, and grow, when you count in the developing countries from Asia. Both companies benefited from the short time energy bubble we witnessed in 2007 and early 2008, and I won't be surprised to see the similar situation reappear in the near future.
5) The Unabated Trends: Go Plastic and More Transactions
I continue to hold and increased my holdings in MA and Visa during the economic downturn. The underlying theory is based on two beliefs. First, the worldwide worldwide secular shift from cash and checks to electronic forms of payment will be inevitable and fast. And second, when people scale back their spending, it may, on the other hand, boost the total number of transactions. The report from both companies confirmed such views.
6) Final Conclusions
- Both companies delivered very solid performance, and Visa is even more impressive.
- I won't say MA is cheaper than Visa. I am holding onto my old opinion, Visa deserves a higher multiplier owing to its advantage over MA.
- Both stocks are not cheap. But I think the overall market may continue to push them higher.
1) Economic Indicator
For a long time, consumer spending has been the driving force of American economy. Albeit the arguments that now finally comes the end of such an era, it is fair to say the consumer spending remains as the most accurate indicator of the economy. Many researchers publish reports, articles, statistics, etc. to track the economic activities, looking for all sorts of signs of the economic trend. But as a matter of facts, no indicators are more accurate than the financial results from Visa and MasterCard. Actually in my opinion, both companies themselves are the indicators.
There are two aspects of the consumer spending, the number of transactions and the total spending volume. I believe there are no entities capable of tracking these numbers as accurate as V and MA. The reasons? these numbers are their business and they simply occur on the information systems owned by the big two. On the other hand, Visa and MasterCard dominate the electronic payment market, which has been widely adopted across all industries. Listening to their conference call, you will hear them talk about virtually everything, the gas, the grocery stores, the fall of CircuitCity, the restaurants, the overseas travel, etc, somewhat their business represents the overall economic picture.
Then what does this mean for the investors in both companies? In my first article on my blog (read it here), I mentioned in the bear market, we pick companies capable of holding up well during the economic downturn, and benefiting the most from the economic upturn. At that time, I listed both MA and V as my favorites. Economic recovery means more consumer spending transactions and higher spending volume, which translate directly into the improved financial results from both companies. When observers read these numbers and conclude the economy is back to life, both companies have already harvested the fruits. From this perspective, we say both companies proceed the economic upturn, and not in a speculative manner, but in a concrete and logical manner. So if you believe the American economy will come back, these two stocks will be the ones definitely flying earlier and very probably, higher.
2) Visa's Advantage Over MasterCard
In my previous discussion about MA (here), we mentioned that the Visa's dominant market position gives it the competitive edge over MA. Since MA can't produce anything with real or perceived difference from Visa's products, the competition pattern somewhat mimics that between Intel and AMD. Now based on the recent reports, it seems the Visa's dominance in the debit market gives it another layer of advantage over MA.
When we look back, the logic seems to be really simple. We are experiencing the credit crisis. Consumers cut back in credit card usage, and resort more to debit cards. This simply is a big positive for Visa. Visa saw the growth in debit card revenue offset the negative results from credit cards, but MA doesn't have such a luxury. In addition,talking about the future growth in the international market, especially in the developing countries, we all know that the credit system is a lot more complex and sophisticated than the debit system. It requires a series of setups, establishments, regulations, etc, which normally take long time to mature. But the debit card system, basically only requires the card holders have cash in their bank accounts. Therefore, the debit card's growth usually proceed the credit card. On one hand, compared to MA, Visa's dominance in the debit card market will position it better to take advantage of these growth opportunities. On the other hand, not everything is so negative for MA. Visa's advantage is mostly in the developed countries, while in the emerging markets, the opportunities presented to both are equal.
One noteworthy interesting point. In MA's 2008 10K, they quoted the recent bank consolidations as one potential risk, but in Visa's earning conference, they confirm that they expect to be the beneficiary of such consolidations. This certainly reflects Visa's dominant position, but also servers as a sign of Visa's long-term, established, strong relationships with big banks, which is intangible, but might very well be another advantage over MA.
3) International Growth
Both companies posted strong growth in the international market. Their strong performance outside the US helped offset the weak US market, guaranteeing their stock will recover at a faster pace than the US economy. Actually the global diversification is another rule I proposed to apply to pick stocks during the recession.
4) Energy Play
Both companies noted the dropping gas price negatively affected their results.
Actually MA and Visa are all good candidates for energy play.
Many believe the future era will be featured by high energy price, in that case, both companies will be benefited from this trend. After more than 100 years, the human world has been built to be relying on energy. There is no short term solutions to change this fact. High gas price may reduce several trips to Florida, but the enormous basic need will still be there, and grow, when you count in the developing countries from Asia. Both companies benefited from the short time energy bubble we witnessed in 2007 and early 2008, and I won't be surprised to see the similar situation reappear in the near future.
5) The Unabated Trends: Go Plastic and More Transactions
I continue to hold and increased my holdings in MA and Visa during the economic downturn. The underlying theory is based on two beliefs. First, the worldwide worldwide secular shift from cash and checks to electronic forms of payment will be inevitable and fast. And second, when people scale back their spending, it may, on the other hand, boost the total number of transactions. The report from both companies confirmed such views.
6) Final Conclusions
- Both companies delivered very solid performance, and Visa is even more impressive.
- I won't say MA is cheaper than Visa. I am holding onto my old opinion, Visa deserves a higher multiplier owing to its advantage over MA.
- Both stocks are not cheap. But I think the overall market may continue to push them higher.
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