market folly

Continuing coverage, we're posting up notes from the Value Investing Congress.  Below are notes and the presentation of David Einhorn of Greenlight Capital.  His talk was entitled 'Kicking the Tires' where he covered a range of topics, but mainly pitched General Motors (GM) and Cigna (CI) as longs and Chipotle (CMG) as a short.

"Do your homework and kick the tires." It's not the answers that make you good in this business, it's the questions you ask. Talked about how Green Mountain Coffee Roasters (GMCR) was down 6% as he spoke during his presentation last year, but the point is it dropped right away, before people listened to the slides.  So he says you must do your own work.

Einhorn also mentions Herbalife (HLF), talks about him asking questions on the conference call. Because he said people were worried about the quarter.  Says he was quite surprised by the reaction.  Caris actually downgraded the stock based on the probability he was short. 

He mocks investors for not doing the work, but just trying to blindly follow him.    DO YOUR OWN WORK!  This is something we try to emphasize on MarketFolly.  Tracking hedge funds is a great way to find ideas, but only use it as a starting point.  Due diligence is key.


Einhorn's 4 Ideas This Year

1.  Long General Motors (GM): Remains an "ugly duckling" due to long investor memories, government ownership overhang and weak Europe division.

Bull case: Fixed cost structure improved. Pension risks overblown, unfunded liability may have narrowed by several billion, rising interest rates would help, too.  No required pension contributions until at least 2019.  Balance sheet cleaned up, brand quality improving across the board, improving pricing. $23.09, $42B, cash is 3/4 of the market cap.  $70B in tax shields; no taxes in US for a decade. EV is actually only $6B when you take these things out. $6.6B in EBIT this year, P/E depressed due to cash hoard earning nothing.  Consensus is too low, SAAR may be higher than street.

GM is #1 in China and growing faster than industry.  Europe is a problem and should restructure to at least break even by 2015. Government stake is an opportunity, not an overhang. US demand is 16M units:  Scrap is 13.2M units/year in a normal year. Ave age is now 11 years, up from 9 a decade ago.  5.5% scrap rate implies 19 year average life. Population growth alone is 2M units of annual demand. Recessions cause less vehicles per driver, but it rebounds as economy does.  This is 500k units/year. His SAAR is 16M units, not peak, but midcycle. Implies 315k incremental units for GM, $1.00 per share eps. 60% of units new in 2013/14 vs. 23% in the last 2 years. 2013 Cadillac ATS- "Esquire Car of the Year"

Does not believe European losses will persist indefinitely. $42B market cap, $32B cash, and $6B revolver.  So $38B total liquidity.  What should it do with its cash?  Government has 50M shares.  Repurchase of these is accretive, even at $30 per share, costs $15B.  $53 is break-even, so no sale will occur before election.  If Obama is re-elected, he may be willing to sell at a loss. Otherwise, they could still do a large open market buyback instead. 2014 "taxed" earnings could be $6 in 2014, $8 cash earnings.  This is midcycle, not peak result, so deserves a better multiple.


2.  Long Cigna (CI):  Lots of work. Have to understand HMOs, then Obamacare, then how it influences CI.  Then you have to understand their non-HMO businesses. Investors don't like HMOs now.  Earnings are hard to predict from Q to Q.  Obamacare scares investors.

Scary things: Humana (HUM), Wellpoint (WLP), Healthnet (HNET) all missed this year.  Obamacare: capped profits, risk of financial penalties 

Bull case: Secular growth, high barriers to entry, big players have scale already.  Still, ROE has been strong over time. CI is the best performer in the group.

Things that won't affect HMOs: Greek debt, Europe, China slowing, etc. They reprice annually so they always make money.  Obamacare is just "a homework problem" that can be analyzed. Also has Group Disability/Life and International business. 82% is non-risk bearing ASO business.  PBM is a potential high multiple sale GDL segment is consistent source of earnings despite weak employment trends. International is for multinational corporations' employees living overseas.

Trades at 7.7x 2013E, at a discount to sector which is cheap already.  You can see further comments from Einhorn on Cigna in Greenlight's Q2 letter.


3.  Short Chipotle (CMG):  Trades at 35x, nosebleed valuation. Average sector multiple is 22x. Compares to PF Chang, Boston Market.

Restaurant business:  low barriers to entry, Obamacare brings additional costs since they don't currently provide health care for employees, summer drought affects costs in coming periods.

The biggest near-term challenge: A resurgent Taco Bell (part of Yum Brands ~ YUM).  Most analysts think Taco Bell is low-end quick service restaurant, and CMG competes with higher end Panera.

He did a survey of CMG customers, and they actually visit Taco Bell almost as much.  Taco Bell SSS up 12% last year, while CMG missed. Taco Bell has more locations and cheaper menus. Taco Bell has decided to compete directly with CMG with their "Cantina Bell" menu which is almost exactly the same, but with 35% lower prices. 2/3 of CMG customers that tried Cantina Bell thought it was good; almost 1/2 liked it as much or more. Makes sense, Taco Bell has more money, locations, and can just add the Cantina Bell menu items to blunt CMG competition. Lots of insider selling as well.


4.  Short Green Mountain Coffee Roasters (GMCR):  He believes there is still accounting fraud. CEO said they had an investigation, but only took 23 days. Cites the SBUX "Verismo" system. Agreement for K-cups with SBUX is vague- how long?  CAPEX/sales is very high, 9-11-13% of sales, vs. industry average of 3.3% He also says a price war is coming, and GMCR generated no FCF during it's years as a monopolist.  Thinks the stock has further downside.  You can view Einhorn's presentation on GMCR from last year if you haven't seen it.


Question & Answer Session:

Does he like Yum Brands (YUM)?  Likes Taco Bell, but KFC in China may hurt too much. Not long.

Future price for CMG?  He says "we don't have to worry about that, we just think risk-reward favors the downside." GM, is government stake affecting sales?  He says they will sell sooner rather than later, and they are a passive role.  Chevy Volt obviously not going well and it's a tiny part of GM's business.

Anything on Moody's (MCO)?  Still thinks it’s a short, lawsuits are very persistent.

What about Apple (AAPL)?  His opinion unchanged

He's short steel, which he says is a hedge in a way, and lower steel prices are good for autos.

On Cigna (CI)?  "Less than 1% of the business is individuals"

Comments on St. Joe (JOE)?  Says they finally had a conference call, sales are zero, says you should listen to it.  Management, other than CFO, were too busy to take questions.


Embedded below is Einhorn's slideshow presentation from the Value Investing Congress: 

(.PDF coming soon)

Check out the rest of the hedge fund presentations from the Value Investing Congress.