Saturday, July 07, 2007

Heads Up versus Chou

In 2006, Francis Chou gave a presentation in which he outlined his investment in BMTC Group, a large Canadian retailer of furniture, mattresses, and appliances. He discusses his rationale for betting big on the company in 2002. The company was generating extraordinary returns on capital, and it was trading at a very cheap valuation: 8.9 times earnings, and 5.5 times EV/EBITDA. Since that time, the company has appreciated from $9 to $23 per share, allowing us to now say that it was clearly an excellent investment.

I'm mentioning this because one of my company's, The Brick Group, is in direct competition with BMTC in the Canadian retail space. Both companies earn high returns on capital and distribute a bulk of their earnings back to shareholders. But my purchase was made at 8.1x EV/EBITDA compared to the 5.5x purchase made by Chou. Some of this difference is justified- since Brick is an income trust, it does not have to pay taxes for 4 more years, allowing it to keep more of its EBITDA. But, earnings in 2002 were a lot more stable than today. The massive liquidity of the last five years has inflated corporate earnings and made it difficult to figure out what true earnings power is for most companies. So, kudos to Francis Chou for taking advantage of the great opportunity presented to him at the time.

Key terms:
Ebitda- Earnings before interest, taxes, depreciation and amortization
EV- Enterprise value, which is market capitalization plus net debt.

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