In this post, I want to take a look at Alico, a small orange grove that has an interesting approach to capital allocation. Alico currently has about a $205M market capitalization. The company owns orange groves, and also ranch land in central Florida. In order to get a high level overview of Alico’s capital allocation, I am going to focus on their cash flow statement to see where the cash is coming and going.
Cash Flow Summary
Starting at the top of Alico’s cash flow statement is their cash from operations. This figure varies quite wildly. The cash flows from 2018 and 2021 are probably normal, with 2019 seemingly abnormally high, and 2020 and 2022 below average. Looking deeper, it appears Alico had a large increase in revenue from 2018 to 2019, which explains the high operating cash flow in the data shown (and 2019 revenue was similar to 2017 FWIW). The reason for the lower cash flow in 2022 was due to frost and a hurricane damaging Alico’s orange crop. Ideally the cash from operations would be a bit more smooth.
Alico’s cash spent on investments also varies quite a bit. As we will see later, ALCO has been selling off some of their land which causes the big swings in cash from investing.
Cash outflows for financing were slightly more steady than the previous cash flow categories. Alico spent the most in financing in 2019 at $52.29M. The two years of 2018 and 2020 had about the spend on financing, while 2021 and 2022 were close in figures.
With the big swings in Alico’s cash flows, it shouldn’t be a surprise that their net change in cash also varied over the past several years. Last year, ALCO practically broke even. The company had the largest boost in cash in 2018 with $28.86M, and drew down their cash balance the most in 2021 at $18.8M.
Cash from Investing
After seeing Alico’s use of cash at a high level, we can now dive deeper to see why their cash flows vary so much and get a glimpse of how they are allocating capital. Alico’s capital allocation spend has been slowly growing over the past years, except it declined a bit in 2022. If we take an average of ALCOs 5 year cash from operations, about $18M, and compare it to their average capex, we see that most of the operating cash flow is going into capex. This high proportion of capex to operating cash flows would seem to indicate the company is capital intensive.
Alico’s acquisition of business, or in this case acquisition of orange groves, was fairly small the last several years. However, the company did do a large acquisition in 2021 amounting to about a full year’s worth of operating cash flow.
Despite Alico making some purchases of orange groves, they have been quite the seller of property. About ⅔ of ALCOs land is the orange groves, but they do own quite a bit of ranch land. It seems the ranch land is primarily what the company is selling. Alico’s selling of the land is an interesting capital allocation decision, which is what caught my eye with the company. While 2019 was a lull, the company has been selling around $35M a year of property. This is about twice as much as their average operating cash flow.
As we can see, the swings in Alico’s cash from financing is mostly due to their sale of varying amounts of land and the large acquisition in 2021. Next we can look to the cash for financing to see how Alico is using the proceeds of these property sales.
Cash from Financing
Now to look at Alico’s use of cash for financing. Alico has been consistently paying down debt over the past 5 years, peaking in 2021 with about $25M. I believe the land that Alico is selling is encumbered with debt, so they are using the proceeds to pay off the principal.
Currently Alico’s D/E ratio is about 0.42, which suggests the company is not very leveraged. Looking at ACLOs D/EBITDA, the figure is about 3.2, which is slightly high. However the company’s 2022 EBITDA was affected by the frost and hurricane.
As for share buybacks, Alico has not done much except for 2019. The buyback in 2019 is more than the company’s 5 year average operating cash flow. It would be interesting to look at Alico’s valuation during 2019 to see if this large repurchase was actually beneficial to shareholders.
Alico has been consistently paying a dividend, dramatically ramping up the payout in 2021 and 2022. These increased payouts are probably due to the land sales. I think selling land and returning some of the proceeds is an interesting capital allocation strategy. If Alico can maintain selling land and paying large dividends, then the stock could be worth some consideration.
In 2019, the company had an $11M charge for “payment on termination of sugarcane agreement”. I am not sure what that is, but it seems like a one time charge.
Conclusion
Alico is a small company with pretty inconsistent operating results. However, their strategy of selling off ranch land and returning some of the cash to shareholders is an interesting capital allocation move. It is also interesting that Alico made a decently large acquisition of orange groves in 2021. Going beyond this snapshot, I would look further back in Alico’s financials to get a better understanding of their operating cash flows. Also I would try to estimate a sustainable dividend payout in case the company had to put a pause on selling land.
For Q4 2022, the multi-asset portfolio was up 8.3%, yet down 10.8% over the full year. The Q4 starting balance was $160,358.87, and finished the quarter at $181,597.13. Contributions to the portfolio during the quarter amounted to 7,083.
As for the portfolio of individual stocks, the Q4 starting balance was $77,297.12, with an ending balance of $86,299.07. Over the quarter, there were no additions of cash into this portfolio. Performance for the stock-only portfolio was up 11.7% for Q4, and down 4.5% for the year.
Two stocks were purchased this quarter: Advanced Emission Solutions (ADES), and EMCORE (EMKR). The Sprott Physical Gold Trust (PHYS) was also added to the precious metals section of the portfolio. Several deep value stocks were sold this quarter: MI Homes (MHO), Boise Cascade (BCC), Seneca Foods (SENEA), Gray Television (GTN), and Koppers Holdings (KOP). The rolling over of tail hedge put options continued.
The current allocation of the portfolio is shown in the chart below. Currently, the portfolio consists of discretionary value stocks, oil tankers, deep value, 401k stocks, precious metals, and cash. It can be seen that 80.9% of the portfolio is in stocks, while 19.1% is in cash and safe haven assets.
Year in Review
This year has been the most difficult year to invest in since I started buying individual stocks in 2017. The year was not so bad because of the portfolio returns, I expect some down years worse than my performance this year. Instead, the year was frustrating because inflation was elevated, so I felt like I urgently needed to put cash to work, yet I was not finding many bargain priced stocks. Sure, the major stock indices and bonds were down quite a bit this year, and speculative junk crashed, but many quality stocks were unphased. This contrasts to March 2020, where the panic was creating a once in a blue moon buying opportunity.
Another point of frustration was the slow downward grind of the market. The SPY put options I buy as my tail hedging strategy do well during market panic, which by proxy is associated with a high level in the VIX volatility index. Since there was little panic in 2021, the VIX did not reach high levels. While the tail hedging paid off mightily in 2020, it was a drag on performance throughout 2022. Despite money burned through tail hedging, I still find the strategy appealing to provide some anit-fragility to the portfolio.
Returning to the topic of bargain priced stocks, even though I did not feel like there were many undervalued stocks worth purchasing, there were many stocks that appeared cheap. During the year, there were plenty of stocks trading at earnings multiples below 10, even several large companies trading below 5x earnings. The problem is that I am not too confident these stocks are actually cheap. The vast majority of the low earnings multiple stocks were cyclical/commodity based companies in industries such as mining, steel, fertilizer, basic chemicals, poultry, homebuilding, paper products, etc. These commodity stocks have had huge run up in earnings due to inflation and supply/demand being out of whack due to COVID. Looking at years prior to COVID, these companies had much lower earnings, and often had unprofitable years. To add a cherry on top, many of the commodity companies were trading at all time high stock prices during 2022.
It is possible that we are in a period of sustained inflation and a long term commodity bull market. However, I feel like this is more of a macroeconomic call than a story of undervalued businesses. Inflation could persist for years, or we have a recession this year that would crush all these cyclical commodity stocks. I have no idea, so I do not want to load up my portfolio with these types of companies (that being said, I do own a chemical company and some other cyclical companies, so I’m not completely missing the party).
To me, value investing is about finding companies where the stock price is beat up due factors such as the industry being out of favor, the business missed short term expectations but has solid future earning prospects, or perhaps some kind of scandal that will not dramatically affect the business. At a high level, valuing businesses usually takes the form of estimating the value of the assets, or a reasonable future earnings power. I think it is more prudent to look at a normalized 5 year earnings figure when determining value, than to give weight to current earnings that are several times higher than average. We shall see if my prudence works out or if I will regret not loading up on cyclical commodity businesses during 2023.
Discretionary Summary
Discretionary value is the label I’m giving to the positions that are fairly large (~5% of the portfolio) I believe are undervalued and may have the following characteristics: quality business, competitive advantage, misunderstood by the market, or a good company in a heavily sold off industry. The current discretionary value stocks I own consist of Capital One Financial (COF), Emerson Electric (EMR), Simon Property Group (SPG), British American Tobacco (BTI), Qurate Retail (QRTEA), and Warner Bros Discovery (WBD). The table below shows the cost basis, current value, and gains/losses for these positions.
Avg Price
Cost Basis
Current Value
Current Gain (Loss)
COF
63.25
3,478.75
5,112.80
46.97%
EMR
41.00
3,485.00
8,165.10
134.29%
SPG
74.50
3,427.00
5,404.08
57.69%
BTI
37.45
7,114.91
7,596.20
6.76%
QRTEA
7.60
5,700.00
1,222.00
-78.56%
WBD
24.50
4,957.00
2,085.60
-57.93%
Most of my discretionary value picks have been humming along this year without any major news. Emerson Electric did recently announce that they were selling a majority stake of their HVAC business to Blackstone. The deal values the HVAC unit at $14B and Emerson will initially receive $9.5B for their stake. The Emerson management stated they want to focus on the higher growth automation side of their business. Between this deal, and the recent AspenTech deal, Emerson is making some big capital allocation moves. I will have to spend some time reviewing my position in Emerson with these big changes happening at the company.
Qurate Retail has been my worst investing mistake so far, with the share price constantly grinding lower not long after I made my purchase. What drew me to the business was the qualitative aspect. Qurate is the holding company for QVC and HSN shopping channels, which are popular with older women. These channels provide entertainment in a way that e-commerce does not provide, with a demographic that may be more resilient to switching to online shopping. Additionally I was lured in by the siren call of Qurate’s large special dividend.
Not long after I bought Qurate, a fire destroyed one of their distribution centers. Supply chain issues also affected the company late 2021 and through 2022. For example, Qurate was unable to have the right product mix during the 2021 holiday season, lacking consumer electronics which typically drives sales during that season. Supply chain issues and management missteps seemed to have mucked up QVC’s “daily special value” segment that draws in customers.
Despite the issues within Qurate’s control, and beyond their control, I still held onto a stock that declined 80%. I should have focused more on the company’s financials and performed a more rigorous valuation of the company before my purchase. A big reason why QRTEA stock declined so much is the high debt load. A small decline in sales can crush a heavily indebted business. I typically shy away from companies with high debt unless they have a history of steady cash flow. So with Qurate, I learned a lesson that I already knew.
Warner Bros Discovery is also a sore spot in my portfolio. Originally I owned Discovery ahead of their merger with Warner Bros, which was spun out from AT&T. I believed Discovery was undervalued due to the uncertainty of the merger, and I thought the merger would provide an opportunity as a special situation. Discovery produces cheap, but popular content should pair well with the quality content from HBO and other parts of the Warner Bros library. Once the merger gets sorted out, I think WBD can be a top tier streaming service.
The problem is that the restructuring costs from the merger are high, content is expensive, and the merger occurred right during a slump in advertising revenue. WBD also has a lot of debt from the merger, but luckily it is at low interest rates and pretty distant maturities. While it is frustrating that the stock has not performed well so far, I think if they can reduce costs and put up a mediocre level of EBITDA in 2023, then the stock will be on solid ground to revert back to a market multiple.
Deep Value
Deep value is a sub-strategy I’m employing in my portfolio. This is a quantitative strategy that buys a basket of statistically cheap stocks. The metric I use is EV/EBIT, based on the wonderful book The Acquirers Multiple. Historically, this strategy has provided excellent returns, although it has not kept up with the S&P 500 the past few years. Additionally, I am making an effort to apply this strategy to microcap companies. Microcaps are classified as having a market capitalization between $50M-300M. These small companies are more volatile, but have the potential for attractive returns.
My position sizing is smaller than the discretionary side of my portfolio because I want to own a basket of about 20 stocks. Since this is a quantitative strategy, I do not spend much time analyzing these businesses. The main idea is that these companies are trading at very cheap valuations, and the winners will (hopefully) outnumber the losers.
The new additions to this part of the portfolio were EMCORE (EMKR), and Advanced Emission Systems (ADES).
Avg Price
Cost Basis
Current Value
Current Gain/Loss
EMKR
1.00
2,003.95
1,925.00
-3.94%
WSM
115.00
5,175.00
5,171.40
-0.07%
OMC
65.86
4,610.37
5,709.90
23.85%
BASFY
11.54
4,269.80
4,555.44
6.69%
SMTC
30.00
3,000.00
2,869.00
-4.37%
USNA
58.00
2,900.00
2,660.00
-8.28%
CHTR
360.00
3,600.00
3,391.00
-5.81%
FOSL
3.50
2,975.00
3,663.50
23.14%
ADES
2.75
3,025.00
2,673.00
-11.64%
INTC
30.00
3,000.00
2,643.00
-11.90%
SIX
20.00
3,000.00
3,487.50
16.25%
HXL
36.80
1,803.20
2,883.65
59.92%
Several companies were sold this quarter due to the one year rebalancing of the portfolio. Several of these stocks were sold for a loss, so hopefully the next batch of deep value stocks perform better.
Cost Basis
Sale Proceeds
Realized Gain/Loss
KOP
2,958.18
2,042.56
-31.0%
GTN
3,105.00
2,020.88
-34.9%
SENEA
3,000.00
3,048.52
1.6%
BCC
3,025.00
3,494.65
15.5%
MHO
2,520.00
1,720.32
-31.7%
Tanker Stocks
Oil tanker stocks performed pretty well this year. I will continue to hold them, but if they start to go against me again they will be sold off.
Avg Price
Cost Basis
Current Value
Current Gain/Loss
DHT
8.17
1,755.90
1,909.20
8.73%
TNK
23.86
1,765.88
2,279.94
29.11%
Dividends
During the quarter I received $378.35 total in dividends, which is broken down in the table below.
Ticker
Quarterly Dividend
BTI
120.75
DHT
8.60
EMR
44.20
COF
33.00
SPG
82.80
WSM
35.10
HXL
4.90
OMC
49.00
Total
378.35
401k and Precious Metals
My 401k is through my current employer and actively receives contributions. The 401k consists of a Blackrock Target Date Fund (which is no longer being funded), and the Oakmark Fund. The Oakmark Fund is a large cap value fund. Since I am actively contributing to my 401k, it will naturally have a growing influence on my portfolio.
I also have a decent allocation to precious metals that are used as a bond substitute, recession and inflation hedge. The table below shows the YTD performance for the precious metals and 401k, which includes the effects of contributions.
12/31/21
12/31/22
YTD Gain/Loss
YTD Cont.
Precious Metals
12,854.19
15,091.98
-0.1%
2,100.00
401k
60,578.76
70,943.77
-15.3%
20,466.14
Tail Hedging
This quarter I continued a tail hedging strategy that I have used in the past. The strategy involves buying 30% out of the money SPY put options that expire in a couple of months. Each month options are sold and a new set is bought. This quarter, the options have had a cost of $2,491 and proceeds of $1,116, resulting in a net cost of $1,375. For the full year, the hedging strategy cost $8,261 with proceeds of $3,159, resulting in a net cost of $5,102.
KLA Corp. (KLAC) is an American company that manufactures process control and yield management equipment for the semiconductor industry. It appears the large semiconductor equipment companies have high profit margins, great returns on capital, and barriers to entry. Currently, there seems to be a cyclical downturn in semiconductors in general, so many of the stocks are down quite a bit from their recent highs. Given this background, I want to do a rough valuation on KLA to see whether it is fairly valued or undervalued.
Since I believe KLA has a moat, I will use the growth return valuation method from Bruce Greenwald’s valuation book. With this valuation method, first a sustainable shareholder yield is estimated, then estimated growth rates are added to get expected return from buying the stock.
The first step is to figure out a reasonable steady state revenue. In 2022, KLAC did a record $9,212M in revenue. Since the semiconductor capital equipment industry can be cyclical, I will smooth out KLACs revenue by using a 5 year average. The 5 year average comes out to be $6,108M, which I’ll use for the preceding analysis.
After revenue comes operating margins. KLA has averaged 35% operating margins over the past 5 years. Using these margins, KLA should be able to produce $2,138M in operating earnings based on my estimated go-forward $6,108M revenue figure.
The next step is to get an after tax earnings figure. KLA typically pays an effective tax rate of around 17%. This tax rate applied to the $2,138M in operating earnings produces an after tax earnings of $1,774M.
Now that we have the estimated after tax earnings, we almost have a sustainable shareholder yield. KLAC has 152M shares outstanding, which produces an estimated EPS of $11.67. Looking at past shareholder returns, KLA tends to return most cash back to shareholders. I will estimate that KLAC can sustainably return 70% of their cash flow as dividends and stock buybacks. Applying the 70% to the $11.67 in EPS, we arrive at a distributable earnings of $8.17. With a current share price around $375, KLAC estimated shareholder yield is about 2.2%.
Once we have the estimated shareholder yield, Greenwald adds the estimated returns due to revenue/earnings growth to get the total expected yield of the stock. Revenue growth comes in two forms: organic and through reinvestment.
Thinking about the organic growth rate of the semiconductor equipment industry over the next 10 years, there are many tailwinds with increased semiconductor demand in automotive, cloud compute, Internet of Things, etc. Despite these tailwinds, the semiconductor industry is cyclical, so I want to be a bit conservative with a long term growth estimate. If GDP is usually around 3%, a long term revenue growth rate of 5-7% could be reasonable for the semiconductor equipment industry.
Reinvestment growth occurs when a company reinvests its leftover cash in things such as expanding production, performing research for new product lines, or performing major acquisitions. However if a company is returning a large portion of its cash back to shareholders, then the business is most likely in a mature state. Since KLAC is returning most of its profits back to shareholders, my view is that they are not reinvesting in their business at a large scale. Therefore I will only utilize the organic growth figure when estimating the return in KLAs stock.
Finally we have all the pieces to estimate the long-term returns of KLAC at its current stock price. The estimated shareholder return gives us 2.2%, then we add the growth return of 5-7% producing a total return of 7.2-9.2%. Given these ranges, KLAC seems fairly valued. However, if we re-compute the returns using their current 52 week low of $250 a share, the shareholder yield would be 3.3%, bumping the total return to 8.3-10.3%.
After doing this analysis, I think a decent return could be achieved from buying KLA at the current prices, however as a value investor I would prefer to see it get a bit cheaper. If the stock sells off back around $250 I may consider it. Another point is that my organic growth estimates are quite hand-wavy, so it could be possible that higher returns are realized if revenue growth surpasses my expectations.
