DETTA INLÄGG ÄR ETT UTDRAG UR KVARTALSBREVET JAG SKICKADE TILL PANDIUMS ANDELSÄGARE 31 JULI 2015.
Since the start of the Fund I have looked at a couple of hundred companies, most of which have been either too bad or too expensive. If a company is good but too expensive I put it on a watchlist and wait for the price to go down. That paid off during the second quarter when the market became more volatile and we were able to make a couple of investments. Thank you Mr Tsipras!
Precision Castparts Corp
One of the investments is a high quality business with a great management that we bought at a discount. US-based Precision Castparts (PCP) is a diversified manufacturer of metal components and products. The company is one of only a few that can manufacture certain highly complex components (used in aircraft jet engines and power turbines) that maintain their functionality under extreme temperatures and conditions.
The main reason PCP is such a good business is that once a customer has decided to use PCP’s products they are very unlikely to switch to another producer given the high costs of doing so. So, once PCP has become part of a new airplane model they have a long runway of revenue ahead of them. For example, PCP has had a relationship with their largest customers GE since 1967.
Recently PCP has increased their revenue per aircraft, in some cases with up to 2-3 times. That combined with the fact that Airbus and Boeing together have an order book of ca. 12,000 aircrafts, representing ca. 9 years’ production makes me quite certain that PCP has good prospects going forward.
PCP is run by the great Mark Donegan. He is obsessed with improving efficiency, lowering costs and serving customers, which is reflected by the results. Since he took over as CEO in 2002 operating margin has grown from 14% to 28% while sales have grown from USD 2.5 billion to USD 10 billion. Not only is Mark great in generating cash, he is also very good at spending that cash wisely. (Cash flow that is wasted on stupid investments is not worth much.) For the period 2003-2014 Mark has increased the value per share three times for every dollar he has retained, which is impressive.
PCP is a great company being priced as an average one. At a price-to-cashflow multiple of around 16 it might not look cheap, but it is. First of all, PCP deserves a higher multiple than the market since it is a higher quality business. Second, we have very good visibility into the future revenues and they will continue to grow. Third, I think margins will improve going forward. Fourth, PCP will buy back around USD 2 billion worth of shares during the next 18 months. Combined, those factors make me believe that PCP can grow earnings per share in the mid teens for the next couple of years. As an extra bonus, smart acquisitions might additional value, although I have not included in my case.
 The process of being incorporated into an airplane or jet engine is long, requires deep technical expertise and is surrounded by red tape in the form of regulatory requirements. The main concern of the manufacturer is to ensure that the machine works and they will not replace an established supplier unless they absolutely have no choice.
 For every dollar of profit a company make the management has the choice to either return it to the shareholders (in the form of dividend) or to re-invest it into the business. The choice should depend on what opportunities the management has to re-invest it profitably. If expected returns are not high enough the profit should be returned to the shareholders. Many CEOs do not follow this simple rule which leads to that a dollar of profit becomes worth less than a dollar a couple of years later.
 Just improving the performance of some recent acquisitions would be enough.