[Valuation Analysis] Honeywell's new spin-off may present a great buying opportunity

Since I read the book, You Can Be a Stock Market Genius, written by Joel Greenblatt, which suggests that spin-offs often present great investment opportunities (you can read the reasons here), I have been kept eye on new spin-offs to try the strategy in real life. After about a year of search, I finally came across an attractive opportunity: Honeywell (HON: NYSE)’s spin-off of its Transportation Systems (Garrett Motions Inc., will be listed as GTX: NYSE).

o   Company Overview

Garrett Motions Inc. (“Garrett”) is a company that is about to spin-off from Honeywell (HON: NYSE) on October 1, 2018. Garrett develops, manufactures and sells turbochargers, electronic boostings and automotive software. The company’s business exposures are mainly as follows:

o   The Spin-Off

In October 2017, Honeywell announced that it would spin-off its transportation systems business (Garrett) as the result of portfolio review. After almost a year, in September 2018, Honeywell announced that it would distribute the shares of Garrett to existing Honeywell’s shareholders on October 1, 2018. Honeywell’s shareholders will receive 1 Garrett share for every 10 Honeywell shares. The shares will be traded on NYSE with the ticker GTX.  

o   Competition

Garrett has over 1,400 patents issued and pending today, providing the competitive edge and leadership in the industry.

o   Valuation Analysis

Based on the information provided by Honeywell and my own assumptions, I decided to come with a valuation before the Garrett shares are listed on October 1, 2018.

 Projections on Garrett’s P/L, B/S and other items, created by the author.

Projections on Garrett’s P/L, B/S and other items, created by the author.

 Main assumptions used for the projections.

Main assumptions used for the projections.

For reference. (Excerpt from: Garrett Investor Conference, Sep 6, 2018.)

Although the Garrett will be loaded with substantial amount of debt (long-term debt: $1.6 billion) and other liabilities (asbestos related: $1.6 billion, the projected payment is already incorporated in the “other expenses” in the P/L sheet), I believe the company will generate enough cash flow to compensate it.

The beauty of spin-off is that it gives management more accountability. The CEO of the company will be awarded $4.3Mil worth of Garrett’s restricted stocks, half of which can be vested in 3 years and the rest in 4 years. Such substantial amount of stock compensation should align CEO’s motivation with the shareholder’s best interest. I believe he will try everything he can to meet the 4% annual revenue growth through FY2022 and generate free cash flow.

 WACC Estimate

WACC Estimate


Since the valuation varies greatly based on WACC and terminal growth assumption, I created a table with a wide range of combination of the assumptions. Although the valuation changes based on the assumptions, my main target is terminal growth of 0% to be conservative and WACC of 14% based on the estimate above.

o   Conclusion

Based on my valuation, the Garrett’s shares (GTX: NYSE) could be a buy if the shares end up being traded below $14. Although Garrett will be loaded with a substantial amount of debt and purchasing its shares will be somewhat risky, I believe the company will generate sufficient cash flow to repay the debt and reward the shareholders well in the long-term. As spin-off stocks tend to face a sell-off in short-term, I would recommend buying the shares only if you are willing to hold them for over 2 years to see how it plays out.

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The stock recommendations and comments are the opinion of writer. Investors should be cautious about any and all stock recommendations and should consider the source of any advice on stock selection. Various factors, including personal ownership, may influence or factor into a stock analysis or opinion. All investors are advised to conduct their own independent research into individual stocks before making a purchase decision. In addition, investors are advised that past stock performance is not indicative of future price action.

You should be aware of the risks involved in stock investing, and you use the material contained herein at your own risk. I cannot guarantee its accuracy or validity, nor am I responsible for any errors or omissions which may have occurred. The analysis, ratings, and/or recommendations made in the valuestocksblog.com do not provide, imply, or otherwise constitute a guarantee of performance.

The material on this website are provided for information purpose only. I do not accept liability for your use of the Valuestocksblog.com. The website is provided on an “as is” and “as available” basis, without any representations, warranties or conditions of any kind.

I currently do not own any Honeywell stocks (HON: NYSE). I may purchase Garrett Motions Inc. (GYX: NYSE) in near future, depending on the pricing actions and availability of my own capital.

[Valuation Analysis] Buy CVS before the Aetna acqusition is completed.

As discussed in the November 2017 portfolio update, I recently purchased two call options of CVS Health Corporation (Ticker: CVS, Exchange: NYSE), an American retail pharmacy and health care company.

Company Overview

CVS Health Corporation (“CVS”) mainly operates in two segments: Retail/Long-term Care Segment and Pharmacy Benefit Management.

o   Retail/Long-term Care Segment

·         CVS has the largest pharmacy store chain in the U.S. with approximately 23.8% share of the U.S. retail pharmacy market.

·         CVS currently operates 9,709 retail pharmacies, online pharmacy websites and over 1,100 retail health care clinics.

·         The pharmacy retail drugstores sell prescription drugs and a variety of over-the-counter and personal care products, cosmetics, etc.

·         Long-term care (“LTC”) operations include the distribution of pharmaceuticals, related pharmacy consulting, etc.

·         CVS serves about 5 million customers each day.

o   Pharmacy Benefit Management

·         CVS offers Pharmacy Benefit Management (“PBM”) to employers, insurance companies, unions, government employee groups, health plans, Medicare Part D plans, etc.

·       Pharmacy Benefit Management includes developing and maintaining the formulary, contracting with pharmacies, negotiating discounts and rebates with drug manufacturers, and processing and paying prescription drug claims.

·         In short, CVS provides services which helps its clients (notably government and insurance companies) reduce pharmacy costs.

·         CVS filled or managed approximately 1.2 billion prescriptions in 2016 for nearly 90 million PBM Plan Members.

 Summary of CVS's business lines (excerpt from a CVS investor presentation)

Summary of CVS's business lines (excerpt from a CVS investor presentation)

Aetna Acquisition

On December 3rd, 2017 CVS and Aetna (NYSE: AET), an American health insurance company, announced that they reached an agreement for CVS to acquire Aetna. The transaction is expected to close in the second half of 2018.  It is subject to approval by CVS Health and Aetna shareholders, regulatory approvals and other customary closing conditions.   

o   Aetna Overview

·         The third largest health insurance company in the U.S. with about 6% market share, serving an estimated 44.6 million people.

o   Potential impact of the acquisition (synergy, etc.)

·          Aetna currently has $61 billion in revenue. The combination of CVS and Aetna will most likely make the largest health care company in the U.S. in terms of the revenue. 

 (excerpt from a CVS investor presentation)

(excerpt from a CVS investor presentation)

·          CVS is foreseeing $750 million of synergies in second full year after the acquisition. 

 (excerpt from a CVS investor presentation)

(excerpt from a CVS investor presentation)

·          CVS also lists several potential long-term synergies. 

 (excerpt from a CVS investor presentation)

(excerpt from a CVS investor presentation)

Competitors / Potential Entrants

The following are examples of CVS’s competitors in the Pharmacy and PBM field.

o   Walgreens (Pharmacy)

·         The second-largest pharmacy in the U.S, operating 8,175 stores across the country. CVS and Walgreens account for about 50% of total market share.

·         Unlike CVS, Walgreens does not offer PBM. Walgreens business strategy seems to simply focus on expansion on the pharmacy business, as seen in the acquisition of Switzerland-based Alliance Boots to form a global business.

o   Rite-aid (Pharmacy)

·         The third-largest pharmacy in the U.S.

·         Walgreens has attempted to acquire Rite-aid several times but failed to attain regulator’s approval. After all, Walgreens purchased 1,932 stores of Rite-aid, which is about half of Rite-aid’s store.

o   Express Scripts (PBM)

·         The largest PBM organization in the U.S.

·         The company recently lost its biggest client, insurer Anthem Inc. over dispute about drug prices and rebates.

o   UnitedHealth Group (PBM & Insurance)

·        The largest health insurer, with more than 45 million members in the U.S.

·        UnitedHealth also owns more than 400 surgery centers and urgent-care clinics and runs medical practices for about 22,000 physicians across the country.

·        UnitedHealth offers PBM filling more than 100 million prescriptions per month – taking big customers away from rivals CVS and Express Script. For example, UnitedHealth won a five-year, $4.9-billion contract for the California Public Employees’ Retirement System against CVS and Express Script.

o   Amazon (Pharmacy, potential entrant)

·         There has been speculation that Amazon may enter the retail pharmacy business as media reported that the company has gained approval from a number of state pharmaceutical boards to become a wholesale distributor.

SWOT Analysis

Assuming that the acquisition will go through, the combined entity (“CVS-Aetna”) will have significant strength in my opinion.

o   Strength

·         As far as I know, CVS-Aetna will be the only health care company in the U.S. which offers pharmacy, PBM and health insurance as one entity, which will be a comparative advantage against most competitors in the U.S. healthcare sector. 

 Summary of the competitive landscape

Summary of the competitive landscape

·         For example, CVS’s 9,709 retail pharmacy locations can serve as a marketing entity of the health insurance business. Such strong exposure to consumers should provide the company an edge against UnitedHealth.

o   Weakness

·         The very long-term growth might be limited since CVS only seems to focus on the domestic (U.S.) market.

·         Health insurance business entails political risks. For example, the demand for private health insurance will plummet if the U.S.A decided to offer free-healthcare.

o   Opportunity

·         Aging population and increasing health care spending in the U.S. are strong tailwinds for the industry.

·         Trump’s corporate tax cut should boost CVS’ after-tax earnings. CVS’s current effective tax rate is roughly about 38%. The tax cut to 20% will be quite significant.

o   Threat

·         I personally do not believe that Amazon’s entry into pharmacy business alone will be a threat as CVS’s retail locations provide “last mile” advantage in terms of home delivery. However, if Amazon decided to team up with Walgreens, the alliance could be a large threat at it obscures CVS’s location advantage against Amazon.  

Valuation Analysis

o   Assumptions

I will assume the following for the sake of my valuation and setting a price target. These assumptions include both conservative and optimistic measures.

1.      The acquisition completes in 2018 without issue.

-          It’s a vertical integration and I believe CVS has sufficient justification to convince the DoJ that the merger will be beneficial to the consumers, lowering the overall healthcare cost.

2.      Synergy takes in effect starting 2020. No growth or cost savings in 2018 and 2019.

-          Due to the size of each company and its operations, I believe it is reasonable to assume that the post-merger integration (PMI) will take at least 1.5– 2 years. Until PMI completes, I assume no growth or cost savings.

3.      The synergy will result in $750 million cost savings in 2020

-          This is based on CVS’ own projection. I will use their projection as it is since the explanation seems plausible. 

4.      2% annual growth in Free Cash Flow to Firm for 2020-2030 and 0% onward.

-          I believe 2% annual growth will be achievable as the CVS-Aetna merger will have a wide range of growth and cost saving strategies as follows:

Ø  CVS can use its 9,709 retail location as the sales center of Aetna’s insurance business.

Ø  Aetna can provide its insurance members incentives, such as product discounts, to visit CVS’s retail pharmacies and health clinics.

Ø  CVS can provide PBM services to Aetna to further reduce the insurance expense.

Ø  The CVS-Aetna will have higher leverage to negotiate price with drug manufacturers, significantly lowering its expense. If drug manufacturers do not agree to lower the price, for example, CVS-Aetna can threaten to exclude their drugs from the insurance coverage and stop selling their products.

-          Since the CVS-Aetna only has access to the domestic (American) market, I feel that potential growth will be somewhat limited. Though I do expect healthcare spending in the US to keep rising, I assume the 0% terminal growth to keep the valuation somewhat conservative.

5.      Discount Rate at 7.21%

-          I set the discount rate at 7.21% based on the following assumption:

Ø  Cost of Equity  = FCF / Price

Theoretically, CVS could have used all of its FCF for dividends and stock buybacks, resulting in 10.8% annual return in equity, assuming the FCF is fixed. In a sense, this is the minimum return that shareholder’s should expect from the company’s investment.  

Ø  Cost of debt = Highest yield of the company’s bonds

To keep the valuation conservative, I chose the highest borrowing cost that I could think of.

Ø  Debt/Equity Allocation = The fund structure which will be used in the Aetna acquisition

CVS will fund the Aetna acquisition with 44.8 Mil debt and 25.1 Mil equity, which translates to 64% in debt and 36% in equity.

Assumptions and Cash Flow.png

o   Valuation

Based on the assumptions above, I came up with the following valuation:

 CVS+Aetna Valuation Summary

CVS+Aetna Valuation Summary


Assuming the Aetna acquisition goes through, I believe that the CVS stock price has a significant upside potential in the near term, possibly within the year upon which the completion of the acquisition is completed. I believe it’s one of the best stocks to buy if you want to gain exposure to the U.S. healthcare sector, which should grow along with the aging population.


Disclaimer: I own the call option on CVS Health Corporation (Ticker: CVS, Exchange: NYSE). I am long CVS and plan to add to my portfolio if the price goes down even further. Since the potential acquisition is involved, the price movement can be pretty volatile. Please be aware of the inherent risk of such an investment. I only recommend purchasing the stock if you can endure the price volatility and potential loss of capital.

[Valuation Analysis Series] Gran Colombia Gold: One Stock You Should Seriously Consider Buying

For the first post of my new Valuation Analysis Series, I will provide financial analysis on Gran Colombia Gold (GCM). Gran Colombia Gold Corp is a Canadian-based gold and silver exploration, development and production company with its primary focus in Colombia. GCM currently has 3 gold mines: Segovia, Marmato and Zancudo. The stock price is currently at CAD 0.10 (as of November 15, 2016). Though the company is a Canadian company, the earnings are reported in USD since the gold price is normally quoted in USD. The company just released its Q3 2016 earnings, posting USD 0.03 EPS on the quarter. The EV/EBITDA [EV/ (Q3 EBITDA x 4)] of the company is less than 3. You can see how stupidly cheap the company is valued at.

Why has the price been so low?

The price of stock has been extremely cheap most likely due to two reasons: its convertible feature of debenture bonds which could significantly increase the outstanding number of shares and the lack of analytical coverage as the company has a small market cap of less than CAD 50M.

However, it is silly to overlook such a great company just because of the possibility of dilutions and its size. Gran Colombia now produces more than 100,000 ounces of gold per year and it has more than 14 million reserves of gold. The company has done a fantastic job with its debt restructuring as well and recently initiated a strategic review which could allow the company to buyback the convertible bonds. I believe, given current circumstances, the stock is significantly undervalued.

As mentioned earlier, due to its size of market cap, there is no analyst coverage for the Gran Colombia Gold. To help investors see how undervalued the company is, I decided to share my valuation.


Let's just jump into the most exciting part.

According to my valuation, my target price lies between CAD 0.21 and CAD 0.61, within the time frame longer than 1 year but shorter than 5 years. The stock price depends on the number of shares converted from the debentures, the result of the strategic review process and the gold price.  If the strategic review goes well and the gold price remains near USD 1,200 per ounce, I am expecting the price to be closer to CAD 0.61 within the time frame.

Compared to GCM's current stock price of CAD 0.10, the stock can easily rise by more than 100% in the long-term.



Here is a summary of my assumptions.


My assumptions are mostly very conservative.

  • Conservative assumptions

1. Only count cash flows until 2022.

The main reason is that the company website shows that the expected life of Segovia and Marmato mine is 2022 and 2020, respectively. I am not including the potential cash flow from those mines thereafter or the cash flow from Zancudo. The exclusion of such cash flows can be significant since Marmato  has more than 11 million ounces of measured and indicated gold resources, which should not be depleted by 2020 and Zancudo has a "good exploration potential to encounter additional mineralization" according to the company's technical report.

2. All-In-Sustaining-Cost (AISC) per ounce at USD 850 for Segovia during the period.

This is the high end of the company's estimate for 2016 guidance.

3. Segovia gold production will remain constant over the period.

This is a very conservative measure considering that production grew 14% from Q3 2015 to Q3 2016.

4. Required rate of return is 10%

I incorporated the cost of 6% coupon on 2020 debentures, 1% coupon on 2018 debentures and the geopolitical risk which comes from the location of the company.

5. All-In-Sustaining-Cost (AISC) per ounce at USD 1,017 for Marmato Mine during the period.

This assumes that there is zero cost improvement at Marmato Mine for the next 6 years, which is not very likely.

  • Somewhat optimistic assumptions

1. Marmato production grows at 20% annually over the period.

The 2016 production guidance of Marmato is 24K ounces. The production level is very low considering that 11.6M ounces of gold has been measured and indicated at the mine. Since the major drilling program of Segovia will complete by the end of 2016, I expect the production growth of Marmato to catch up.

2. Roughly 20% of inferred resource of Segovia can be realized.

Cash flow analysis

Based on the assumptions above, I generated the following cash flow analysis (numbers are all in USD).



This is a typical value stock. The company has been completely overlooked by the market despite such attractive valuations and significant upside potential (easily more than 100%) in long term. I sincerely recommend choosing this stock if you are wanting to incorporate a gold stock into your portfolio.

Have any thoughts or suggestions for the next company I should analyze? Please let me know in the comments below.

Disclaimer: I own Gran Colombia Gold (GCM.TO) stock. I am long Gran Colombia Gold and plan to add to my portfolio if the price goes down even further. Since it's considered a penny stock, the price movement can be pretty volatile. Please be aware of the inherent risk of such an investment. I only recommend purchasing the stock if you can endure the price volatility and potential loss of capital.