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Volume 1 Number 1 December 2011

A Trefis Interactive Portfolio Report Inaugural Issue Blood in The Street: Value in Bank Stocks

Introduction From a Contrarian Investor

Oscar Wilde said a cynic is someone who knows the price of everything and the value of nothing. I simply call that an ignorant investor. A wise investor knows price, value and the difference between the two. The wise investor also understands that not every cheap stock is a bargain. United Continental (UAL) is one of the most undervalued stocks in the Trefis universe with a Trefis value of $26.23, well above the market price. It sounds like a screaming buy. But remember Warren Buffetts plea of Temporary Insanity! excusing his 1989 purchase of US Airways:

James Berman

CONTENTS Introduction From a Contrarian Investor Blood in The Street: Value in Bank Stocks Bank of New York Mellon (BNY) Company Stress Test: BK Test Our Assumptions Company Highlights Automatic Data Processing (ADP) JP Morgan (JPM) CSX Corporation (CSX) United Parcel Service (UPS) Heinz (HNZ) The Berman Value Folio

There's no worse business of size that I can think of than the airline business. You're selling a commodity product with no variable costs. Huge fixed costs. It's a terrible business. I have an 800 number now which I call if I ever get an urge to buy an airline stock. I say, My name is Warren, I'm an air-aholic,' and then they talk me down.

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Some stocks are value traps, not true values. I believe its important to think of companies holistically about their competitive advantage or lack of one and how that fuses with its valuation, or the intrinsic value of the company. Welcome to the first issue of The Berman Value Folio. Forget the typical canned newsletter content with an unknown shelf life here

It sounds like a screaming buy. But remember Warren Buffetts plea of Temporary Insanity! excusing his 1989 purchase of US Airways?

James Berman, the president and founder of JBGLOBAL.COM LLC, a registered investment advisory firm (SEC registered), specializes in asset management for high-net-worth individuals and trusts. Mr. Berman is a faculty member in the Finance Department of NYU SCPS. He has appeared on CNBC and the Fox Business Channel and has been quoted and published in a variety of publications, including Barron's, Fortune, Bloomberg, The Huffington Post and CNN Money. Mr. Berman holds a B.A., Magna Cum Laude, Phi Beta Kappa, in English & American Literature from Harvard and a J.D. from Harvard Law School.

youll find a dynamic, interactive Trefis interface that allows you to alter the assumptions. As with any model, its important to remember the old adage: garbage in, garbage out. A spreadsheet is only as good as the numbers that support it. Thats why I invite you to adjust the Trefis numbers based on your own macro view, specific knowledge or plain gut instinct on what drives the business. You can modify and keep your models on the Going against the Trefis site for reference later. craven herd is the only way to I like to review other viewpoints and incorporate any worthwhile get good prices. insights. The Trefis price the Trefis estimate of intrinsic value will When the macro always be our starting point, but Ill use your inputs and my experience picture appears as a portfolio manager to make the final stock selection. grim, bargains Warning required: our approach will always focus on fundamentals, the abound. long term and the intrinsic value no trading tips, no momentum strategies, no technical analysis. If you look at a stock for what it really is the ownership stake in a business youll like our approach. Todays market confronts multiple macro pressures: a euro debt crisis, a feeble global economy and social unrest in many parts of the world. But as a value investor, I believe contrarianism works. Im often buying what others are selling and selling what others are buying. Going against the craven herd is the only way to get good prices. When the macro picture appears grim, bargains abound. As Baron Rothschild famously said, The time to buy is when theres blood in the streets.

Product to price to portfolio: Using Trefis tools to choose stocks

Blood in The Street: Value in Bank Stocks Bank of New York Mellon (BNY)
In the spirit of bloodletting, heres the first holding in the Trefis Value Portfolio: Bank of New York (BK). BK is not the cheapest choice according to Trefis, but with a Trefis price of $26.86, 38% above its $19.31 market price, BK is still undervalued:

(See Interactive Model at Trefis) BK is a custodian bank a bank that specializes in holding other peoples money in the form of vast pools such as mutual funds, hedge funds, ETFs, and ADRs. Founded by Alexander Hamilton in 1784, BK has muddled through recessions, depressions and wars. It has many elements of a great business: dependable recurring fee revenue and supersized economies of scale. Unlike a commoditized airline, bank custodians distinguish themselves by brand and balance sheet strength. With relatively modest financial leverage and the highest debt ratings among large U.S. banks, BK is less a traditional lending institution than a transaction processor. It collects a toll for servicing accounts, managing assets, and everything in between. Scale is essential for BK where servicing assets amounts to rolling up billions of nickels. As you can see from the Trefis diagram, Asset Servicing and Asset & Wealth Management comprise the key value of this legendary franchise. These are both business lines with high operating leverage enhanced by BKs panoramic global reach. At a time when banks are reviled from Main Street to Wall Street to Occupy Wall Street, they trade at steep discounts to any historical value metric. In short, no one wants to own them. As a result, the price is right. The stigma that comes with being a bank in a post-gilded age is unlikely to lift quickly, but history shows it someday will.

Like any value stock, BK has its warts and blemishes: a lawsuit brought by the NY Attorney General alleges that BK defrauded clients in currency transactions. A large settlement and dent to reputation are in the cards -- but both are already discounted by the current price. Seasoned veteran Gerard L. Hassell took the reins in August. While Hassell looks like a good choice, a CEO transition always introduces risk. Finally, the macro pressure of a weak global economy is BKs greatest present challenge.

Company Stress Test: BK

While I think BK is a superior company, its important to see if they can withstand even the most intense pressure. What better way than to stress test the stock? The Trefis diagrams help you spot the main sources of value the heart of any business. For BK, lets apply stress to one of those major drivers: Assets Under Management. By dragging assets down over 20% to under $1 trillion in 2013, we model in another severe market decline:

(See Interactive Asset & Wealth Management Driver)

This change lops nearly a dollar off BKs fair value per share, but leaves it at $26.16, well above the market price. If we also lower Assets Under Custody & Administration to fully account for global contagion that decimates emerging market growth, the Trefis price drops to $24.96, still well above the market price.

(See Interactive Asset Servicing Driver)

We can apply further pressure by lowering Interest Earning Assets and Net Interest Margin. By also raising the Discount Rate (a measure of risk) and lowering the banks Terminal Growth Rate, we see the implied valuation under draconian assumptions:

(See Interactive Discount Rate Assumptions)

BK survives with a Trefis Price of $22.21, more than 13% above market. If a companys Trefis price remains at a healthy premium after such intense pressure on the heart of its business, it clears a major hurdle. A fine company at the right price, BK is the lead addition to our new portfolio.

Test Our Assumptions

Trefis members have posted their own models. The BK community average estimate sits at $27, with a range from $23 to $34. Theres no substitute for personally kicking the tires of any prospective purchase. Try it yourself: alter our worst-case assumptions for BK by dragging the variables to fit your own macro view on the Trefis site here.

Company Highlights Automatic Data Processing (ADP)

Bermans Take: ADP is the worlds leading payroll processing company. Now that Herman Cain has ended his bid for the Oval Office it looks like payroll taxes are here to stay. ADP makes money on every check processed and on float (the payroll tax money it holds temporarily). The company has been hurt by persistent unemployment and low interest rates, which reduce return on that float. I believe that when (not if) the economy shows a stronger pulse, employment levels and rates should both rise, offering a boost to ADPs bottom line.

(See Interactive Model at Trefis)

Trefis Key Drivers: ADPs payroll processing business accounts for 87% of the Trefis price estimate of $57.67. International payroll processing remains a large opportunity for ADP. Only $1.4 billion of the $6.4 billion earned by ADP through payroll processing fees in FY 2010 came from international sources, which Trefis expects to outpace domestic growth. Small businesses have been the most vulnerable to changes in economic conditions and have higher bankruptcy risk. Although ADP serves small business customers, it is less exposed to the risks of small businesses than its primary competitor Paychex, and as the economy recovers, small business will help add to its revenue growth. ADP is also focused on expanding its services portfolio and recently acquired The RightThing, the market leader in recruitment process outsourcing solution. This new offering targets large companies with over 15,000 employees. Market Capitalization $26.2 B Annual Revenues $6.9 B Dividend/Yield $1.58/2.9% 52 Week Range $44.72-55.12

JP Morgan (JPM)
Bermans Take: JPM has one of the strongest balance sheets, with a Tier 1 common equity level of 7.6% under Basel III standards and a low assets-to-equity leverage ratio of 12 to 1. JPM is the leader in many business lines and should be able to seize market share given the weakness of rivals. In Jamie Dimon, JPM has the best bank CEO. I dont think theres any better way to take advantage of the current revulsion to bank stocks than to own JPM and BK.

(See Interactive Model at Trefis)

Trefis Key Drivers: JPMorgans credit card business is the biggest source of value for the bank at around 27% of the stocks value, considering the substantially higher interest rates applicable to credit cards compared to retail loans. The fact that Chase-branded cards are one of the most widely circulated credit card in the U.S. has helped the bank garner substantial revenues from its card business as consumers start spending. Its geographically diverse retail business comes as the second-biggest earner for the bank at 21%. The bank inched beyond Bank of America to become the largest holder of deposits in the country last quarter. And with investors shying away from the extremely volatile markets, retail banking services will trump sales & trading operations as a more important source of income for the bank in the foreseeable future Market Capitalization $123 B Annual Revenues $17.6 B Dividend/Yield $1.00/3.1% 52 Week Range $27.85-48.36

CSX Corporation (CSX)

Bermans Take: CSX has a unique competitive advantage: they own track that runs farther North to South than competitors, giving them a wider reach to carry coal, fertilizer and industrial freight on the east coast. CSX has improved operating ratios, producing a return on invested capital in excess of its cost of capital. A less obvious beneficiary of globalization, CSX is well-positioned to run freight via east coast ports all the way to China.

(See Interactive Model at Trefis)

Trefis Key Drivers: Coal forms almost a quarter of the total freight volumes carried by the company and accounts for 32% of the stock value. Trefis estimates that the total carloads of coal in U.S. to increase to 7.7 million by the end of 2012, driven by increasing demand and higher coal exports but limited by soft domestic demand, a sluggish economy and some replacement of coal due to low natural gas prices. The companys strong network along the east coast and several Atlantic and Gulf Coast ports position it to take advantage of the increasing coal exports to Asia, South America and Europe. Industrial freight is the second largest value driver at 28%, and we expect the revenues from the segment to grow to $3.5 billion next year. Market Capitalization Annual Revenues Dividend/Yield 52 Week Range $22.9 B $3.9 B $0.48/2.1% $17.69-27.06

United Parcel Service (UPS)

Bermans Take: UPS is a direct beneficiary of the growth in online shopping, as shipping volumes catch the tailwind of this powerful trend. In the delivery business, there are large barriers to entry: assembling the logistical know-how to provide seamless and reliable package shipment at a decent price is no easy task. Concerns of a double-dip in the economy have hurt UPS. If you look past the fear of a cyclical downturn and toward the secular trend of online shipping, you get an underpriced stock.

(See Interactive Model at Trefis)

Trefis Key Drivers: Delivering packages to consumers and businesses in United States contributes to more than half of the stock value for UPS, as growing package shipments and unit revenues across Ground Package, Next Day Air and Deferred Package services continue to provide momentum domestically. However, with the slowing domestic economy, volume growth has largely stabilized back home and the company is scouting for opportunities internationally, which accounts for 40% of the companys value. The company is especially bullish on the intra-Asia and intra-Europe theaters as Asia trades more within Asia and the continuing migration of integrated supply chains in Europe drives the intraEuropean shipments. Market Capitalization Annual Revenues Dividend/Yield 52 Week Range $71.5 B $22.7 B $2.08/2.9% $60.74-77.00

Heinz (HNZ)
Bermans Take: Heinz dominates the U.S. ketchup market with 60% market share. Lets put it this way: who reaches for Hunts Ketchup? Competition is heating up from private labels to organic independents but HNZ is introducing healthy product extensions. And HNZ is not just ketchup. As you can see below, significant value comes from Meals and Snacks the division that makes everything from Ore-Ida French fries (obvious synergy) to Smart Ones low-calorie frozen entrees.

(See Interactive Model at Trefis)

Trefis Key Drivers: Heinz is the market leader in the ketchup, condiments and sauces market with a 60% market share in the US, 70% in Canada and 80% in the UK. This accounts for 44% of the stock value. Meals and snacks account for 37% of Heinzs value. The recent spate of acquisitions by the company in developing markets will help it compete with local brands and continue to take market share. The adoption of western lifestyles by working professionals in urban areas with the highest disposable incomes ensures the demand for meals and snacks will continue to grow. Trefis estimates that Heinz will generate 20% of sales from emerging markets by 2012 and 30% by 2016. While profit margins have been under pressure, Trefis believes that as the economy recovers, Heinz can leverage its brand recognition to raise prices on core products. Currently, 15 of Heinzs most popular brands represent nearly 70% of its sales. Market Capitalization Annual Revenues Dividend/Yield 52 Week Range $17.0 B $11.0 B $1.92/3.6% $46.99-55.00


The Berman Value Folio

Buy Hold Sell Buy Buy Buy Buy Buy Buy Buy Reference Date 12/21/2011 12/21/2011 12/21/2011 12/21/2011 12/21/2011 12/21/2011 12/21/2011 12/21/2011 12/21/2011 12/21/2011 Reference Price ($) $8.87 $26.98 $53.15 $65.84 $31.04 $59.49 $41.33 $19.43 $25.74 $32.12 Market Price ($) $8.87 $26.98 $53.15 $65.84 $31.04 $59.49 $41.33 $19.43 $25.74 $32.12 Trefis Estimate ($) $16.47 $38.64 $54.73 $71.56 $35.19 $73.48 $55.46 $26.86 $34.86 $39.11

Ticker Name Basic Materials AA Alcoa Dow DOW Chemicals Consumer HNZ H.J. Heinz Procter & PG Gamble Walgreen WAG Co WMT Wal-Mart Energy BP BP

Financial Services BK BNY Mellon Buy C JPM Citigroup JP Morgan Buy Buy

Tech, Media, Telecom ADP ADP EBAY PAYX eBay Paychex

Buy Buy Buy

12/21/2011 12/21/2011 12/21/2011

$53.21 $30.18 $29.14

$53.21 $30.18 $29.14

$57.67 $38.68 $29.73

Transportation CSX CSX Corp UPS UPS

Buy Buy

12/21/2011 12/21/2011

$20.80 $72.40

$20.80 $72.40

$33.80 $83.60

The Berman Value Folio (TBVF) provides information and investment ideas on stocks. The selection of portfolio stocks is based on rigorous fundamental analysis. There is, however, no assurance that these securities will produce profits. Past performance does not guarantee future results. Investment in stocks can result in serious loss. Although all content is derived from data believed to be reliable, accuracy cannot be guaranteed. James Berman, JBGlobal.com LLC, Insight Guru Inc, Trefis and their employees shall not be liable for investment losses as a result of securities purchased on TBVF recommendations. TBVF is not intended to provide personalized investment advice. Readers and subscribers should consult their financial advisor before investment. James Berman is an investor in Insight Guru Inc., the parent company of Trefis. Employees of TBVF, Insight Guru Inc. and Trefis may hold positions in some or all of the stocks mentioned here. James Berman and JBGlobal.com LLC may hold positions in some or all of the stocks mentioned here, both personally and in the accounts and funds they manage for others.