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  Our portfolio's big fat loser

BENJ GALLANDER and BEN STADELMANN

Friday, August 15, 2003

So far,this has been another banner year for the portfolio, as 24 of our 27 stocks have risen from their purchase price. Clothier Hartmarx, known for the Tommy Hilfiger and Jack Nicklaus lines amongst others, was sold for 12 cents below our average purchase price of $2.81, and funeral home operator Service Corporation International, the largest in North America, is down about 12 percent. Our humongous loser has been Stelco, sold recently in two nearly equal tranches at $1.10 and $1.29.

When we first bought Stelco in 1996, it had turned a devastating corner and teetered on the brink of insolvency. In 2001, we quadrupled our position, knocking down our average purchase price substantially.

Averaging down is a strategy that many experts deplore, but we are quite happy to deploy it when our initial gambit fails, if our original rationale for buying the stock remains sound.

How clever we felt as the stock price moved smartly upward. We're never ones to discount paper gains as many do -- we also laugh when people say stuff like, "My Nortel is down to $4 and change from $85, but hey, it's only a paper loss." A strong automotive market, a robust economy, and management that we ignominiously praised as sure-handed, combined to maje this investment look like a lock.

Oops.

To describe the steel sector over the past few years as beleaguered would be optimistic. About three dozen enterprises in North America have filed for bankruptcy or Chapter 11 protection from creditors. Many have disappeared from the landscape altogether, while others have merged or been subject to takeovers.

Stelco is again on the edge of insolvency. While a miracle rescue may occur, as it did in the early 1990s, the recently deposed CEO Jim Alfano, a lifer at the corporation, won't be the one to lead the charge.

For the moment, the salvage operation is in the hands of chairman Fred Telmer, who did spirit the previous comeback as CEO from 1991 until 1997. Many question whether he is again up to the task a decade later, but other capable candidates prefer to test the links rather than butt heads with a headstrong union.

While those union fellows wish to see their employer survive, they don't appear willing to make financial concessions to increase the feasibility. Unfortunately, a fairy godmother with a magic wand wonit do the trick, boys.

Telmer's first public move was to put AltaSteel on the market. Apparently, there is interest in this operation and once the deal is done, we imagine that the money will be used for ongoing operations.

Covering the extensive debt and cavernous pension shortfall would be no less helpful; these two elements are major bugbears, and Standard and Poor's is consequently making noises about further reducing Stelco's credit rating. Such a move would impair the outfit's ability to raise additional funding.

Before Mr. Alfano left, during the conference call that announced the recent hideous loss of $82 million, we asked about the probability of bankruptcy. Mr. Alfano responded that the company did not "speculate" about this possibility.

We found that difficult to comprehend; surely the top brass of an outfit should at least contemplate this scenario -- we certainly did.

Our decision was to jump ship, claim the tax loss, and put the enterprise on our Stock Watch List for a possible future purchase. Perhaps Stelco, the largest employer in this sector in Canada, will be a Boxing Week bargain.


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