Tuesday, December 21, 2010

We'll See M&I Played Over And Over

I continue to dislike almost all banking stocks. The only positive they have going for them is a large short position that could trigger a short lived spurt upward on any bullish news, but I don't believe it would be sustainable.

Banking faces large earnings headwinds and those are not all credit and spread driven issues. All banks have had to change their approach to excessive overdraft fees and now they face a dramatically smaller fee stream on debitcard transactions. Any real estate refi mini-boom is nearing an end as interest rates are rising, so the non- interest income contribution to earnings is going to be putrid.

On the interest income side of the P&L, I don't think banks can build enough reserves, through earnings, to cover past lending mistakes. They just have to keep doing what the banks and government have been trying to accomplish, and have to a large degree, that is talk a good story, defer losses, and raise equity. So far so good, unless you were among the diluted. Loan demand is anemic, bond yields minimal, and trading is being curtailed. I don't look for growth in net interest income. You won't reverse those trends by what a bank can earn on excess reserves held at the Fed.

I don't think a big short position and the prospect of dividend increases are more important than the lack of earnings growth in the long run. plus the guys running the banks today are proving to be less than brilliant as some some are already treading back into past mistakes. Credit card banks are already offering credit, at higher rates, to strategic and first time defaulters! Where are the regulators and Boards of Directors?

M&I was a good case of the walking wounded and sold to Bank of Montreal for about 1/2 book. More will be forced into the arms of the world's remaining healthy banks. Regions, Suntrust, Fifth Third, Huntington,Key etc. all are some degree of toast as they probably aren't too big to fail and will be forced into a sale at some fraction of book value as earnings growth will not be adequate to keep the balance sheet sound.

Monday, December 13, 2010

A Purchase Today Of CLD Will Result In A 5% Gain Shortly

I already own a full position of Cloud Peak, CLD, so I haven't added to my holdings in today's sell off. CLD is off about a dollar, 5%ish, due to an announced secondary offering by the company of most of the stock owned by the major shareholder, BHP Billiton. Cloud won't receive any of the proceeds, but it does distribute its ownership and will no longer be controlled by BHP.

Once the dust of the secondary settles, I believe the price will readjust back to Friday's level and continue upward. Cloud is a low cost producer of coal for power plants and sells for 10X forward earnings and a modest cashflow multiple. Today's price decline, anticipating a lower offering price to move the large secondary, gives a new buyer a 5 % head start.

Sunday, November 28, 2010

This Loose Cannon Either Made Me Lots Of Money Or Will Be The Cause Of My Shrunken Net Worth

I'd been watching Posco [PKX], the huge South Korean steel manufacturer, for several months as its stock price trended downward. Last week North Korea lobbed some artillery shells at a South Korean island and the price of Korean securities cratered. I took that opportunity to buy PKX.

Some back of the envelope calculations indicate that you can buy PKX for a hair above book value, 7ish X forward earnings, and 5 X cashflow. The balance sheet is sound with debt at about 40% of equity. The world economy is performing adequately and Posco is well positioned in Asia. Input costs are obviously rising, but so far not crippling. PKX is at a reasonable entry point for the longer haul.

I'm already in, and ahead a couple of dollars, so it is unlikely that I'll buy more, even if the little dictator puts on his uniform, stops drinking beer, and causes more problems on the Korean Peninsula which causes PKX shares to drop further. That may happen and prove to be a gift as I don't believe we are in for a repeat of the Korean War and PKX owners will be rewarded as demand for Posco's steel grows.

Friday, November 26, 2010

Life Is Good In Spite Of The Goverment

I've already exercised, we have plenty of turkey for sandwiches, Nebraska football is on the television soon, and the dog is sitting next to me and thinks I'm wonderful. Could it get any better? Yes it could if our government entities would lessen their intrusion into our collective lives and businesses.

After decades of misguided government programs and policies, combined with very poor corporate leadership, we've found ourselves in a debt saturated world. No matter how the politicians, the Fed, the economists, and the opportunists spin their story, there is only one answer to our problem. I've done the research. The capital has been squandered and haircuts must be taken and losses recognized. Further, the losses must stop being assumed by tax payers.

When you invest you take risk. When you're stupid, unlucky, conned, or short on due diligence you are apt to lose some of your capital and you should. That's where discipline is learned and reinforced. Default and failure is necessary if we are to rescue ourselves from our current situation that rewards the risk taker and burdens the taxpayer for other's mistakes.

On the national level the Treasury/Fed is engaged in a weakening of the US Dollar in an attempt to lessen the pain of debt service and improve the ratio of debt to GDP. The alternative is austerity and/or default. I've done the research and they're not going to abandon "business as usual" so rule out austerity, except for tinkering around the edges then declaring victory. They won't default either, but the bond market will demand greater yields before long and that, unfortunately, will be born by all taxpayers again. What they can do to help, and the populace must insist, is to stop bailing out companies, industries, states, and foreign governments. Let the haircuts and losses commence. Investors and owners need to bear the losses from here forward.

Beyond a commitment to quit institutionalizing losses, governments, and the electorate, needs to recognize and believe that the best of all possible worlds are corporations and employees that agree to share the wealth without any capital contribution by the government. A new business agrees to commit the capital, build or lease the facility, fund the inventory, keep the lights on, make the product,pay the employee wages and benefits, AND GIVE THE VARIOUS LEVELS OF GOVERNMENT 50% OF THE PROFIT!!!! Why isn't that encouraged? I've done the research and lower levels of taxation lead to more new businesses, expansions, and hiring.

Since I'm not full of BS, who is? Don't believe their line and hold government's feet to the fire on future bailouts, regulations, and taxation. I am full of turkey.

Sunday, November 21, 2010

Waste Management Is A Core Holding

Mount Dora is a town with a canopy of live oaks covered with spanish moss. Consequently, acorns are always falling. Occasionally they hurt as they drop on the unsuspecting walker's head. Mostly they are just a nuisance as neighbors are always sweeping walks and street cleaners are tidying up the avenues.

On my walk today I commented to an ernest sweeper " it's a endless job isn't it?". Her response was apt : "I wish they had value and we could sell them." Alas, acorns don't have any value, they're just waste. Other than acorns and spanish moss, most waste does have a value and that brings me to a long time holding, Waste Management.

I've owned this company longer than any other and have grown accustomed to it and its yield, about 3.6% at todays share price. The market values it fairly, not cheaply, at about about 9 X cashfow, 15 X forward earnings, and 2.75 book value. WM uses debt, but isn't overly leveraged.

It, like its major competitor, Republic Services, run little monopolies in the communities they serve. Even if the monopoly comes unraveled by losing a franchise renewal on the pickup of refuse, they still control the landfill and are in an excellent negotiating position. Besides the standard garbage pickup and recycling, they have a large and growing portfolio of gas from waste and electricity from waste projects. They are the ultimate green company. They make money off of everything, including the acorns that adorn the streets of Mount Dora.

I bought WM years ago as a turnaround and both it and its share price have done nicely. I don't think there is any large underpricing here and the share price will mirror the market moves. But that's OK as I also get the 3.6% dividend yield. The payout ratio is about 60%, higher than I'd like, but the rather consistent revenue stream gives me comfort.

Waste Management is a fine company available at a reasonable price that throws off an excellent dividend. A core holding that pays much more than a CD or savings account.

Thursday, November 18, 2010

Pensions And Commodities Are Stiff Headwinds For Industrial And Consumer Product Companies

Recent news articles on Honeywell, UPS, and General Motors have served as a reminder to pay attention to pension obligations and their corresponding impact on cashflow. Before establishing a new position I attempt to make sure that I've factored into my decision making the potential negative impact of a defined benefit pension plan. Occasionally I'll take a shortcut and that aspect is missed. Annually I scour my portfolio to make sure I'm aware of pension issues. Many multi-national industrial and consumer product companies are saddled with underfunded plans that must be addressed.

The impact on earnings isn't always negative, as in HON's case, as they may be able to change accounting treatment and lessen the impact on net profit. But they can't change the impact on cashflow. Less cashflow, less balance sheet cash, or more debt are the only real ways for a company to bring their pension plan up to snuff. None of which are positive for the cautious investor.

While the stock market's rebound is beneficial to pension funding, the bond component of pension assets remains dismal. Plan assumptions have been too optimistic, for too long and companies are addressing the issue. But the timing is far from perfect.

Not only are we in a global slowdown, commodity input prices are raging. Any company that makes a product is facing significant pressure on margins. Now, after several years of poor performance in equities and low bond yields, companies are needing to start a more aggressive refunding of their defined benefit pension plans. Unfortunately it is at the same time as sales growth is difficult to capture and input costs are soaring. Difficult headwinds.

QE2 and emerging market growth may continue to lift all stocks, but my suggestion is to cull portfolios of the weakest firms with underfunded pension plans. Battling rising costs in a tough sales environment is difficult enough.

Saturday, November 13, 2010

Annaly Remains A Reasonable Position Despite Cramer's Endorsement

A 15% yield is normally an omen of impending dividend suspension. Combine that yield with leverage usage and the mortgage industry and one should generally avoid the security in question. Now toss in a recommendation from Jim Cramer and it is often time to duck. I'm now worried, but I agree with Cramer that I should keep my position in Annaly Capital Management [NLY].

Annaly is a REIT that invests in agency securities, therefore it takes no credit risk assuming you view the U.S. Goverment's guarantee as solid. It leverages its capital to purchase more securities, although not like the financial time bombs of several years ago, and enhance earnings. It does take on interest rate risk, but through asset/liability management attempts to limit the impact of interest swings. It uses a barbell strategy of floating rates on the shorter durations and fixed rates on the longer holdings. How well it will work as QE2 accelerates interest rates remains to be seen, but the management team has done a credible job since its creation in 1997.

Is a dividend cut coming down the road? Don't know. As a REIT they have to distribute 90% of their net income, so it is all dependent on NLY's continued earnings ability. Clearly the current rate environment is one that is working for them. As rates rise their profitability will depend on how well they execute their A/L strategy. A sudden, sharp interest spike would be the worst scenario, but with a Fed intent on keeping rates low, NLY probably faces a slow creeping interest rate environment which is easier to navigate. Thus, several more years of attractive dividends and yields. Continued dividends and low yield alternative investments also leave room for share price appreciation.

NLY has treated me well for quite some time and I remain confident it can overcome Cramer's recent praise.

Monday, October 25, 2010

How Does The Blogosphere Function Without Me?

It's been about 45 days since I last had something worthwhile to write. While that has left Crusty's readers in the lurch, my in-person buddies have remained subject to the same verbal drivel that they have become accustomed to. But, again, time has flown and I've been busy, busy, busy. Time to write.

Almost all stocks have risen with the market's recent advance. I'm only bleeding on a few short positions and my ownership of Smart Balance. A few covered calls have been taken away and several others are hovering around the strike price, but that's OK.
Crusty is feeling happy as the market and my net worth has rebounded.

But, that feeling of elation is starting to feel a bit tentative. There is quite a consensus regarding QE2, a weaker dollar, and the attraction of commodities and equities during a period of money printing. While I suspect there isn't a ten percent correction coming between now and year end, who really knows? A Democrat victory, a European melt down, or deteriorating numbers from the emerging markets, and a host of other possibilities, could cause serious problems. Celebrate, but remain wary.

Some recent purchases are INSU, the sewer replacement company, SHAW, the engineering nuclear giant, and CLD, a BHP Biliton North American coal spin-off. All have turned in good earnings performances of late, look solid going forward, and have been creamed by the market.

Time to walk the dog. It's finally turned cold in Nebraska and I can't delay any longer as she is staring at me with some extreme urgency. So no more stock talk, out the door I go.

Monday, September 13, 2010

MO: Not Altria, Not Momentum, But Molybdenum

I haven't smoked since college, never owned a tobacco stock, and I generally don't think favorably of momentum investing, so I've rarely thought of "MO". But I got interested in MO this Spring and remain so. Molybdenum is atomic number 42 and periodic table symbol MO.

MO is a necessary component of steel and industrial products. It's not a precious metal, it was nearly so when it sold for $40 per pound several years ago, but an industrial metal selling at about $16 per pound today. Recently the London Metals Exchange started trading MO, but the price is mostly determined by industrial usage. That could change.

I generally don't speculate in commodity prices, but inflation and currency debasement concerns gets me thinking about protection. The best way for a value investor to participate in commodities is through a reasonably priced company. I found Thompson Creek Metals [TC] awhile ago and like the company even more now than before as it is about to go from a pure moly miner to a mining company that also has gold and copper interests. The latter come through the acquisition of Terrane Mines which should close yet this year. Terrane brings diversification and a precious metal component.

Thompson Creek is a solid operation, not some "junior" mining operation that could go away tomorrow. TC has a market cap of $1.5 B, over $600M of cash, and no debt. Before you get too excited, much of that cash and about 25MM shares will go to Terrane shareholders, but the company gets significant mining assets and a revenue stream. Pre-acquisition it is trading at a forward P/E of 7X and EV/EBITDA of 4.5X. Trailing twelve months ROE is 16%.

If the world economy plods along, TC will do well. If it craters, they won't fail. If central banks weaken international currencies like I think they will, molybdenum and other industrial commodities will explode and TC will participate. Beyond central bank mischief, MO will be in demand because China has now entered an import phase and is no longer an exporter. If China builds stocks like they have in copper and other industrial metals that should encourage LME activity and price rises. TC is an efficient miner and roaster that will certainly benefit from rising prices of their product.

Current pricing of TC is attractive and even though it will go down if the world economy slows, a several year out time horizon will be rewarded.

Saturday, September 11, 2010

Tinet Kickstarts Neutral Tandem's New Growth Initiatives

Maxwell Smart was an idiot that employed cutting edge communications. Mr. Market represents today's idiots that don't understand, and can't differentiate among, telecommunication companies. Intense price competition doesn't always result in Level3 [LVLT] like financial performance. Yet, that is exactly how the market is treating Neutral Tandem [TNDM].

Disruptive technologies and commodity offerings do result in revenue challenges, but all companies aren't affected equally. The downfall of LVLT and most similar companies was severe over capacity and usage of debt, two factors that do not negatively affect TNDM. Neutral Tandem is debt free and asset light, as they have taken advantage of industry over building and leased their fiber at attractive rates. They have also stayed out of the retail business of their customers and also not pursued enterprise business in competition with those same customers. They've remained wholesalers and have, consequently, be able to gain market share of carrier business.

While TNDM has gained share, total minutes are growing 20+ percent, prices are falling. Revenue is flat, but margins remain healthy. Their niche in voice switching remains solid and viable for the forseeable future. But growth is elusive and a company needs to grow. Management has pointed the company in the direction of termination of international calls and ethernet exchange. They have been expensing all of their expansion efforts and have the balance sheet to accomplish the mission.

Thursday the company jump started their international and ethernet plan. They announced the acquisition of Tinet, an Italy based IP transit and ethernet services company. TNDM is paying $95MM in cash or 6.1X post synergies EBITDA; 7X without the synergies. After the all cash transaction, TNDM will still have over $90MM of cash on hand. The balance sheet will remain strong as TNDM continues to project throwing off over $30MM of free cash next year.

Tinet, with sales of $56MM and EBITDA of $10MM, brings a strong presence in wholesale IP transit and about $5MM of ethernet revenue. The combination of TNDM's North American voice business with Tinet's international data networks offers significant new business opportunities within the customer base. The combined network will offer future ethernet customers over 100 locations worldwide, much broader than any of the fledgling ethernet providers. This growth area now looks much more promising and the CEO states that ethernet revenue should be growing nicely in 2011. Additionally, termination of international calls should ramp up revenue as TNDM solicits Tinet's customer base.

The combined company, at 6/30/10, would have had sales of $230MM and $99MM of EBITDA. After deducting $95MM of cash for the acquisition, the enterprise value of TNDM is only $236MM or 2.4X combined EBITDA. TNDM is cheap.

Maxwell Smart, I mean Mr. Market, will eventually accept that TNDM's voice market isn't near-term terminal or become ethernet exchange believers. Short sellers, over 10% of the float, have made a killing on the ride down and must be near the exit point as the bottom must be near for a company with no debt and lots of cash per share. We may be several quarters away, but at $10 Neutral Tandem is a buy. I thought so at $13 and I'm a bigger believer after yesterday's announcement. I bought more shares on Friday and harbor no thoughts that TNDM will follow the path of Level3.

Sunday, August 22, 2010

I Prefer Watching A Bull Elk Rather Than The Bear Market

August has been a lazy time for Crusty. More lazy than normal. The market has meandered and my portfolio decisions seem sound. Or, if not sound, void of new ideas.

A couple of weeks ago a deer jumped over my back fence and bounded towards the neighbor's yard and the lake. I'm used to pheasants and an occasional raccoon in the yard, but the deer was a first. I see them in the parkland surrounding the lake so I'm aware of their presence but, as I wrote, seeing a deer in the backyard surprised me. It also made me want to go to the mountains. So, we packed up the car with the wife and the dog and headed to Colorado.

Around Estes Park you can't miss the elk. They are everywhere. They seem to be particularly fond of yards, shade, and flowers. I sure enjoy watching those beautiful animals eat other people's flowers and shrubs. Elk, deer, aspens, pines, peaks, canyons, rivers, and mountain cabins all provided outdoor enjoyment. Why spend time thinking about investments? But I did sometimes.

Mountain forests got me thinking about Redwood Trust [RWT], a holding of mine that, at present is working fine. RWT is a REIT that invests in mortgage loans, bonds, and securitizations. It sells for about $14 and yields 7%. It actually returns more as the dividend is classified as "return of capital" since RWT has no accounting taxable income. So, the income stream is attractive and will remain so for another year or so before the dividend starts being ordinary income again, but, by then, I hope Redwood can pay a higher dividend like they once did.

RWT isn't without risk as real estate investing isn't surefire. But, they have made it through the worst of their portfolio decisions and have huge reserves put aside against their likely losses. They have plenty of cash, capital, and good credit controls. They don't take interest rate risk. They take credit risk and are good at it. Wally Weitz thinks so and so does Crusty. RWT provides both income and upside.

Another REIT that has done well by me as the Fed has held interest rates down is Annaly Capital [NLY]. Just the opposite of RWT, NLY doesn't take any credit risk as it buys agency securities, but it assumes lots of interest rate risk as it borrows short and lends long. And leverages itself about 5 times. But it does all that well so it can pay a hefty dividend. Currently 15%. It should remain a good position until rates start climbing which will obviously impact its spread and stock price. NLY is a different animal than RWT, but that's why they are both worth owning.

All REITS are not the same, so if tempted by their yield, do some homework. I hope I've done mine correctly. If I haven't, I may have to return to Colorado and live in a trailer, not a chalet.

Monday, August 2, 2010

Prepare For Disappointment

I had great hopes that last Thursday would be a good stock market day for me. I was sorely disappointed. Mentally I was ready for some lousy results on three of my companies that were reporting earnings that day, but the rest of Wall Street wasn't as sanguine and brutally punished those securities.

The percentage moves were huge for a one day period. Bunge had been trading around $54 and was pummeled to $46, Neutral Tandem was taken down from $13 to $10.50, and Brunswick moved up from $14 to $17.50 [ a short put that stopped working ]. Lots of shares changed hands, probably lots were momentum driven, as the market reacted first and studied, if they did, later.

If a person's investing time horizon is longer than a nano-second, BG and TNDM were, and still are, attractive at those lower prices. The negative bet against BC will also still work, but it will work better for new money as it continues to act strongly. It will take another couple of quarters before company results start looking promising and I feel smart again. Bunge has already climbed back to $52; that's up $6 from the day of panic.

Nap time.

Friday, July 16, 2010

How Come The CPI Doesn't Equal The Rising Prices I Pay?

Deflation is on the Fed's mind and pundits propose that inflation isn't possible as long as banks aren't lending and excess reserves continue to pile up at the Fed. Those worries may be valid, but I sure seem to be feeling the impact of rising prices. Aren't rising prices inflation?

Today's CPI release showed a tame inflation number, both headline and core. One of the key components of the CPI is the owners rent component, at appoximately 30 percent of the index, and that makes some sense as it is a major driver in consumer spending monthly. This number has been decreasing due to the depressed housing market, but I own my homes and see no benefit to this mythical benefit. Many other components may be statistically decreasing, but factually increasing.

I recently purchased a new car. It cost more than a few years ago because the manufacturer and dealer equip them better and the CPI calculators figure I've gotten better value, therefore, that equates to a price decrease. But I really didn't want a navigation system, super exterior and interior coating, and a sunroof. But I got them and I'm supposed to be happy that I really paid less, but my checkbook says differently.

The same is true about my favorite snacks. The prices have remained the same, but I get either fewer or smaller portions. I don't need the calories, but I'd like to have an actual lower price rather than a hypothetical one.

I had a guy out a few days ago to repair my cedar deck. He said he doesn't even bid a cedar job without calling the lumber yard to get the current quote as it has been rising consistently. Peachy! Cedar must not be in the CPI.

My mail a few weeks ago included a price increase from my health insurance carrier, American Republic Insurance, and, you guessed it, it was going to go up about $200 per month. Thank you President Obama and the non inflation calculating feds. Yesterday my car insurance went up $1200 per year because they switched a car from a Nebraska policy to a Florida policy. The non-insured driver component in Florida is out of this world and now I have to pay for it. I think I'll sell the car as we hardly use it, but none the less, that price sure didn't go down.

My nephew just told me of his tuition increases and they aren't going down. In fact, the increases in college tuition is darn near criminal and, once again. due to government mettling. If it weren't for student loans, universities would find a way to provide more affordable education in combination with parental support and part time work. No inflation here!

Take a look at all of your tax bills. Not the big ones, but the stealth ones. Cable, telephone, wheel, licensing, fees, they're all going up and governments are becoming more creative daily.
If it doesn't qualify as inflation, it surely affects my pocketbook negatively.

You get the idea, prices that real people pay are rising no matter what the CPI calculates out to be. You may get a great deal on a house or boat, but if you aren't in the market, that doesn't help. Prices are rising for day to day expenses and that continues to crimp the consumer. Don't look to Washington, or Obama, for help as they are about to make things worse by raising taxes and decreasing deductions by the elimination of the Bush tax cuts. Once again, that may not appear in the CPI, but it's a price increase and price increases don't create prosperity.

I hope I'm just old and cranky, but it sure feels like I'm paying more all the time and Washington's policies aren't helping.

Monday, July 12, 2010

52 Week And All Time Highs

The path to a security's 52 week or all time high isn't always pretty. But who cares? In today's market I feel fortunate to have noticed that several of my holdings are at or very near all time highs.

None of the three, DEP, EPD, CCW, are traditional stocks. The first two are Master Limited Partnerships in the gas services industry and CCW is a "baby bond", often referred to, incorrectly, as a preferred stock of Comcast, the huge cable television operator. The common thread is steady income to the investor.

All three have distributions/yields of approximately 7 percent and, as interest rates have been decreasing, have gained value. All have good underlying fundamentals, but are no longer cheap. The old saying is "every day that I don't sell I'm a buyer" applys here. I still own them so I must think they are a reasonable place to keep money parked.

It's fun to have a few securities that are hitting new highs.

Tuesday, June 29, 2010

If Long On Colombian Oil, Forget HUSA and Consider GTE

It's days like today that I congratulate myself on my attempts to look for value and put emotions aside. Short positions are, obviously, doing quite well and my dividend payers are falling less precipitously than the average security. Still I review my thesis to confirm that logic still prevails.

While my HUSA short is doing very nicely, it is worthwhile to compare Houston American Energy to other Colombian exploration companies. If I wanted to own a piece of Colombia's growing oil business, I'd consider an investment in Gran Tierra Energy [ GTE ], not HUSA. GTE is an actual operating company that is proving itself nicely in South America while HUSA is a hope and a prayer speculation. HUSA could turn out to be a huge winner, but I strongly doubt it. A person could earn a good return with GTE and, maybe, get a huge winner. A comparison of the two companies is worthwhile.

Today, the market values GTE at $1.3B and HUSA at $315M. Per share, you can buy GTE at 1.5X book value, but must pay up to 10X for HUSA. On a sales basis you only have to pay 4X for GTE, but must fork over 29X sales for HUSA. Clearly, on a financial valuation basis, GTE is the better buy. How about on a production basis?

GTE is running at 15,000 BOPD net. HUSA's net is only 1000 BOPD and that production is for sale as it is controlled by Hupecol, the operating partner. Gran Tierra owns 100 percent of it's wells and leases. GTE produces 15X more oil, but is only valued at 4X more than HUSA. Not only are HUSA shareholders paying more per share for each sale, they are paying a huge amount more for cashflow as EV/EBITDA is only 4X while HUSA is valued at 94X cashflow giving GTE a cashflow yield of 25% and HUSA only about 1%. So, HUSA loses on the basis of financial valuation and production metrics. How about future big oil finds?

HUSA has an interest in about 1.1 M acres in Colombia, but only at approximately a 12% ownership interest. GTE owns 100% of over 6M acres of exploration in not only Colombia, but also Peru and Argentina. With GTE you get the potential excitement of Peru as well as Coumbia. I won't delve into who has better drilling prospects due to proximity to large, producing wells since they both say they do and I don't have the expertise. Both aren't burdened by debt, but face large exploration budgets. Both sets of investors hope that big oil finds are ahead.

If I want to own a lottery ticket on South American oil, GTE has much safer odds and more upside per share. Conversely, HUSA is priced too richly and I'll continue to say short.

Monday, June 14, 2010

Ray Charles Couldn't Miss This Opportunity

Since Neutral Tandem is down about a dollar since I launched my latest telecom investment, I decided to review the wisdom, or lack thereof, of that decision. I remain convinced and Ray has to be with me. He would have been able to see the value if he was still with us and I'm sure he can see this no brainer from above.

Here are the fundamentals on TNDM:

Forward P/E 10X
Earnings Yield 10%
P/B 1.6X
ROE 19%
Cash per share $6
$184 million cash and NO DEBT

Negatives? Revenue growth has slowed as prices are coming down, but market share is growing as minutes handled is growing by 25%. This trend will likely continue, but the company has a neutral business model, it doesn't compete with its customers like other competitors do, and an amazing stable of customers. It's service offerings are growing and customers are buying more. An ethernet exchange is the next growth area, much larger than the current switching opportunity, and it has a leg up on its competition again due to its neutral positioning and established customer base. TNDM is priced like it is going out of business, but it isn't and that's where the opportunity arises.

Neutral Tandem presents at William Blair's Growth Conference on Wednesday. Maybe Ray and the Blues Brothers will help TNDM impress the Chicago investment house's attendees and the market will start to appreciate this very cheap stock.

Working The Numbers Backward Can Be Enlightening

Houston American Energy [ HUSA ] has been causing me some pain lately. I'm still ahead of the game, but don't enjoy the cushion I once did. The last several days have caused me to question my thinking and consider covering my short position. OK, I've considered my options and I'll stay short. The pain may get worse, before it gets better again, as HUSA's new found market cap makes it a likely candidate for inclusion in a Russell Index at the June 30 rebalancing. Inclusion will cause some one time buying by index funds and remove a little float. But it doesn't change any of the fundamentals of the company itself and those fundamentals are very over valued.

HUSA is a three employee operation that has some small working interests in a couple of Louisiana and Texas wells that hardly produce any oil/gas. Additionally they own other minority working interets in some Colombian properties. That's right, Colombia land of the drug cartel and women that wear funny hats. Those wells are producing some oil, but not huge amounts. Basically the Colombia properties are speculative in nature, not proven reserves. They do happen to be near proven properties and that leads to the hype. And that is what I believe is in full gusher at HUSA, hype, not substance.

Here are the numbers that speculators are willing to pay:
Price/Book 12X
Price/Earnings 108X
Price/Sales 35X
Market Capitalization $434 million

Can it get better than that? Do buyers really think shares can double? Let's work some numbers backwards from the current market cap of $434 million. If HUSA was a real operating company with current production and very good future prospects, an investor might be willing to accept an earnings yield of 5%, or a 20 P/E. That would mean the $434 million market cap should be justified with $22 million of after tax earnings. HUSA has been making about $500,000 per year until last year when they lost $670,000. They did do considerably better in the 1st quarter as they made $800,000 or annualized, $3.2 million. Clearly current revenue and net income doesn't justifiy the current market cap. What does then?

In the last quarter of 2009 HUSA raised about $15 million at about $4.50 per share and used that money to buy some Colombia concessions. Magically the stock price rose and the company is now worth multiples of that equity raise. Additionally, most of their producing Colombian properties are for sale. Hupecol, the managing partner, is attempting to sell wells and leases that produced most of HUSA's $4 million of revenue in the 1st quarter. How much can $4 million of revenue be worth? The unproducing areas require lots of expense and risk, so how much can the rest be worth? The company points to a similiar, they say, sale by Hupecol, 6/08, that fetched $920 million with HUSA's share amounting to $11.5 MM. Those proceeds didn't last long as HUSA needed to raise cash in 2009 and will spend an additional $10 million in 2010, fortunately they have about $14 million on hand and no debt. Even if Hupecol can arrange a sale that, pick a number, gets HUSA twice the proceeds, they have more cash and no operating wells. What would you pay for cash today? It's still going to be a company that is valued on hype because they won't have any production after a sale.

Can 1000 barrels per day production and a bunch of leases be worth $400 million? I think there is little danger that actual business results begin to justify the current share pricing. Therefore, the price will adjust downward again as soon as the euphoria ebbs.

Wednesday, June 9, 2010

Not As Short As This Fellow, But Owe A Few Shares

What do the following all have in common? The nation's largest boat builder awash in debt, a legacy airline hugely awash in debt and union issues, an tiny oil company with a huge market capitalization, a well regarded bank with a huge subprime portfolio, a fancy fitness club operating in a terrible industry, and a broad market index. They represent most of my short positions. They've provided a good hedge against my longer term holdings and have kept me from finding a high ledge.

Mid June is nearing and, as I mentioned in an earlier post, expect the media to feast on a California budget crisis as we near mid month. Comparisons to Greece will be rampant and requests for more Federal help will fill the front pages and cable shows. California will once again bring our over borrowing to the forefront. Sounds scary, so I would guess the markets won't like it even though they should already know its existence. I'd be surprised if my shorts didn't make me happy and my long positions cause me anguish. But I'll try to remember that I own stocks for a purpose and a long horizon. In the meantime I will borrow some more shares. Especially Brunswick as the California problems and Florida oilslick are not going to be conducive to sales of new boats.

Time to go tally today's damage and see if mama can buy new shoes.

It Never Hurts To Ask The Question

Bunge is up $4 this morning, for all the wrong reasons! It's not their repositioning from fertilizer to sugar and ethanol. It isn't the valuation metrics that are much improved since the share price has come down from the lower 70s. It is due to last evenings announcement of a $700 million stock buyback program. An authorization that may, or may not, be used to its fullest authorized extent. It's a wonder I make any money at all since my thinking is sure different than many on Wall Street.

I've also been questioning myself on my Smart Balance position. I'm currently into the second year of my estimated 5 year holding program on this venture. SMBL doesn't have a fortress balance sheet or a sterling earnings performance, but it is building a great brand and someone, over time, will take it out. Management has done this same gig many times, all successfully. They will again and lots of money will be made. But it was a lot easier staying true to my thesis when the stock was several dollars higher. The market has taken the company steadily lower over the past month and I am now only slightly over my basis. SMBL is a bet on management and mangement is still on the job. I'll continue to wait even though those smarter than me continue selling. I could be wrong, but as Charles Barkley says, "I doubt it."

Natural gas companies have been more in demand lately. Devon, a company like Bunge that has largely liquified its balance sheet and changed it's emphasis from offshore oil to gas, has been doing nicely. The safer side of a Devon investment is some of the pipeline Master Limited Partnerships, guys that get paid for carrying the product. Names like EPD and DEP are down, but still yield 7%. They are a reasonable place, in this low interest rate enviroment, to have some exposure, especially as the country moves to a more natural gas environment.

Time to quit typing, get another cup of coffee, it's too early for scotch, and see what the market is doing to me. Am I smart or stupid?

Friday, June 4, 2010

Bunge Has Gone From Worthy To Compelling

It's difficult to buy equities in a lousy market, but if you truly believe, and have discipline, that you will hold the securities for many years then it becomes easier. Remember I said easier, not easy, as you will kick yourself with each market swoon. But, you ought to make money. Since I think we'll stay in a difficult market for a long time, it's obviously better not to bet the farm at one time as the market will continue to give you opportunities at lower entry points, so scale into a company like Bunge.

Not too many years ago, during the great fertilizer mania, BG was selling for about $140. Today you get to buy it at about $49. That's still higher than was available at the bottom, but still an excellent entry price. Espescially since Bunge is significantly changed since that time. It has ramped up it's sugar and ethanol production in Brazil through an acquisition and, just days ago, closed the sale of its ferilizer mining operation, keeping retail.

BG will net $3.5B from the sale and use at least $1.5B to reduce debt. If they decide to use it all, they could almost be debt free. Before the sale, today's price was about 85% of book and I'm guessing that when we see the quarterly numbers, book value per share will be higher than last quarters's $55 per share. It never hurts to buy at less than book. On the earnings front, they project 2010 earnings of between $5.30-$5.70, say $5.50. At a share price of $49 you are acquiring an ag leader for less than 9 X earnings. And you get a large exposure to Brazil.

Bunge pays a dividend and has a good coverage ratio, is an excellent grain merchandiser, has some leading brands overseas, now has an ethanol component, possesses a good balance sheet, and is the best ag name to own. Much more attractive than ADM or Corn Products, a company that BG could take another run at with their new cash horde.

Buy a little here and more later and eventually you'll be happy. You can't get beat up too badly in the interim like you can, and will, on those 15-20X P/E companies.

Friday, May 21, 2010

If You Are Attracted To Brazil, Buy EWZ

I happen to like Brazil and find many similiarities to an earlier time in the USA. Immense natural resources, export and internal consumption opportunities, population growth, and an expanding middle class. The government is stable, debt manageable, and the future bright. President Lula doesn't appear to be a total socialist.

EWZ is an ETF that tracks the Brazilian stock market. It had an amazing 2009. It has fallen like a rock the past several weeks as speculators have fled riskier assets, i.e. commodities and emerging markets.

If one's investment time horizon is longer than a couple of days, EWZ has merit. At present pricing, it has a distribution yield of about 4%. It is an income play as well as an emerging market bet. The 4ish percent distribution evolves from the portfolio composition. About 60% of the portfolio is invested in preferred stocks. These yielders not only throw off dividends, but are higher up the priority ladder should Brazilian companies start to falter.

The stock price may decrease further from here, but you get 4 percent to wait for Brazil to prosper. And prosper it will. There's too much oil, agriculture, steel, and consuming citizens to avoid growth. Yesterday was the best day in quite awhile to buy Brazil, today wouldn't be bad either. Expect it to go down, be happy if it doesn't, enjoy the distribution, and reap the benefits down the road. In the mean time sit back and enjoy the precision flag twirling half-time show on Brazilian soccer.

Saturday, May 15, 2010

Book Rooms For The IMF In Sacramento this June

What do you do when you have time on your hands and don't get your way? Ask the Greeks. Ask our illegal alien population. Soon you will be able to ask those with their hands out in Portugal and Spain. Why riot of course. Tell the news media the world will end and children will be harmed. Threaten not to vote for anyone that cuts your entitlements. Why would you vote for the SOBs that cut your six weeks of vacation? Riots, riots, riots and we're going to see more. Right here in the good old USA.

California is supposed to have their budget approved in mid June for the 2010-2011 fiscal year. The Governor and the legislature are miles apart. Arnold says all the low hanging fruit has been picked as well as the medium hangers and the high hanging fruit as well. All the easy cuts are history. Republicans refuse to enact tax increases or new levies/fees. Cutting programs that have loud constituencies is all that remains. What do loud constituencies do? Complain to the media and riot.

June ought to be a difficult month for the markets. California's problems aren't new or surprising, neither were those of the PIIGS. But no one worried until they were upon us, then panic set in. First with traders, then politicians. Expect the same to occur this coming month as California deals with its budget and angry recipients and taxpayers. Arnold & Co will hit close to home. It's not some foreign land, it's part of us and it will remind us of all of our own unsolved problems.

If markets don't like uncertainty, then we ought to see some significant downward pressure on stocks as the drama unfolds. Here's the sequence of events: talk of program cuts, recognition of huge deficits and debt, riots, pleading to Washington for help, panic and stock plunge, buckets of money from DC, promises to cut and tax enough to get California's house in order, equities rebound significantly. Bet I'm right.

So, even though they will go down in value also, I'll stick with my income stocks and MLPs, gold and silver positions, long-term hold speculations, and short positions. On the first big bounce back day from last weeks decline, I am going to pitch my index funds and buy a few more puts. I should do more, but I'm often wrong, especially with timing so I always have to hedge my bets. But the future sure looks clear and the picture isn't pretty short, nor long term. Too much debt everywhere and an investor class that has started to recognize that fact and is becoming more fearful daily.

Invest in Sacramento hotel rooms as they will have high occupancy as the media and Obama's henchmen come to town.

Sunday, May 9, 2010

The Circus Starts Anew Monday

The circus comes to town again tomorrow morning. Possibly this evening if the Asian markets get flustered. Later the Europeans will be celebrating a Greek bailout or stewing over the next candidate and the taxpayer footing the bill for the shiftless. The day's stage may be set by the time the U.S. markets open.

What will we fear or celebrate on Monday?
Greek stalemate? A strong Eurozone plan? Contagion? Volcanic ash clouds disrupting air travel? A gigantic oil slick that can't be contained? American bank exposure to Europe? Goldman Sachs? A slowing Chinese economy? IMF funding of the Euro plan with 40% contribution from the USA? Riots in Greece? Riots in Arizona? The latest, mind numbing statistic?

Will I be happier with my Brunswick short or my new Neutral Tandem position? We'll find out shortly as volatility has returned and markets are being swayed by the concern of the day. It isn't investing, it's speculation and fear that are driving the day to day pricing of the stock market. The actual value of the underlying companies cannot gyrate to the extent their stock prices do. But the prices do gyrate. So wait for a return of sanity, sell into declines, or a little of both.

Who will have control of the bigtop in the morning?

Saturday, May 8, 2010

I Need My Head Examined

Be cautious, look over your shoulder, lighten up on rallies, all make sense and generally describe my investment behavior. But it gets boring staying with the same long term holds, dividend plays, and anti-inflation stocks. So, in the midst of the recent melt down, I opened a new position that will either do extremely well, as everyone seems to hate the company, or limp on as another Level3. In fact, it is a Level3 competitor. I invested long in the telecom field. I need my head examined.

The latest proof of my increasing dementia is my purchase of Neutral Tandem, TNDM. This is a relatively young company that went public in the Fall of 2007 and has grown rapidly in sales and profits. 2010 revenue is projected to be $180M and analysts predict earnings per share of $1.11. TNDM currently sells for $13; a PE of 11. It went public at about $17 and was in the mid 30's as recently as 6 months ago. It's gone the opposite way of the market.

The company is performing wonderfully. May 5th TNDM announced 1st quarter results and revenue grew 17% due to a 26% increased in minutes billed. EPS was flat for the quarter. They have $171M of cash and no debt- a rock solid balance sheet.

So why doesn't anyone like the company and why has the stock price been cut by nearly 2/3rds? I wish I knew for sure. The concerns that have been discussed are a patent battle with competitor Peerless [ since they already compete, and the company has other competitors, the worst outcome is high attorney fees], recent competition from both Peerless and Level3 [ revenue growth shows the company is holding its own, but flat earnings on a 26% increase in billable minutes the indicates pricing pressure of competition], and finally more direct traffic between carriers that doesn't require tandem switching.

Neutral Tandem's business is the switching of calls between new carriers [Sprint, cable, etc] and telecoms majors. TNDM doesn't compete with their customers like other carriers do and their tandem system is state of the art. They are the big player in this subset of telecom. Competitive pressure and the future of IP switching will not decimate revenue and earnings overnight. They are also expanding into ethernet switching which should add new revenue streams.

The stock price trend is down and it sure could continue, especially if the market continues to hemorrhage, but I think $13 is a good entry point. At an EV/EBITDA ratio of 3, you usually do well with a position, especially if the balance sheet is sound.

I've pulled the trigger so lets see how it turns out.

Thursday, May 6, 2010

Yessiree, Crowded Exits Are Painful

It might have been caused by a trading error at Citibank, executed by a computer, and compounded by mechanized sell programs, but it was still illustrative of fear. Investors have been staying far too invested, even when they knew they were in the danger zone, because prices keep climbing and they had a false confidence in their ability to exit before trouble was recognized. Today's market action proved them wrong. Everyone wanted out at the same time. Fear was in charge.

While the market was crashing today, I was at a memorial service for a friend that had passed away. It was a beautiful service and the family was comforted. I was enjoying the ride home until the phone rang and a distraught friend told me the Dow was down 1000 points. Now I was sad again. I was short a few positions and owned gold ETFs, but my long portfolio would suffer more than the negative bets would help. Intellectually, buying stock then would have been scary, but proper. I was a long way from a computer, so I went to lunch. By the time I got home the Dow had gained back 600 points and ended as just a crummy day, not a disaster. Tomorrow is not a day to pick up bargains. If the market does rebound, enjoy it and consider lightening up some positions. Fear has raised its ugly head and she isn't pretty. The exit is also real small. Getting through is difficult.

Thursday, April 29, 2010

Bet Against Brunswick

Everyone likes a ten-bagger and speculators have become giddy over the future prospects of Brunswick. The company was being given away at about $2 twelve months ago. Today it was up 27% to $22.69. Quarterly earnings handily beat analysts' expectations, but the company still lost .15 cents per share or $13 million. BC doesn't plan to make money in 2010 and is hopeful it can return to profitability in 2011.

Revenue is running about 1/2 of its 2007 level, but it did grow quarter over quarter for the first time in several years. Like housing, since the boating/recreation industry was also supercharged with home equity funny money, former revenue levels aren't coming back for a decade. The company is forecasting that industry retail sales will decline 20% this year and sales at BC are reflecting that pace in January and February. March was much better at the wholesale level, but the company is cautiously optimistic about the boating/marine outlook.

In 2007 when the company recorded sales of $5.7 billion, they dropped $111 million to the bottom line, or 2 percent. Analysts are forecasting sales of 3.7 B for 2011 and earnings of 2 cents per share. With 90 million shares outstanding, that $.02 is net income of about $1.8M. Not the stuff of legitimate ten-baggers. If by a miracle they were to get back to the 2007 earnings level of $100M, today's price would still be valuing BC at almost 20 X peak earnings. Management isn't even close to thinking about returning to peak earnings. But speculators and financial illiterates have become devotees.

Their marine business may be seeing some uptick in business with replacement mercury engines, but all 16 boat lines have to be suffering. My marina and reports from the lake of the Ozarks say that sales are slim as they have to compete with repo boats and inventories are slimmer as floorplan financing is difficult to obtain and afford. In exercise equipment, most individual sales are New Year related and health club chains have cut back new openings-not a lot of growth potential here. Pool tables flourished with easy home equity financing and newly purchased McMansions. We know the state of real estate. Finally bowling isn't a hot market, but may be the best BC has available to it at present. The more I talk about their prospects, the more I consider increasing my bet!

The last over-valued company that I wrote about, Valmont, was a well run, solid operation that had just run too far. I never did sell any shares short as the upward momentum was too great and the company too good. BC may have momentum, and that can be dangerous and costly, but it isn't a great company. It has about $900M of debt and, even after significant cost cutting, doesn't have the revenues to start making money. I'm not predicting bankruptcy, but I don't think the market should be valuing it, today, at 20 X peak earnings when those earnings are years away. The price may run further, but it isn't sustainable.

This afternoon I sold BC short and intend to sell some more, especially if it continues to run. There isn't a big dividend involved so the margin interest should be easily covered assuming I'm correct. Additionally, if I'm wrong and the market takes it upward then the rest of my long positions will do well, reduced by the BC short. If it tanks, by itself or with a market swoon, the gain will soften the pain of the decrease in value of my stock ownership.

The world is starting to understand that government debt is a huge problem and that realization can't end well. The swoon yesterday, on big volume, shows that there are lots of very, very nervous investors that are playing a game of chicken or musical chairs. Fear in the government arena will negatively affect the equity markets. All of those ten baggers are at significant risk.

No one go out and buy an exercise bike, new SeaRay, or open a bowling alley. It's okay to bowl a few frames, I won't be mad.

Tuesday, April 27, 2010

Sleeping At Night Is Superior To Yield

All my adult life I've secretly, and sometimes openly, sneered at goldbugs. The world wasn't going to end and gold didn't yield anything. There were better places to put my money. I put gold accumulation in the same camp as bombshelters and canned rations. Fools thought that way and ended up without any net worth.

While those people were fools, I'm aging and my world has definitely changed. The aging part may have made me more cautious, but I still prefer yield and growth to precious metal safety. The changed world part continues to scare me towards gold. Government deficits and debts worldwide are past out of control and, worst of all, we are now beginning to understand the situation. The potential resolution of governmental malfeasance is frightening.

Our world isn't going to end, but we're facing a decade of sovereign defaults and devaluation of currencies. I can't envision that helping the equity markets and it has to be a killer to the bond markets. Broad market index funds aren't going to perform well, most diversified mutual funds will underperform, and balanced funds won't be the conservative place to park money due to their bond and stock components both being out of favor. Picking the right sectors or individual companies will continue to be profitable, but, as always, that is extremely hard to accomplish. Hence, the need for metals.

A recent GAO report says that by 2020, 93 percent of U.S. Government receipts will be committed to entitlement programs and interest on the national debt. Ninety-three percent! Virtually no money left for the military, education, etc. Certainly no bailout funds available. I'm not talking about Portugal, I'm talking USA! And Obama's not done. Our future is uncertain at best and maintaining wealth, let alone earning some, is going to be difficult. I only hope it plays out slowly, not rapidly, like the subprime/banking meltdown of 2008. Another European banking/sovereign collapse would take stock and bond markets much lower.

Last year I weakened and bought some gold ETFs, but sold at a gain since i still hadn't had my conversion. This year I am convinced that there is a place for gold in all portfolios. The ETFs have become a part of mine as has a Vanguard mutual fund of miners.

A testament to my true conversion is my belief that physically possessing the metal is also appropriate. Rather than owning just a share of ore in the mountain or bars in a depository, coins in my safe deposit box now makes sense. I'm, going to need a larger size safe deposit box. maybe I'll need two larger ones in both Nebraska and Florida. I don't know where I might be when the world starts to end.

I haven't stooped to filling my downstairs with MREs yet, or buying small plots of ground where I could, at least intellectually, grow my own food, but I have become convinced that the next ten years isn't going to be like the prior decades that I've lived through and prospered in. Real change is afoot and it isn't going to be easy or pretty. I intend to continue to prosper, but I'll have to change some of my investment patterns.

Wednesday, April 14, 2010

The Broken Record of Omaha

I haven't written lately because nothing has changed. I continue to fear for the future, but am enjoying the increased value of my equities. My cash assets continue to under-earn, but provide an Ambien effect at nights.

I haven't followed through on any short, or put, positions except AMR. Valmont and a few other serious candidates have risen steadily since I considered betting against them. Once again, either procrastination or fear saved me some money. I keep my negative list nearby incase my gonads grow.

Given the stock market's current pricing, the economic negatives far outweigh the potential positives. Last summer the negatives were out manuvered by the economic rebound. But after a 75 percent run, reflecting the improved economy, the negatives remain and there can't be much left that is sustainable.

The market goes up, but on relatively light volume. Conviction, or mania, is lacking. That means there are lots of investors that know they should be selling, but are enjoying the present ride up. At the first sign of trouble the exits are going to get congested. We could see a large decrease in valuation. But when? And how much further will the averages rise before the descent? I don't have the foggiest on the timing.

Markets like to inflict the maximum pain on the maximum amount of people, so with light volume we probably aren't really close yet. I just deleted my guesstimate for the downturn as I really have no conviction in my ability to predict macro economic timetables. I'm the Crusty Credut Analyst, not the Crusty Forecaster.

Sunday, March 28, 2010

Keep Looking Over Your Shoulder

The stock market has performed nicely over the past few weeks. Confidence appears to be growing and investors have been piling in. However , confidence can be fleeting. When it changes, damage can be severe. Making money is exhilarating, but losing is traumatic.

I hate trauma. That's why it's prudent to always look over your shoulder and see if investor psychology is changing. And change it will. Every professional investor knows that debt as a percentage of GDP is at an all-time high, far exceeding the Depressions ratio, and rapidly growing. Not just in the USA, but worldwide. They are all exhilarated and will continue to ride the momentum until they are shocked. Then the exits will become crowded and trauma pricing will set in. A forward looking stock market will soon see issues that government can't solve because government is a large part of the debt problem.

2011 is coming. Bush era tax cuts will soon be expiring. Quarterly estimated tax payments will hit the psyche of businessmen between the eyes. The realization of higher taxes will be here. Higher taxes stunt growth, hiring, and investment.Will the market actually anticipate the upcoming damage of rising taxes? I think it will.

Will we lose confidence prior to the tax increases for other reasons? I think so. State and Soverign debt is a smoldering problem. Central banks and governments can't bail them all out. Taxpayers, eventually, won't stand for all the debt forgiveness being placed on their shoulders. If debt will no longer be able to be transfered to taxpayers, banks, bond funds, and pension plans will need to start eating losses. Confidence and markets will erode. Everyone will look for safety and the exits will get crowded.

Our debt binge hasn't been solved so keep looking over your shoulder, better yet, shoulders.

Thursday, March 4, 2010

Valmont's Rise Is Overdone

February 17, 2010 seems lightyears away. On that day Valmont Industries [ VMI ] reported earnings and offered 2010 guidance. The good news was that net income grew 5% on expense control success. The bad news was that revenue declined 19% due to weakness in the utility and construction business. The company sees a 25% decline in net income for 2010! VMI stock fell several dollars to about $69.

Today, Valmont announced the acquisition of Delta, PLC, a similiar company in the galvanization business and manufacturer of utility poles and highway products. Delta is strong in Asia and Australia. The price is $430 million, including $350 million of Delta debt. The debt component elicited a warning from S & P that the company could be downgraded should deal terms or market conditions change negatively. VMI sees the transaction as accretive to earnings in 2011. The stock was up $8.12, 11%, to $81.63.

VMI is up $13 in 14 days. The company's recent guidance for 2010 has dropped concensus earnings to $4.26 resulting in a forward P/E of 19. A 19 multiple is fairly stout for a company with declining sales, a 25 % decrease in net income, and the likelihood of higher interest rates, thus lower P/Es.

Valmont is a solid company. It has generally earned a good ROE and hasn't over leveraged itself. It builds quality products and is a leader in each of its businesses. International business provides access to the faster growth of emerging markets. VMI is a company that is hard to bet against, but I think I will.

At 19 times 2010 earnings there isn't a lot of logical share price growth ahead. Poor earnings comparisons and potential merger integration issues, as well as the specter of a S & P downgrade, could cause pressure on the shares.

I haven't pulled the trigger yet, but I'm seriously thinking about selling shares short.

Thursday, February 25, 2010

Structured Products Are Alive And Well, Not Dead, Thanks To "Too Big To Fail"

After the demise of Lehman Brothers I recall reading an article about the end of structured products on Wall Street. The author's premise sounded logical given that the purchasers of Lehman structured products were considered unsecured creditors in Lehman's bankruptcy. Who would line up to "lend" money to a bank without either FDIC insurance or as part of the FDIC's Temporary Liquidity Guarantee Program? Hence, the end of structured finance. The end of a lucrative line of business for banks and, hopefully, less ways to lose money for investors.

Well, wrong. Structured products are alive and well. They may not be quite as daring as a few years back, but they are being sold with abandon and playing to investors quest for a deal too good to be true. Want a 10+ percent return with a relatively short maturity, plus the possibility to earn even more yield if underlying security does well? Would you like it even better if you were given ten percent downside protection? These are the kinds of deals that a proliferating in todays market satisfying investors desire for yield, growth, and safety. But it takes about 170 pages of disclosure to protect the issuer.

The main components of the typical deal aren't terribly complicated. To varying degrees, the bank buys the index or security, sells a call, buys some downside protection, collects their fee and uses the excess, if any, money. An investor could do the same thing for a lot less cost AND WITHOUT ANY CREDIT RISK! Plus, it can be done more tax efficiently than structured as all ordinary income.

What I find offensive is the credit risk. In these structured products you are making an unsecured loan to the issuer! You aren't making an investment in the S&P500 Index or Ford or a commodity. The issuer owns the securities. All the buyer has is the issuer's promise to pay. An investor should substitute Lehman for Bank of America or Citigroup when considering a structured product. Do you want to be an unsecured creditor? If you buy, you are.

Government bailouts have kept these types of investments alive. "Too Big To Fail" takes some of the risk out of making big banks unsecured loans. But government policies can change. There isn't a law that says the government will protect all stakeholders the next time a big bank self destructs. And sales pitches that sound too good to be true, usually are.

Thursday, February 18, 2010

Time To Tax Non-Profits

Politicians will resort to off balance sheet tricks such as Greece's recent admission, celebrate the Fed's "earnings" and dividend to the Treasury, and defer reality until retirement. If they admit that we face problems, more time will be spent blaming someone else than is devoted to solving the dilemma. Serious cost cutting will stay off the table until near the brink.

What can Washington do now that is politically palatable? Raise taxes on the rich is the likely answer. But if taxes are to be raised it should be on the untaxed. I'm not talking about the poor and undocumented immigrants. I'm suggesting the non-profit world. There is a huge swath of American business that isn't taxed due to their form of organization.

Credit Unions used to be mom and pop operations that served factory workers and were manned by volunteers. Now they represent a huge, untaxed portion of our financial system. It's not fair and doesn't generate tax revenue. Bankers would provide cover for the administration on this revenue enhancer. Goodwill Industries does worthy work training the handicapped, but they run an untaxed retail business of significant size. Non-profit hospitals compete with tax paying hospital companies. The list can go on longer than my typing stamina.

If tax increases are required, tax the untaxed. Cuts in spending, not in the rate of growth, are the best idea, but our elected officials don't have the gumption to do what is right. Next best is the tax changes I've proposed.

Tuesday, February 16, 2010

Copper Defies Supply And Demand

The rule of supply and demand states that as a commodity becomes scarser the price should rise. Conversely, as inventories grow, prices should weaken. The rule doesn't say how soon the price should rise or fall. You can go broke waiting for the rule to kick in. But, eventually people won't pay a lot for a commodity that is abundant.

Copper seems to be defying the rule. Inventories have been increasing dramatically and so has price. London Metal Exchange physical inventory has doubled since August!

Now let's look at the rise in copper prices.

Copper versus LME Inventories. Source: Bloomberg, LME

The copper bull market corresponded with a reduction in inventories. But as stocks of copper have grown, the price of copper has decoupled. Instead of going down, price has been rapidly rising. Why and for how long?

China is the reason most often mentioned.That and the weak US Dollar. Many believe that China was hoarding copper as an alternative to buying Treasuries, plus their lending and building boom would make good use of the metal. In fact China did buy over 40% of ALL copper in 2009. It's economy is no where near 40% of the world's economic output. Many feel that the Chinese have a huge inventory in addition to the LME and Shanghai warehoused inventories. Odds are that China will not be a 40% buyer in 2010. And the dollar has been anything but weak lately. Yet copper continues to rocket upward.

If the Chinese have slowed their purchasing and the dollar has strengthened, what keeps copper up? Pure momentum and speculation. Some of the same economic recovery belief that the stock market sees. In fact, copper has been fairly well correlated with the S&P500 lately.

Even speculators can read charts and when you read the inventory chart you should get scared. When producers like FCX say they aren't seeing enough pick up in demand to warrant capital investment that should be a warning that production is exceeding demand. As inventories continue to grow the price of copper will need to adjust downward.

I haven't figured out how, or if, to profit from copper's mis-pricing. Shorting high beta stocks like FCX could get painful as could buying an inverse ETF. I'm going to keep thinking and exploring as I think copper is overblown.

Monday, February 15, 2010

Are Longleaf and Fairfax Visionaries Or Just Stuck?

Years ago, like nearly everyone else who resided in Omaha, Nebraska, I drank the Level3 Kool-Aid. Level3 was an offshoot of Kiewit Construction and everything the Kiewit guys touched turned to gold. They built roads, tunnels, big buildings and mined coal and aggregates. They bought the failed Continental Can Company, stripped it and came out with huge profits. They started a fiber optic company that became the forerunner of MCI and sold it to WorldCom. Level3 was a do-over of a business that they had already made billions in and directed by the same management team that led the former success. Additionally, the managers and accountants of Kiewit would once again make sure the venture was run soundly. But Kiewit was a private company. You could only envy, you couldn't participate unless you worked there.

Level3 eventually went public. We could all get in and become Kiewit millionaires. Omaha did. In the dot-com bubble it hit $158 per share. It became not only the darling of Omaha, but the high tech investing world. It has been all downhill from there. Paper fortunes have been lost and many margined fortunes sunk real fortunes. The devastation has been significant on Omaha Kiewit wannabes. I thank my lucky stars that I wasn't a pig as I often am. I made a few dollars and have watched the saga from the sidelines.

Walter Scott, Level3's Chairman and former Kiewit CEO, has a great business reputation, in spite of Level3's performance. He has an engineers mind, a businessman's nose, and integrity. Those qualities have attracted some quality associates: Warren Buffett, Leucadia Financial, Mason Hawkins of Longleaf, and Prem Watsa of Fairfax Financial Holdings. The first two have done bond financings while the latter two have done both bonds/convertibles and common stock. To the best of my knowledge Berkshire and Leucadia are not involved with Level3 at the present time.

Southeastern Asset Management, Hawkins' company owns 429 million shares and Watsa's Fairfax owns 139 million shares. Both Fairfax and Southeastern each own about a $100 million in a convertible issue paying 15%! I'm not sure if the potential convertible shares are factored into the ownership totals and it really doesn't matter. Included or not, these two guru investors have placed a huge bet on Level3's future. They own approximately 35% of the company, possibly more. While respected value investors, they must be betting on the company's franchise value and moat. LVLT sells at over 4 X Book and has virtually no tangible book value, it's $6 Billion of debt dwarfs it's equity, interest charges gobble up over $1/2 Billion per year, and net earnings have been rare over it's lifespan. It doesn't fare well under almost any value investing metrics. Yet, two guys smarter than me have parked lots of money here. Additionally, both have the bulk of their net worth tied up in their companies, so they aren't some Wall Street hotshot playing with other peoples money while skimming large fees. They must believe.

It's obvious that they too have drunk the LVLT Kool-Aid. Will the result be different from the losses sustained by many of the Omaha faithful? Buffett and Leucadia were attracted by the generous terms offered by LVLT, made a well calculated investment and have exited. Hawkins and Watsa have the bulk of their money at risk in common stock. Their 15% yields on the convertibles is attractive, but the majority of their investment pays no interest. Whether they are under or above water on their positions, they are believers. They still own a ton of LVLT shares.

None of the other security companies are even close in their devotion to Level3, in fact, many other holders are indexers and smaller institutional positions. Analysts aren't impressed. The stock is the province of penny stock speculators and two, well respected value investors. Not the usual bedfellows. When the share price moves it is the result of rumors touting a Google or Sprint acquisition, not any improvement in financial condition. Why do Hawkins and Watsa stay and should I join them?

I think I'm going to keep watching this drama from the sidelines. I had a taste of the Kool-Aid, but have been able to kick the habit. With $6 Billion of junk debt, declining revenue, and poor operating results, I see lots of dilution ahead. LVLT has been masterful at balance sheet management as they have restructured, refunded, converted, and issued securities along their route to telecom survival. But, more of their debt will get turned into equity. Even at a discount, more shares equals dilution.

If Level3 doesn't work out well for Fairfax and Longleaf it won't sink their funds, but individual investors would be better off staying away from dilution prone balance sheets.

Saturday, February 13, 2010

The Pension Bubble

The United States faces a ticking time bomb that needs to be defused. The threat is government pensions, almost all of which are seriously underfunded and poorly designed. Taxpayers are at risk of large tax increases, or significant cuts in services, unless changes are made. The problem exists at the federal, state, county, and city levels. It encompasses the general employee base as well as first responders. It's a large problem given the growth in government employment.

Private business has moved away from defined benefit pension plans about 25 years ago. Defined contribution plans, such as the 401K, have become the norm for business. They need to become the norm for government as well.

The following email was sent to my local newspaper and it's easier to cut and paste it than to re-type and make it fit this post. It serves the purpose nicely. Just transpose your city, county, state, federal government for Mount Dora. The plans are all similiar and almost all in trouble. If they aren't fixed, add a tax increase to the one's we will be getting for the stimulus and bailouts.

Here's my letter:

Lauren, I appreciate your desire to see Mount Dora not only retain it’s charm, but improve as the economy recovers. I share that vision. However, as a resident, and healthy taxpayer, I also expect my city to operate efficiently and show fiscal responsibility.

A major area of fiscal irresponsibility is the pension benefits currently offered to employees in the General Employee Pension Plan. I think it is entirely appropriate that the city council examines the Plan and, after study, makes changes. The current plan is not sustainable, for employees or taxpayers. Employees have not had a raise in pay for two years because the city could not afford it, largely due to an accelerating pension contribution. Not only the absolute dollars contributed to the plan, but the percentage of total payroll have skyrocketed. Additionally, investment performance has been poor. The combination of overly generous benefits and poor investment results has left the Plan in a seriously under funded position. A continued acceleration of this situation will affect all city services, as Plan contributions will take up larger and larger portions of the annual budget.

The goal of pension reform is not to harm employees. Some, however, would not have such a sweet deal. Others, the rank and file, could see paychecks actually increase as they currently pay up to 7% toward their pension plus 6% for social security. And, due to budget constraints, haven’t been receiving pay raises. Some employees may very well welcome a 401K Plan that allows them to keep a few more dollars of net pay and gives the city the flexibility to offer pay increases.

Let’s look at the Plan. It uses a .03 multiplier, and is generous on vesting, early retirement, final year income adjustments, and other components. What that means is that a long-term employee can retire with an income that exceeds his final pay level! For life! Mostly funded by taxpayers. An example: Multiplier [ .03 ] X years of service [30 years] X Final Pay. So, .03 X 30 =. 9 then, .9 X Final Pay, say, 80,000 =$72,000 PLUS Social Security of, lets say $25,000. resulting in a city/employee funded retirement income of $97,000. Remember, both city and employee pay 6% of income into social security. Most plans deduct that benefit from the pension, but the Mount Dora Plan doesn’t!

The over-riding question is should the taxpayer continue an employee’s income for life? Is 30 years of work worthy of that amount of compensation? In the past possibly as government salaries were not as generous as in private business, but for a long time city employees have enjoyed comparable pay scales.

The Council should solve the pension situation and also look at any other areas that affect the fiscal soundness of the city. Luckily for our community, the city isn’t burdened with a large debt load and if the Council acts diligently, it won’t become so.

Thanks for listening. Bill Kabourek

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