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.

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.

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.

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.

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.

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.

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.

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. 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.

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.

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