Two Ideas to Capitalize on Distressed Sellers

Right now, there are unprecedented levels of stress in pretty much every tradable market. It's difficult to navigate a market with such information asymmetry, not to mention tiresome to look at your portfolio (seemingly) every day and see things down. But for those of you with cash on the sidelines, the number of distressed sellers out there is presenting opportunities for smart pairs trading, which is fantastic at a time like this because the long/short nature of it provides for a natural market hedge.

One truism that I believe was overlooked too much in recent years – and I'm pretty sure we're almost all guilty of this – is that you should only look to be buying from distressed/irrational sellers. Markets aren't efficient all the time, but they do a pretty good job on average, and thus odds are you don't have that much of an advantage over whoever you're buying from. At times like this, however, the investor with liquidity (and it tends to be the intelligent ones who sat on their hands as things were going smoothly) has an enormous advantage on an overextended trader who needs to raise cash.

To personalize this and give you a profit opportunity, last week (Sept. 29) the Boston College Investment Club was voting on whether or not to sell Hugoton Royalty Trust (HGT), a spinoff of XTO Energy (XTO). Hugoton holds several natural gas-producing properties in the Midwest and Western US, and simply distributes the royalty income – which is a percentage of the profits derived from the sale of natural gas extracted from its lands – tax-free. Roughly 90% of the distributions and remaining reserves come from natural gas, and the monthly dividend reflects the short-term price of natural gas. Because these kinds of stocks (technically units) are somewhat obscure, there's a lot of misunderstanding about them, especially when the dividend gets annualized and the stock price subsequently gets crushed… like now, as Hugoton is showing a yield in excess of 24%. But that's beside the point; consider how HGT is priced relative to the price of the natural gas (UNG) from which the distributions are set:

I wanted to sell HGT, but the majority vote needed to do so wasn't there, so BCIC still owns a small position in HGT. This chart, however, makes me think I'll continue to wish we had gotten rid of the units, at least in relation to its underlying commodity… and that there is a profit opportunity for traders looking to short HGT and own UNG, and ride the trade back down to its historical range.

As a second possibility, I offer the much more deterministic bet on Mueller Water (MWA), which has two classes of stock with equal economic interests but with differing voting rights – the B shares have 8 votes, to the A shares' 1 vote – yet the B shares trade at nearly a 20% discount. Lest this be misconstrued as my own brilliance, I just read it from Sham Gad a few days back.

Stock position: None.

Comments

[davemcc3300:]

I'm a HGT victim too. In last 4 mo, HGT is -45% vs S&P -33%. PBT is a better performer with a -29% drop. When market and oil prices recover, both will outperform market. Dividends for next 3 months probably lower, reflecting NG and oil income.

I like MWA, but see it falling more. A good infrastructure play ..if that's where government money goes (which might be pretty tight for another 2 years).

Only things I own that are working are KO and ABX (until today).

I'm holding. Selling at these levels validate the stupidity of the usual stockholder. Their panic is outdone only by institutions trying to scrape up cash in this negative environment.

Dave

2008 Oct 10 02:19 PM

[tdon1229:]

don't fail to note that dividend payments of HGT lag by two months, so the impact of falling oil and natural gas prices will not be seen right away ... also, HGT has been hit with high capex costs for well over a year and the paybacks for that additional drilling and production are just beginning to be factored into the returns ... at current pricing, this appears cheap vs. future dividends and also vs. reserves in place ... as always, your mileage may vary.
TDON

2008 Oct 20 03:44 PM