Assured Guaranty Ltd.
 

Investment Rationale

Assured Guaranty is a Bermuda-based holding company that provides, through its operating subsidiaries, credit protection to the public finance, infrastructure and structured finance markets in the United States as well as internationally. This means that if a city requires a new incinerator for instance, and uses bonds to finance it, then AGO can insure the bonds and due to the insurerʼs superior credit rating, the interest rate on the bonds will be lower than as a standalone issue guaranteed by the city. AGO also insures structured finance transactions on mortgages and other asset backed securities.
 

Now there are few if any more cloudy or disliked industries than the financial guarantee business, and the stigma of that has certainly affected AGOʼs share price. AGOʼs primary competitors over the year, MBIA, Ambac, FGIC, PMI, are at different levels of runoff in the industry due to their more lax underwriting standards. AGO avoided the worst of the CDOʼs such as the synthetic versions, therefore the primary sources of losses for the company has been in their HELOC and CES RMBS portfolios. Anyone following the bond industry must be aware of the significant legal battle currently waged by the insurers, including Freddie Mac and Fannie Mae, and the mortgage originating banks. Basically the insurers are alleging that the originators didnʼt properly verify the validity of mortgage applications, which is a contractual obligation for obtaining insurance.

I certainly donʼt profess to be an attorney but in studying the financial results of both the banks and the insurers it does seem that payments are coming in slowly and surely to cover the losses on the fraudulently conveyed mortgages. Eventually it seems likely that a settlement will be needed but this represents a substantial and non- dilutive capital injection to the insurers that to my estimation is not factored into the market properly.
 

In July of 2009 AGO acquired FSA, a subsidiary of Dexia from the French and Belgian government at a huge discount to book value. AGO did have to issue shares below intrinsic value to pay for the acquisition in addition to some cash, but the rewards seem to far exceed the risks. Just as with the Wells Fargo acquisition of Wachovia, there is no doubt that there are some questionable assets in the FSA book, but if you get in at the right price from a distressed sale it can be difficult to lose money even in these trying economic times. The acquisition is already enormously profitable due to the accretion from the discount to book value and the lack of significant impairments within the portfolio.
 

AGO certainly has some hair on it as there are ongoing issues with the city of Harrisburg and Jefferson County but the municipalities do have the ability and the obligation to raise taxes or sell assets to meet their debt obligations. I think municipal defaults will occur as they have for years, but just like mortgages you must create assumptions for both the default rate and severity to establish an idea of what the consequences of these defaults would be. Over the last 40 years net paid losses on U.S. public finance has been extremely low averaging about 4 basis points per annum of net par outstanding over the last 40 years. It goes without saying that most defaults have been in the non- rated and investment grade categories. 96% of AGOʼs net par outstanding is rated above investment grade according to the companyʼs internal rating scale which in my opinion has proven to be far more prescient than either Moodyʼs or S&P.

I think weʼll see most municipalities execute reasonable expense reductions, including both layoffs, and decreases in CAPEX plans. Another important thing to account for is that the vast majority of debt in this country does not get paid off at maturity but instead is refinanced prior to maturity. Nowhere is this more evident in then in Europe, where AGO has virtually no sovereign debt exposure, where Spain, Greece, etc. have been able to refinance debt at reasonably attractive levels. Rates will be higher for municipalities until their budgets are more balanced and revenues are bolstered by higher economic output, but a few defaults would actually be pretty good for business at AGO. Bond investors that are made good on their defaulted investments as a result of AGOʼs insurance are likely to be recurring customers in the future, and without any defaults there wouldnʼt be any legitimacy to the industry.
 

Due to the lack of any competition AGO has been the only game in town for municipal bond insurance but demand is really low. Future demand will likely depend on confidence in AGOʼs ratings as Moodyʼs, S&P, and Fitch have all been quite capricious in terms of issuing ratings, and have shown little prognostication ability. When the insurers are downgraded, usually the insured bonds are as well which somewhat reduces the value of the insurance. The positive part of the equation is that AGO is pretty much only writing public finance business which is actually capital accretive to the company. A recent deal with Americredit on some auto finance loans has excellent collateral protection, and is likely a preface to an emerging, but more rational structured finance environment.
 

Now moving forward to a valuation analysis on AGO the merits of the investment become considerably more clear. AGOʼs book value as of March 31, 2010 is $19.63. Their adjusted book value which negates non-credit impairment unrealized gains (losses) on credit derivatives, plus the net present value of estimated premium revenues and reserves, minus losses, after taxes is $48.00. Historically municipal bond insurers have traded at a slight premium to adjusted book and it is very possible that AGO could earn between $4.50-$6.00 in 2011 and 2012. I expect them to be able to generate an ROE of about 10% on adjusted book which would imply normalized earnings power of $4.80 at the present. There is a great deal of uncertainty on this investment but getting in at these prices provides you with an adequate margin of safety to the extent that it is difficult to picture a scenario where you would lose money over the long term.
 

Investment Strategy

 

Wells Fargo is the most efficiently run of the super sized commercial banks in the United States. Their service oriented business model has led to consistently higher returns on both equity and capital in comparison to their peers over the long run. One of this big reasons for this outperformance in that Wells Fargo is a “true bank”, as opposed to a closet investment bank like a Citigroup, or a JP Morgan. Wells’s bread and butter is building extremely deep customer relationships with their banking clients. Wells Fargo sales representatives attempt to package together a plethora of products to each client, and the goal is to average 8 products per client. In the first quarter of 2010 they averaged 6 products per client.

 

This business model attracts fee income which is in high demand these days as it doesn’t entail taking on balance sheet risk. Wells Fargo also has the lowest deposit costs of their peers allowing them to 

generate the highest net interest margins in the industry.  According to Morningstar between 2003 to 2008 WFC averaged a net interest margin of 4.9% which is by far and away the highest in the industry. Even better, 21% of WFC’s deposits are non-interest bearing which is emblematic of the significant emphasis on the sales process within the branches. 

 

Now fee income and high net interest margins are great, but loose underwriting can kill a bank of any size. It is here where Wells has really differentiated themselves by writing vanilla mortgages, and avoiding the CDO’s and SIV’s. Most of Wells Fargo’s loan losses have come off of their home equity lines of credit (Heloc) and their closed end second mortgages (CES). These losses were very difficult to avoid, but due to the strength of the Wells Fargo business, model and due to their stringent underwriting WFC has remained profitable throughout the crisis.

 

During the financial crisis WFC bought Wachovia in a transaction that doubled the size of the company. Because Wachovia was somewhat of a distressed seller, WFC was able to acquire it at a bargain price which significantly reduced the risks on the transaction caused by Wachovia’s more lax underwriting. The only real problem with the acquisition was that due to the increased regulatory oversight, WFC was forced to raise equity at prices significantly below the intrinsic value of the company. Wachovia is a strong strategic fit for Wells because they have a large footprint in the Southeast where Wells was historically week. Wachovia also owns a strong securities division which has bolstered Wells Fargo’s retirement and investment offerings. We believe that Wells Fargo’s superb management and sales staff should be able to get a lot more out of Wachovia, and the scale of the new enterprise should provide ample opportunity for cost cutting.

 

From a valuation perspective Wells Fargo is very cheap when you look at the earnings power of the enterprise. As loan losses decline and new loan demand increases we expect Wells Fargo to come close to their historical 18% return on equity. If they can do that we peg their 2012 earnings power to be between $3.5-$4 a share. If you put a 10 price/earnings multiple on EPS of $3.5 you are looking at a stock worth approximately $35. This would be a very low valuation for Wells and we believe they should be able to grow EPS by about 10-12% a year from there for the next 3-5 years. 

 

Investment Strategy


We are recommending selling the WFC $27 put for August which is actually in the money. The reason for this is that if the put expires worthless which we think is a reasonably good probability we can collect a fabulous 64% annualized return on our investment. Being that we are not day traders we have no ability to forecast what an individual stock will do the next few days, or weeks even, so when we set this trade we are completely satisfied taking the stock. That enables us to reap the benefits of owning the stock at a significant discount to intrinsic value.

 

 

Primary Risk Factors

A double dip recession would slow earnings growth. The biggest risk is onerous government regulation forcing WFC to raise capital in a real short time period.

 

Investment Rationale

An investment in WMT might not sound like the most glamorous opportunity in the world, but at www.optimtrading.com we focus on maximizing risk adjusted returns. Walmart has three primary business segments: Walmart U.S., International and Samʼs Club. 

 

Walmart U.S still generates 64% of their sales from Walmart U.S. but the number is dropping, as international sales are becoming a bigger part of the business. International sales in 14 countries and Puerto Rico generated 24.7% of 2010 net sales, while Samʼs Club generated 11.5%. The Walmart brand is synonymous with being the true low priced leader in the United States retail industry. 

 

Wal-Mart has maintained this advantage through capitalizing on their superior scale and top of the line logistics platform, to squeeze the best pricing and efficiencies, out of both their suppliers and operating costs. Retailers as a whole arenʼt usually fertile grounds for value investors due to the volatility of fashion trends, and the fickle nature of their clientele. WMT is unique in that its appeal is to those that are looking for the lowest prices possible. In a downtrodden and consumer strained economy, pricing is more than ever a leading factor in the consumer spending decision making process. 

 

Wal-Mart's operational efficiency and scale has allowed them to enter businesses such as electronics, pharmaceuticals, and financial services, and in a very short time they are able to compete with the industry incumbents. If you have been following the volatility of Gamestopʼs (GME) stock price you are probably aware of the impact that Walmart is having on its business, and this is a very common story as WMT has eaten many businesses lunch in the past, and is likely to continue to do so in the future.

 

Revenue growth is beginning to slow for Walmart and their competitive advantages internationally are vastly inferior to their domestic footprint, but WMTʼs model of being the low cost leader is likely to lead to a reasonable share of victories abroad. Markets such as Brazil, Mexico, and China offer bright growth prospects, and due to Walmartʼs superior financial condition we believe that they should still handily out-earn their cost of capital making the growth profitable. Walmart has also bought in excess of 40 MM shares over the last two years at prices that are below our intrinsic value estimate, so management seems to be improving in the essential role of capital management by avoiding costly acquisitions, and returning cash to shareholders.

.

WMT is currently yielding about 2.52% but we believe that there is a tremendous amount of flexibility for WMT management to increase that yield in excess of 4% at some point in the near future. By returning money more aggressively to shareholders through both dividends and share buybacks we believe that WMT could appreciate to the mid 60ʼs with very limited risk. WMT is generating in excess of $14 Billion in net income while investing close to 90% of that to fund its growth initiatives. At any point WMT could scale down on CAPEX to grow free cash flow. As growth slows and as the return on invested capital declines WMT should start returning money hand over fist to shareholders. We believe that when they do the stock will reflect the trust that such actions would instill in management by going significantly higher.



 

JUNE 21, 2010 BY optimitrading.com

 

1.)    Symbol:                C

 

2.)    Stock Price: 3.99

3.)    Company Name: Citigroup

4.)    Market Cap: 115.6 Billion

5.)    Book Value: 151,421 Billion

6.)    Tangible Book Value: 111,043 Billion

7.)    2010 Net Income: TTM $1,229 Million

8.)    2009 Net Income: ($1,606 Million)

9.)    2008 Net Income: ($29,416 Million)

10.) Debt/Equity: 2.91

11.) Return on Equity: 1.11%

12.)  Normalized Return on Equity: 12%

13.)  Normalized Earnings Power: $15 Billion

14.) Shares Outstanding: 17,944 Million

15.)  Normalized EPS: $.75-1.00

16.) Target Price Range: $7.5-$10

Investment Rationale: Citigroup is now the combination of Citicorp which are the healthier aspects of the old Citigroup and Citi Holdings which consists of the assets that Citigroup is trying to divest in an effort to right size the business.  The main businesses the Citi is looking to move forward with are their global transaction services, investment banking, private banking, consumer banking, commercial banking, and credit cards. Citi is unique in that they have a truly global presence and their exposure to growing international markets provides them with better growth prospects than some of their major American peers.

Citi is focusing on lowering their expenses significantly which had been growing at a higher rate than their revenue growth. This combined with some of the worst loan underwriting of all time contributed to the staggering losses that the bank has faced over the last few years. After the United States government converted their high cost preferred stock to common stock Citigroup emerged as one of the best capitalized financial institutions in the United States. The stock has been under pressure as the government is now significantly reducing their stake in the business after seeing substantial appreciation. As credit quality, specifically mortgages and credit card metrics have been improving of late we believe that the worst is over for Citi. They are likely to return to normalized earnings by 2012 and we expect them to be mostly profitable in 2010 and 2011 as they wind down Citi Holdings. If you put a simple 10 price to earnings multiple on Citigroup’s low ball .75 cents a share earnings power you have a stock that is worth $7.50. Also it is very difficult to imagine how over the long term you can lose on this investment. Citigroup has been examined, scrubbed, cleansed, by the government and regulators over the last 3 years as much as any other company, so we feel like we do have some security that Citi is being appropriately cautious in their accounting.

Interest rates are likely to stay low for the next year or two and the loans being originated have much higher return on investments, with higher credit quality, than the loose underwriting that led to the financial crisis. Citi is improving its deposit franchise so liquidity should not be an issue. Therefore we believe that Citi s a relatively low risk long term investment with upside potential of 100% over the next 2-3 years.

Investment Strategy:

Buy the stock outright at $4.05 or less.

Target Price: $7.50

Target % Return: 87%

We think Citi has a long ways to go on the upside but we think at a minimum the stock should be trading at about $7.50 within the next two years.

JUNE 21, 2010 BY optimitrading.com

 

1.)    Symbol: BDX

 

2.)    Company Name: Becton, Dickinson and Company

3.)    Stock Price: $71.48

4.)    Market Cap: $16.7 Billion

5.)    Enterprise Value: $19.24 Billion

6.)    EV/EBITDA: 8.5

7.)    Book Value: $5.150 Billion

8.)    Tangible Book Value: $3.5923 Billion

9.)    TTM2010 Net Income:$1.272 Billion

10.) 2009 Net Income: $1.231 Billion

11.) 2008 Net Income: $ 1.127 Billion

12.) TTM Free Cash Flow: $1,281

13.) Debt/Equity: .29

14.) Return on Equity: 25.56%

15.) Return on Invested Capital: 11.2%

16.) Shares Outstanding: 244 Million

17.) 2012 Earnings Estimate: $6.46

18.) Target Price Range: 15 times 2012 earnings or $96.9

Investment Rationale: Becton Dickinson is a medical equipment manufacturer that has dominant market positions in the areas of needles and surgical tools. Almost every medical office has exposure to BDX through their syringes and scalpels. Due to the financial crisis BDX like all other medical equipment companies have seen decreases in spending from hospitals which have been impacted by the recession. Also due to the healthcare overhang and new taxes being implemented on medical equipment manufacturers the stock earnings multiple has been reduced. BDX continues to produce, grow, and most importantly generate cash. They boast an extremely well financed balance sheet with very reasonable debt loads. BDX has a current free cash flow yield of 7.6% and free cash flow should grow by about 10-12% over the next couple of years. This means that BDX is going to have the ability to buy back shares or make strategic tuck in acquisitions moving forward. With the aging of the baby boomer generation and the increasing spending on health care from the emerging economies there is likely to be an increasing demand for the products of BDX moving forward. We see BDX as a great opportunity to experience 10+% annual returns over the next couple of years with very limited risk even if we don’t see much of an economic recovery.

Investment Strategy: Buy 100 shares at $71.32 at sell 1 December 2010 75 call for $2.35.

Return if stock closes over $75: $603

Maximum Risk: $6,897

Target Net on max risk return: 8.74%

Days Until Expiration: 182

Target Annualized Return: 17.48%

We believe there is very limited risk to BDX and by using the covered call strategy we are reducing that risk even further by generating the extra premium. Even if the stock stays below $75 during that time frame we will have lowered our cost basis and we will still see the potential benefits of its upside potential, while retaining the ability to continue writing new covered calls.

Primary Risk Factors:

JUNE 30, 2010 BY optimitrading.com

1)      Date:6-30-2010

2)      Symbol: CMCSA

3)      Price: $17.62

4)      Shares Outstanding: 2,885 Million

5)      Market Cap: $51 Billion

6)      Book Value: $43,179 Billion

7)      Enterprise Value: $76,017 Billion

8)      EBITDA: $13,714 Billion

9)      EV/EBITDA: 5.54

10)   Earnings Per Share  2009:   $1.26            TTM 2010: $1.3

11)   P/E:  13.57     

12)    FCF         2009: $5,164 MM 2010 TTM: $5,790      

13)   FCF per share 2009: $1.79 FCF per share 2010 TTM: $2.006

14)   Return on Equity: 8.87%

15)   Return on Invested Capital: 5.07%

Investment Rationale:

Comcast is a leading provider of video, high-speed Internet and phone services (“cable services”), offering a variety of entertainment, information and communications services to residential and commercial customers. As of December 31, 2009, their cable systems served approximately 23.6 million video customers, 15.9 million high-speed Internet customers and 7.6 million phone customers and passed over 51.2 million homes and businesses in 39 states and the District of Columbia. The Cable segment generates approximately 95% of their consolidated revenue. Comcast’s Cable segment also includes the operations of their regional sports networks. Their Programming segment consists primarily of their consolidated national programming networks, E!, Golf Channel, VERSUS, G4 and Style.

Comcast’s other business interests include Comcast Interactive Media and Comcast Spectacor. Comcast Interactive Media develops and operates their Internet businesses, including Comcast.net, Fancast, the Platform, Fandango, Plaxo and DailyCandy. Comcast Spectacor owns two professional sports teams, the Philadelphia 76ers and the Philadelphia Flyers, and a large, multipurpose arena in Philadelphia, the Wachovia Center, and provides facilities management services, including food services, for sporting events, concerts and other events.

Comcast has quality competition from the likes of Verizon, AT&T, Time Warner Cable, etc. Because of their cost advantages in telephone and internet versus the incumbent fixed line operators, they have been able to steal business by lumping together cable, telephone, and internet access.  TV is their biggest business but it also has the lowest margins for them but as you can see from the first chart above the other businesses are growing faster. Over the last 5 years CMCSA has been spending aggressively to expand and maintain their infrastructure and investors grew increasingly frustrated that the company wasn’t returning the cash to shareholders.  The cable companies also were trading at much higher valuations 10 years ago, and due to the slowing growth in their businesses they have been revalued to far cheaper levels. CMCSA finally appears to be getting things right as lately they have been aggressively buying back shares at what we deem to be a significant discount to intrinsic value, and paying a smaller dividend. Their CAPEX spending has slowed down which has allowed for the company’s robust cash flow generation to show through.

At the current valuation CMCSA has a free cash flow yield of 11%. For a company that is well financed with a secure market position this is abnormally high and reflective of the low expectations for the company and the industry as a whole. We expect broadband demand to keep increasing and CMCSA is going to be the low cost provider in our opinion. Verizon’s FIOS platform is the most competitive but Verizon is not really infringing on too much of CMCSA’s territory, and we really question whether or not that whole endeavor will earn a high enough return for Verizon for them to keep plowing cash into it.

Comcast recently made a huge plunge into content with purchase of NBCU which will include the NBC network, USA, Bravo, CNBC, MSNBC, the Weather Channel, and the Sci Fi channel. It also includes assets such as their television stations, Universal Studios, weather.com etc. Comcast will be contributing their own cable networks to the joint venture. The deal terms are extremely attractive to CMCSA in that they placed a high valuation on CMCSA’s own cable networks and Comcast will have to fork over very little cash. We believe that the deal should generate solid future free cash flows, with a very low up-front cash outlay from CMCSA which will benefit shareholders as things materialize.

We believe that CMCSA is likely to grow by about 3-4% annually so by buying it at an 11% free cash flow yield we feel that it will be extremely difficult to lose money. Positive catalysts could be an aggressive share buyback, a higher dividend payout, or just investor realization of how cheap you can buy this tremendous company.

Investment Strategy:

Buy 100 CMCSA shares at $17.62

Sell 1 January 2011 20 CMCSA covered call for .89

Target Profit: $327

Maximum Risk: $1,673

Days Remaining: 205

Target Net on Cash: 19.5%

Annualized target net on cash: 34.5%

Break Even Price: $16.73

Target Price: $26.75 or at a 7.5% free cash flow yield

The covered call strategy maximizes our cash return because there is not an immediate catalyst on this investment, but instead it is just so cheap that it is impossible to ignore. If the call expires worthless which would mean that the market hasn’t realized the value CMCSA represents then we could always sell a call again later and we would benefit from the potential appreciation of the stock. We feel that at this level there is very little risk as defined by the permanent loss of capital.

Primary Risk Factors: