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Who Benefits The Most From Lower Oil Prices?
- There has been considerable discussion of the benefits to the U.S. economy due to lower oil prices.
- A comparative analysis suggests that a number of other countries will achieve much greater benefits due to lower oil prices.
- By comparing net oil imports and GDP, the amount of reduced oil expense can be calculated at a percent of GDP.
- Using this measure, the benefit to the U.S. of a $50 per barrel drop in oil prices is roughly .6 percent of GDP.
- Other countries will achieve much greater savings - Japan (1.7% of GDP), South Korea (3.4% of GDP) and India (2.8% of GDP).
Xerox: Solid Balance Sheet And Enormous Owner's Cash Flow
- Properly analyzed the Xerox balance sheet has zero net debt.
- Xerox trades at 7.3 times owner's cash flow.
- Xerox will benefit from earnings tailwinds in the form of share repurchases and lower interest payments.
- Xerox is misunderstood because earnings are much less than cash flow and the balance sheet contains hidden assets.
- Xerox should trade at 10 times owner's cash flow which would produce a price 39% higher than Wednesday's close.
Beaten Down BDCs: TICC Capital
- TICC is now trading at 20% below net asset value and has a dividend yield of 15.6%.
- TICC has relatively high leverage and relatively high CLO exposure.
- On the other hand, TICC has no oil and gas loans in its loan portfolio and has disclosed a relatively small percentage of those loans in its CLOs.
- TICC has recently authorized a share repurchase plan of up to $50 million which may tend to put a floor under the stock.
The Dollar Dilemma And What It Means For Investors
- The dollar continues to rise against most leading currencies.
- This tends to drive down commodity prices, make exports less attractive and create an increased danger of deflation.
- It is also likely that, if the trend continues, the Fed will be cautious about raising rates.
- A strong dollar is generally good if it is a sign of a strong U.S. economy but can be bad if it is a sign of international panic.
- Investors should focus on companies that do business in the United States and provide stable cash flow; BDCs and REITs are attractive on this basis.
Beaten-Down BDCs: Prospect Capital
- Prospect Capital saw its stock decline in December and is now trading at a large discount to net asset value.
- PSEC is one of the largest BDCs and has an excellent management team, which has been purchasing the stock heavily of late.
- PSEC's investments are diverse and will likely perform well under any reasonable scenario.
- PSEC does have some energy investments that create the possibility of write downs but, even given a stress test, PSEC looks cheap here.
- PSEC has plans for restructuring that could provide the catalyst leading to a higher valuation.
Beaten Down BDCs: American Capital
- In the past several months, a number of business development companies have experienced declines and are now trading below net asset value.
- The recent turmoil in the oil patch is the first situation in which business loans made since 2009 are perceived to be at risk of default on a large scale.
- Thus, business development companies face the risk of significant losses on loans and the consequent reduction in dividends and decline in net asset value.
- Concern about this danger and other factors have led stocks in the sector to decline to levels well below net asset value and have created some bargains.
- I will first analyze American Capital which, I believe, is one of the biggest bargains in the sector.
2015 Outlook And Picks
- The market is roughly 5% overvalued, but will grow into its price in 2015; the most likely result is the S&P 500 up 4.7%.
- The high dollar and low inflation will deter the Fed from raising rates until the second half of the year; year-end Fed funds rate no higher than .75%.
- Oil will stabilize between $65-$85 per barrel.
- We will reach an agreement with Iran, the Venezuelan government will fall, and the ECB will engage in massive QE.
- Picks are Lexington Realty Trust, Hospitality Properties Trust, American Capital, and Google.
The Feds May Sell Oil From The Strategic Petroleum Reserve
- The Government Accountability Office (GAO) has recently completed a report analyzing the Strategic Petroleum Reserve (SPR) and concluding that it may be advisable to reduce its size.
- The SPR contains 691 million barrels of oil which is considerably in excess of the amount required by the International Energy Agency.
- While a sale of oil from the SPR now would constitute bad public policy from a number of perspectives, it may make sense to reexamine the SPR and its role.
- A buy-low, sell-high strategy would generate income for the federal government and would also tend to stabilize world oil markets.
- This strategy would suggest buying oil at this time and possibly expanding the SPR's capacity.
Aemetis: Rewards Outweigh Risks
- Aemetis operates an ethanol refinery in California and a biodiesel plant in India.
- It has been generating solid cash flow this year but the third quarter saw a dip in earnings and cash flow.
- AMTX's share price has declined precipitously due to the general pullback in the energy sector.
- AMTX is certainly sensitive to ethanol price trends but these may not track petroleum price trends.
- AMTX will also benefit from a number of other tailwinds which create the potential for a substantial increase in cash flow and valuation.
Methanex: Pullback Creates Attractive Entry Point
- MEOH is the world's largest methanol producer and dominates the methanol market.
- Methanol is a liquid that can be produced from natural gas (and other inputs) which has a number of chemical applications and can be used as a transportation fuel.
- MEOH is about to add additional capacity which should produce a substantial increase in cash flow.
- MEOH's price is depressed due to the general pull back in the energy sector.
- While the price of methanol has declined, MEOH can generate solid cash flow at a relatively low price and should generate enormous cash flow under normal conditions.
Book Review: The End Of Normal By James K. Galbraith
Nov. 29, 2014 • 6 Comments
- This is an excellent book providing the reader with helpful insight into modern economic debates.
- The author's position is that various factors have resulted in a situation in which "normal" levels of economic growth may not be achievable.
- These factors are resource scarcity, financial fraud, the nature of technological development and the futility of military force.
- The author does not really make a persuasive case that these factors suddenly became important in 2008 or that they effectively impede economic growth.
- His policy prescriptions - more safety net, less military spending, taxes on economic rents - may have some merit, but they do not resolve the problem he identifies.
The Paradox Of Cheap Oil
- The recent decline in oil prices has been welcomed as a stimulant to the economy.
- However, because the United States has become a large oil producer, it is unclear whether lower prices will actually increase GDP.
- On the other hand, lower oil prices will certainly restrain inflation and further postpone the need for an interest rate increase.
- As oil prices decline, high-cost production tends to go off-line and balance the market.
- The investment implications are positive for interest rate sensitive stocks like BDCs and REITs and arguably positive for select oil sector stocks.
American Capital: 50% Upside With Downside Protection
- American Capital (ACAS) is a BDC which is generating strong cash flow but not paying dividends due to a large tax loss carry forward.
- Its current net asset value (NAV) is $20.12 so that it is trading at a discount of 31%.
- ACAS is planning to implement a restructuring which should unlock its true value with the resulting equities trading at or above current NAV.
- If, for some reason, the restructuring does not take place, ACAS will almost certainly resume share repurchases which will drive the price up to the $16-17 level.
- NAV will tend to increase at roughly 10% per year while this scenario is playing out - providing further downside protection.
The Reliable Dividend Yield Metric Is Flashing A Faint Buy Signal
- I have written before about the dividend yield ratio of the S&P 500 and the fact that it has stayed in a range of 1.8 to 2.2 since October 2009.
- In the past year, the dividend yield ratio has remained in a tight range of 1.91 to 1.97.
- At Thursday's close the ratio rose to 2.00, creating a faint buy signal at the top of the range for the past year.
- Although the dividend yield ratio will someday escape the range, it is unlikely to do so until interest rates increase.
- There is more and more reason to believe that interest rate increases are far off in the future.
The Dollar, The Fed And The Market
- The dollar has been rising lately against the currencies of many of our most important trading partners.
- A rising dollar can occur because of robust domestic economic growth but it can also be caused by economic weakness abroad or global insecurity.
- Regardless of the cause, a rising dollar tends to depress domestic economic activity and reduce inflation. Commodity prices tend to decline significantly.
- These impacts - combined with negative impact on earnings of foreign subsidiaries - tend to produce a drag on corporate earnings and can be a negative for the market.
- However, these impacts "should" lessen the pressure on the Federal Reserve to tighten; in our unusual context, the big question is whether this will be the case.
3 Dirt-Cheap REITs
- Real Estate Investment Trusts (REITs) offer investors attractive yields plus potential appreciation.
- The best metric for evaluating REITs is the ratio between price and funds from operations (P/FFO), which measures what an investor is paying for funds generated by properties.
- FFO is measured by adding depreciation and amortization to earnings and excluding losses or gains and sales of property and impairment charges.
- Three REITs have been identified with P/FFO ratios at or below 10; there do not appear to be any negative factors that justify such low valuations.
- The REITS -- LXP, HPT, and FSP -- all pay generous dividends; at these prices, they are strong buys.
Book Review: The Dollar Trap By Eswar Prasad
- This book describes the workings of the dollar as the World's reserve currency in detail.
- It points out many counterintuitive phenomena which have confounded investors - especially the dollar's tendency to rise in times of stress.
- The author correctly concludes that the dollar is unlikely to be supplanted by any alternative in the foreseeable future.
- This creates a complex problem for investors; the dollar's valuation is affected by factors unrelated to the trade balance and dollar denominated prices may not make economic sense.
- In the immediate future, it appears that a rising dollar means less inflation, lower commodity prices and headwinds to economic growth. Interest rate sensitive equities should continue to do well.
The Real Reason For The Housing Bubble And The Financial Crisis - Investment Implications
- The previous decade saw an unprecedented housing bubble and an ensuing financial debacle.
- Federal Reserve Policy seemed out of sync, with the Fed feeding the flames of the housing bubble with low rates and then being slow to respond when the bubble popped.
- The Fed has a dual mandate - full employment and stable prices - which it generally follows by measuring the unemployment rate and the rate of inflation.
- Starting in 1983, the measure of inflation was revised so that house prices became irrelevant and "owner's equivalent rent" was used instead.
- Had the old measure of housing inflation been continued, inflation would have appeared early in the decade and the Fed would have tightened earlier and popped the bubble.
The Private Market Value Strategy: Part 3 - Leveraged Companies
- The private market strategy seeks to capture the value that a private investor (including a corporation making an acquisition) would attribute to an entire company.
- Leveraged companies can contain hidden value which would be attractive to a private investor.
- Leveraged companies have to be analyzed carefully to isolate cash flow, debt terms, and valuation and to determine actual private market value.
- In a sluggish economy, leveraged companies offer one of the rare opportunities to generate earnings growth as debt is retired and interest expense declines.
- The two companies which I have written about using this strategy have both been acquired by larger companies; the third - Aemetis (AMTX) is one of my highest conviction holdings.
Aemetis Still Looks Like A Winner
- A recent article suggests serious problems for Aemetis; the article suggests excessive leverage and an impending downward spiral.
- The article overstates the amount of debt owed by AMTX and exaggerates the degree of difficulty AMTX will have in repaying the debt.
- AMTX is generating strong cash flow and should be able to pay off roughly $35 million a year of the outstanding debt.
- With EBITDA of some $45 million and debt of roughly $42 million in July 2015, AMTX will have many alternatives for dealing with the remaining debt.
- With debt fully paid down in less than 2 years, AMTX can generate $2 a share in earnings and support a share price in the $20 - 30 range.
Current Economic Data Does Not Suggest A Rate Increase Anytime Soon
Aug. 6, 2014 • 3 Comments
- There has been some recent speculation that the 4% GDP growth in the second quarter may suggest an imminent rate increase.
- In fact, the second quarter followed a disastrous first quarter and GDP growth for the last six months is less than .5% or 1% per year.
- Other data - especially labor force participation numbers - suggests a great deal of "slack" in the economy which militates against a rate increase.
- Other central banks are still expansive which means that a US rate increase would push the dollar upward, increase the trade deficit and create deflation.
- I will stick with my earlier prediction that there will not be a two handle on the Fed Funds rate until 2017, most likely the second half of 2017.
The Market Is Overpriced But The Correction Will Likely Be Shallow
- The dividend yield methodology for valuing the market has been reliable for the five years since the Crash.
- Under this methodology, the S&P 500 trades between a 2.2% dividend yield and a 1.8% dividend yield with a midpoint at a 2.0% dividend yield.
- At Monday's closing price, the S&P yields 1.89% in dividends making it overpriced in comparison with the midpoint of the range.
- A pullback to 2.0% would imply a correction of roughly 5% in the Index; a less likely result would be a pullback to 2.2% or a 14% correction.
- The methodology should continue working until there is a major disruption in dividend flow or a major increase in interest rates.
What Happened To 'Peak Oil'?
- M. King Hubbert's prediction of a peak in US oil production proved eerily accurate in 1970.
- Peak oil enthusiasts predicted a peak in world oil production between 2004 and 2008.
- In fact, depending upon how it is measured, US oil production is now approaching the 1970 peak and world oil production has been increasing since 2009.
- The reason is that more expensive sources such as shale fracking, tar sands, and tertiary recovery have emerged and are increasing rapidly.
- A new oil market is emerging with higher marginal costs of production and more stable (but high) prices; there are very important investment implications.
Book Review: Stress Test By Timothy Geithner
- Geithner was in the center of the 2008-09 Panic and this book provides a useful perspective from an excellent vantage point.
- There are some "holes" in the analysis - why didn't authorities jump to action in 2007 when the subprime mess had been revealed and why wasn't it detected even earlier.
- The book reveals that Dodd Frank may have actually made our financial system more dangerous.
- I agree with Geithner on most points but I think he papers over some very tough and important issues.
- The book supports an important thesis of mine - intelligent investors absolutely have to assess public policy responses and incorporate that assessment in their investment decisions.
Dividend Investors Should Consider Private Equity Managers
- Private equity managers, including Blackstone and Kohlberg, Kravis, Roberts, are now publicly traded and pay attractive dividends.
- These stocks offer retail investors exposure (with liquidity) to the private equity market which has traditionally been a high performer.
- There are eight stocks in the sector and recent performance has been solid.
- Downsides include K-1 tax forms, transparency risk, and sensitivity to economic cycles.
- On balance, an exposure to these stocks will produce both yield and appreciation for dividend investors with some appetite for risk.
Aemetis Is A Potential Four- Or Five-Bagger
- Aemetis has converted first generation ethanol and biodiesel plants into advanced refineries and has recently obtained NASDAQ listing.
- At its current price and projecting from first quarter results, AMTX now trades at an enterprise price of less than 5 times enterprise owner cash flow.
- A number of factors should increase cash flow going forward.
- Key factors which will increase earnings are: 1. operations at its plant in India, 2. replacement of expensive debt with cheap debt, and 3. the reduction of outstanding debt.
- Making conservative assumptions, AMTX could earn well north of $2 a share and trade north of $30 within the next 2 years.
Why Piketty Is Wrong: Part 3 - Policy Recommendations
Jun. 9, 2014 • 60 Comments
- Further review reveals the importance of housing values for Piketty's thesis and suggests some counterintuitive results reached in his work.
- Piketty's recommendation for very high marginal income tax rates would lead to a preoccupation with tax avoidance and his tax on capital idea is unworkable.
- A better solution for the United States would be much lower income taxes, a value added tax and other policy revisions targeted at our real problems.
American Capital Is Attractive Below $15: Here's Why
- American Capital (ACAS) current price of $14.73 offers the investor a discount of 26% to the true value of $19.81.
- ACAS management has been shareholder oriented and is currently exploring restructuring alternatives that may unlock substantial latent value.
- ACAS has a subsidiary, American Capital Asset Management, which may be the focus of the restructuring and which could generate substantial value for investors.
Why Piketty Is Wrong: Part 2 - The Spirit Of An Age
May. 26, 2014 • 47 Comments
- Further review has revealed some dubious aspects of Piketty's calculations.
- Piketty assumes we are headed back to the world of Jane Austen and Balzac, a stultifying world dominated by inherited wealth.
- In reality, a world of "too much capital" will be more like the Wild West with opportunities (and unfortunately pitfalls) galore.
Why Piketty Is Wrong: Part 1 - The Math
May. 4, 2014 • 65 Comments
- Thomas Piketty's "Capital in the Twenty-First Century" raises important issues.
- It argues that returns on capital will eat up ever larger shares of national income.
- Piketty's argument is flawed because of assumptions about the return on capital.
- He also makes unwarranted assumptions about the elasticity of substitution between capital and labor.
- Piketty neglects the fact that under reasonable scenarios, implausibly large levels of savings would be necessary for his projections to materialize.
The Perils Of Pauline And The Power Of Monetary Policy
Apr. 18, 2014 • 48 Comments
- We have had a series of economic potholes since the Panic of 2008.
- These have included the Horizon oil spill, the Flash Crash, the Greek default scare, the US debt ceiling crisis, the MF Global Bankruptcy, and the Fukushima nuclear disaster.
- Despite these setbacks, aggressive monetary policy has enabled us to avoid a relapse into deflation.
- The old mantra "Don't Fight the Fed!" has a lot of truth to it; monetary policy is still a very powerful tool indeed.
S&P 500 Is Below Fair Value With A Strong Support Level Of 1668
- The dividend yield model of the S&P 500 has worked very well for more than 4 years.
- The model suggests a fair value based on a 2% yield - this suggests a price of $1835 for the index.
- The yield level of 2.2% has not been breached since the Fall of 2009 - that price level is now $1688.