The Sane Investor

The Sane Investor
Contributor since: 2010
>>[R]ather than continuing to invest in Agency MBS when interest rate spreads are tightening.<<
Have you looked at the yield curve lately? Spreads are expanding.
Sebastian, I actually came to a similar conclusion when I started investing in Annaly.
The mREITs generally have lower leverage than bread-and-butter banks, and for the agency mortgage backed securities these are essentially risk-less from a principal recovery perspective, so any declines in book value are only transitory until the principal is repaid and lent back out at a higher interest rate. Presuming that you don't have a margin call on your short-term borrowings as the transitory declines in book value take place, everything will eventually bounce back.
During NLY's February earnings call, Wellington noted:
"We do get like I said even if you know prepayments cut in half you’re still getting 5 billion in principal pay down each quarter that you have to reallocate."
So when you think about it, as long as there are no margin calls, mREITs like NLY can just keep rolling the principal forward at better NIMs and eventually book value will recover. In the interim, you have the cash flow from the interest.
So there's essentially no credit risk, it's really just a question of:
1) Will the interest margin be sufficient to pay out the dividend a given investor is expecting
2) Could transitory declines in book value lead to a margin call that forces selling and generates a loss on sale
How is the short-term lending that mREITs like AGNC and NLY get any different than the short-term lending that banks get from depositors, outside of the fact that bank saving deposits are FDIC insured?
mREITs are literally the exact same business model as a bank: borrow short-term at a low interest rate, lend long-term at a higher interest rate, profit off of the interest rate difference.
Why don't you just write a put option at an $11 strike? At least you'd be paid to wait that way.
I sold covered calls around the same price point you mentioned. It will be interesting to see if we can hold $14 / $13 going forward. Earnings at the end of July could be a catalyst either direction.
We're in a situation where the 200 MA and yearly average price could actually provide a floor rather than a ceiling to stock moves, which hasn't been the case since 2011.
I've been a long time bull of Cornings, and I don't think there's any reason to sell here. That being said, this run has been way too fast and furious for my liking, and I am really hoping for a vented selloff for the long-term sanity of this stock.
Here's the three year chart:
February/March of 2011 was the last time it was this overbought in the last three years, and we all know what happened to the stock after that.
I think if you're writing calls then now might be a good time to look into that, but in terms of buying I see no reason why to start now with the stock this overbought.
Mark, I must say I find it hilarious you are continuing to write about coal, and that you've now changed the way you describe your PCX position to a "bet".
For those not aware, Mark certainly did not consider this a bet before they filed. Here are some choice quotes of his on PCX, lest anyone be tricked that he has any idea what's going on:
>>I have big positions in coal. I lost nearly a million dollar [sic] on paper just on coal alone in recent month [sic]. But it will all come back. We will see. This is the single biggest investment opportunity I see in ten years. A temporary paper loss is well worth it. I am sticking around.<<
>>There is no possibility of PCX going bankruptcy given all the observations. The theoretically hypothesized quick bankruptcy could only exist in a different universe.<<
It's pure fearmongering. It takes many years of adverse market condition in a sector to drive any players to bankrutcy [sic] at all. I expect quick turn around in the coal sector. There will be no bankruptcy in any coal names.<<
>>When the bond price drops it only means the yield is going up.
If I were a bond holder it makes sense to sell the bonds and use the cash to buy dirt cheap shares instead. That can explain why the PCX bonds fell. Isn't reaping a 10+ fold gain in equities in the next one year better than holding the bonds yielding less than 10%? <<
>>PCX controls 1.922 billion tons of proven and probable coal reserves. If you value each ton of coal reserve for just $2 per ton, PCX should be easily valued at $3.8B worth but it is now valued for only $224M. That means PCX's share price can easily go up 16 fold given a more fair market price of coal. That is being conservative! I think the coal reserves underground should really be valued for at least $10 per ton. <<
>>Right now some one is selling PCX for $1.86 a share. The same people bought those shares at double digits a few months ago. They will come back to buy the same share at $60+ a year from now. But today they are selling at $1.86. I wonder where these people come from. Of course these folk would call me insane because I refuse to sell here but instead am buying more. <<
>>[...]if PCX drops by 50% tomorrow and every one is selling, I am going to double down and move a bigger chunk of my portfolio into PCX. It is a very worthy bet to put more money into it while every one is selling like they are seeing the end of the world. <<
Mark, you made a gutsy call and you were incredibly, incredibly wrong. I suggest you take some time off from writing and reflect on where you went wrong. You clearly DO NOT understand the coal industry.
Have you been following the price of natural gas? That is what crushed this industry.
Pretty sure the credit for destroying coal goes to nat gas
Great find Junc Bond
This is probably one of the more ignorant things you've written.
At this point, the bonds pretty much are equity because in chapter 11, guess who owns the company? The bondholders!
The notion that someone higher up in the hierarchy for getting a payout in the event of bankruptcy would somehow want to be lower on the totem pole as the risk of a default increased is sheer lunacy.
pete123, you are 100% correct. Buying Patriot and CHK are both gambles on extremely idiosyncratic, company specific risk outside of the market. They represent different idiosyncratic risks (Patriot: that management can refinance, CHK: that they can sort out corporate governance issues and complete asset sales) but they are definitely moving to their own tune.
You do not know everything in coal. You do not know what the future price will be for coal, outside of what the futures markets suggest (which is more of a market guess than anything). I think it's a little preposterous of you to paint these things as black and white regarding coal.
There are also tons of players in the natural gas realm outside of CHK, which has tremendous idiosyncratic risks due to their corporate governance and debt problems. So to suggest it's a binary investment decision between CHK and coal producers like BTU is ridiculous.
Frankly, Patriot shouldn't be compared to other coal companies as they are on their own death spiral. If someone is interested in going long coal, Patriot is not the way to do it. Buying Patriot right now is more a bet that management can get their finances sorted out than that the coal market will turn around.
FYI: markets can stay inefficient longer than you can stay solvent
Ok, so first, "spreaded" isn't a word. Second, "fear mongering" should be used as a verb. So you probably should have said "...admit he was fear mongering". I'm not one for dwelling on semantics, but if you're trying to sway people then focusing on your prose a little bit would help.
Third, as Junc Bond mentioned, if there's a 30 day grace period it's possible that there's still some ambiguity out there. I don't have access to the premium news sources for these things (ala debtwire), but the way the stock has behaved (up ~3% friday, down almost 10% yesterday) it doesn't seem clear whether or not this happened.
Chistletoe, at what price can you extract that coal though? And at what price can you then turn around and sell it?
The whole reason Patriot Coal is in this mess is they're primarily mining out of the least price competitive place in the US (Appalachia). Additionally, they have $442M in long term debt, so to say they're worth more than $250M for the equity component suggests the company is worth more than $692M to you, which is a much different argument.
Mark, you are thinking of that the absolute wrong way.
In your math, you're completely ignoring the cost of bringing said coal out of the ground. Your valuation there is assuming $2 in PROFIT, and that you would get all of the money tomorrow. It would take years to bring all of that out of the ground, so you'd have to discount the value there, and then there's the cost of actual extraction. Additionally, you're completely ignoring the debt they have on their books! Equity value is in addition to debt, and Patriot has $442M in long term debt outstanding as of 3/31/12.
Patriot happens to mine coal in one of the most expensive places in the United States (Appalachia) and the whole reason they're in this mess is because at the prices coal has been at for Patriot's entire existence they have not been price competitive. I urge you to look at their income statement and statements of cash flow to see how bad things have gone for them.
Frankly, if Patriot could mine coal profitably, they wouldn't be in this mess! This company was losing money way before the coal market took a dive. Complete dog of a company you should avoid at all costs. I'm short frankly.
Excellent article. Very informative.
I never saw confirmation on whether PCX's coupon got paid on Friday (I know it popped a little on a down day on the rumor it did), but what are your thoughts regarding the near term future of PCX in the event it was paid?
With daily moves of +/- 10% common for PCX, +2.9% isn't really a "pop". But I agree, if your stock ticks up because you paid the coupon on some of your debt, that's kind of sad. PCX is highly likely headed for Chapter 11.
I think if you're picking up Patriot Coal right here you're basically trying to catch a falling knife. Bondholders are no doubt looking at their equity buffer rapidly dissolving and the continually deteriorating earnings outlook and contemplating a bankruptcy and seizing the company.
PCX will likely be a chapter 11.
Does this apply to only the free version of Hulu or also Hulu Plus?
Of course they move from data point to data point. That's what markets do, so why should the Fed be any different? It's not like Bernanke has some crystal ball that only the Fed can see.
"The implication of Blahous’s baseline is that we don’t have a deficit problem. Anywhere. Medicare won’t contribute to deficits because it can’t spend beyond the trust fund. Social Security, similarly, can’t contribute to deficits because it can’t spend beyond its trust fund. [...] Lots of Affordable Care Act’s skeptics are trumpeting the Blahous study. But none of them actually use that baseline. Nor do they plan to switch over to it. And that means they don’t really believe the study."
Enough said.
1) As with any analysis, there have to be simplifying assumptions. Naturally Apple could not just turn around and issue $146B in one issuance and have that massive amount of principal due looming on their books 10-30 years out in the future. They would likely issue in cycles and periodically buy back shares. I felt at the time of this analysis that trying to account for that was excessive detail for a simple article.
Here is what I say in the article regarding interest:
"After turning 30% of the company over, assuming coupon payments of 3% annually, average analyst estimates for the end of the year earnings per share (EPS) of $42.72 would instead be $56.07 (using the 25% Apple typically pays in taxes and taking out interest)."
As you can see in the parentheses, I took out interest from the adjusted EPS, so your argument there is invalid. Please read the full article before you accuse me of not appropriately accounting for certain items.
If you want to split hairs on the definition of ROE, technically what I'm showing is return on market value of equity, which I find to be a far more appropriate metric for someone looking to make an investment in Apple today. The market value of equity to me is more valuable for determining returns than book value of equity, since this is what you could actually acquire in the market.
I don't understand the concern over needing to pay a certain amount yearly for a company that has enough cash on the books to cover dividend and interest with no income for several years. This seems to me a ridiculous concern.
2. This is why companies have a Chief Financial Officer and finance teams. I don't see why Cook's time has to be interrupted to deal with underwriting or any debt issuances, other than a binary "yes/no do we do this" upon review of the finance team's analysis. There are other people in the company whose responsibility it is to deal with these things.
For further evidence of how Apple can continue to outperform, one should consider that with the transfer of 30% ownership of the company to AAA bondholders, AAPL could increase their return on equity by 2.5 percentage points. This combined with their already attractive valuation on a price to earnings basis demonstrates how the stock could continue to climb much higher.
I've written an article ( ) about how Apple could issue a 2.5% dividend without touching their cash pile and maintaining the same amount of net income available for growth and acquisitions as they have currently.
This could be accomplished by transferring 30% of Apple ownership to AAA bondholders who demand a much lower rate of return, leaving more left over for the remaining shareholders. This appears to be a win-win for growth-focused Apple investors and value-focused Apple investors.
Thanks Tradevestor.
I agree that it is certainly sounds "un-Apple", largely because Steve Jobs was not a fan of tweaking Apple's capital structure. With Cook at the helm, I think Apple might be more open to it.
The largest concern issuing debt for Apple will draw is that management will be distracted from the long-term focus to placate bondholders who are typically more focused on free cash flow and value preservation. I think this concern can largely be mitigated by only issuing long-term debt and only AAA bonds. AAA bondholders will likely not feel any need to interfere with the way the company is being run.
One additional positive for Apple's upside is the fact that they could increase their return on equity by 2.5 percentage points by transferring 30% ownership of the company to AAA bondholders.
Tweaking Apple's capital structure may seem like mumbo jumbo, but really it's about bringing different types of investors to the table who will demand a lower rate of return for capital protection, thus leaving more left over for equity holders.
I've written an article ( ) about how Apple could increase their return on equity by 2.5 percentage points by transferring 30% ownership of the company to AAA bondholders.
One way to think about issuing AAA bonds is they're like selling the box seats in a basketball arena. The box seat holders pay a premium to be shielded from the riff-raff outside and have their own private viewing experience, even though they're pretty far away from the action. Therefore it's win-win: the arena gets more money for the box seats versus if they just had regular seats there, and the box seat holders get the viewing experience they're looking for.
A triple-AAA bondholder is like a box seat holder in that they are willing to pay a premium (by not receiving the same returns as equity holders) to be protected from the risks of holding equity. Equity holders still get what they want (the upside), and because they've sold a portion of the company value to investors interested in capital preservation who are willing to pay for it with a very low return, equity holders are rewarded with higher returns.