Category Archives: Special Situations

Reader’s Question: Cyclicals

Structure of production

 

What multiples and metrics to use for different industries? 

A reader struggles with how to value cyclical industries. First you have to understand the particular industry. How to do that–read the reports and financials of dozens of companies in that industry, then note what is important to value such a business.  Take several months.  If you are looking at highly-cyclical businesses, then you should read : Skousen-Structure-production.pdf

Note how long the cycles are in the gold mining industry.  A mine may take a year or two to close or years to open. From discovery of the deposit until extraction may take a decade or more. A gold miner is valued on production, reserves, cost to extract, etc.

Now if you have access to a Bloomberg (expensive!) or go to a library and look at Value-Line, Moody’s Manuals, or industry articles of the industry.   You can scrub around the Internet, but you have to grind through company reports to get a feel.  Obviously, “heavy industries” require analysis of tangible book, replacement value, capital costs, industry capacity and utilization–note what happened in the airline industry when capacity was taken off-line. Go to search box and read my post on CRR, Carbo-ceramics–below TBV and replacement value, for example.

gold
If I seem abrupt with your questions, here is the reason why.

See’s Candies, Sanborn Map, and Inflation Article

SeesA Nor’easter is coming my way (up to two to three feet of snow with high winds) so I may be out of contact for two or three days.  But push on we must. We continue to study Chapter 3, in Deep Value and Buffett’s investing career.Sees 2

The best investment article I have ever read of Buffett’s is:

Buffett & Inflation Highlighted plus if you wish to read all that Buffett has said about inflation then Buffett inflation file.

A key case for you to focus on is See’s_Candies_Case_Study. Combined with Buffett’s Inflation Swindles the Equity Investor (Fortune Article: Buffett – How Inflation Swindles the Equity Investor), you will see a leap in Buffett’s thinking. Both are important to understand and complementary to each other.

Finally, Sanborn_Map_Case_Study_BPLs is another case mentioned in Chapter 3 of Deep Value.

Hopefully, students will discuss in the comments section.

Time to bring out the snowshoes!

It’s not entirely clear what will happen in the near term, but the financial markets are already pushed to extremes by central-bank induced speculation. With speculators massively short the now steeply-depressed euro and yen, with equity margin debt still near record levels in a market valued at more than double its pre-bubble norms on historically reliable measures, and with several major European banks running at gross leverage ratios comparable to those of Bear Stearns and Lehman before the 2008 crisis, we’re seeing an abundance of what we call “leveraged mismatches” - a preponderance one-way bets, using borrowed money, that permeates the entire financial system. With market internals and credit spreads behaving badly, while Treasury yields, oil and industrial commodity prices slide in a manner consistent with abrupt weakening in global economic activity, we can hardly bear to watch..   John Hussman, Jan. 26, 2015   www.hussmanfunds.com

How NOT to be a DEEP VALUE INVESTOR

Repetitio est mater studiorum,” says the Latin proverb – repetition is the mother of all learning.

Lessons for this post:

  1. Know what you are doing.
  2. Avoid paying massive premiums over net asset values.

Below is CUBA, a closed-end fund investing in companies that invest in Cuba or will benefit by an increase in business with Cuba. Note the spike upward on the announcement that Obama would allow a prisoner exchange and take Cuba off the US’s terror list opening up the possibility of the end of the US embargo.

large CUBA

Now go: CUBA NAV Summary  (Click on the button, since exception on the right side of the page, to see the history of price vs. Net Asset Value (“NAV”). Note the results last time “investors”/speculators or the confused paid in excess of 50% to the underlying stocks. We can argue about the intrinsic values of the underlying stocks but not the prices–because price is what it is. Mr. Market has spoken.

Here we are todaysmall cuba

Go back and click on CUBA NAV Summary and view the one year summary. Note that the price reached a 70% premium to the NAV AFTER the news event of “improving” US/Cuba relations.   Upon hearing the news:

My first post on CUBA (CEF) SELL!  Can I predict? No, just common-sense.

Where is the efficient market? Perhaps the unavailability of shares to borrow hindered arbitrageurs who could buy the underlying stocks and short the closed-end fund (“CEF”), CUBA.  But to pay such a premium is almost a guaranteed loss unless sold to a greater fool who will pay an even more absurd premium. That is speculating not investing. What is business-like about paying a 70% premium after a news event?

A closed-end fund sells a fixed number of shares to investors. For example, let’s pretend we start a closed-end fund to buy stocks, called the BS Fund. We sell 10 shares at $10 each for $100 in capital, then we buy 1 share of Company X at $50 and 2 shares of Company Y for $25 (ignoring commissions and fees). The net asset value (NAV) is ($50 times 1 share) + ($25 times 2 shares) = $100.   The net asset value per share is also $10.  So the price per share of the CEF ($10) trades at no premium (0) to the NAV per share $100/10 shares.  Now an investor wants to sell 3 of his BS (CEF shares) to an investor who bids for them at $9.00 per share.  Unless, the underlying share prices of Company X and Y change, then the discount is now 10%.  We, as the management, must institute a decision to buy back shares of the BS fund to close the discount or investors increase their demand for the shares.

Carl Icahn got his start as a closed end fund arbitrageur, who would force the managements of the closed-ends funds that traded at large discounts to NAV, to buy-back their shares.

Setting aside the emotional impact of the news announcement, the prisoner exchange and Obama’s reducing of sanctions doesn’t change much.  By the way, if sanctions and embargos don’t work (I agree) as Obama claims then why the sanctions on Russia? If the Russians didn’t surrender during Stalingrad, what are the odds now? Color me cynical.

The US is ALREADY one of the top ten trading partners with Cuba. Of course, the embargo is a farce, kept in place for political purposes. Congress still has to vote to remove the embargo, but even without the embargo Cuba lacks the production of goods and services to trade. Why? Cubans lack the capital to produce because they lack the security of property rights and the rule of law to acquire capital. No Habeas Corpus, no freedom of speech, and no rights. No tyranny generates LONG-TERM economic growth.

What returns will foreign investors require to invest in Cuba?  Say you whip out your spread-sheet and suggest 25% annual returns to build a new hotel in Cuba based on your projection of American tourists hitting the shores of Cuba like locusts.  Two years after the hotel is built, Raul Castro and his military cronies tears up your contract. Investment lost.  Without the rule of law and sanctity of contract, the rest means little. The first lesson is to know what you are doing.

Life in Cuba:

  1. Tengo Hambre A Cuban Says I AM HUNGRY!
  2. Life for Cuban Youth (Cuba with highest suicide rates in the Western Hemisphere.

The investor who buys CUBA would have to understand what the current changes mean for the companies in the fund. Anyone who spends time understanding the current economic conditions there would grasp how little the current announcement means for investment there.  Ask the Canadian investor rotting in a Cuban jail today Canadian investor rots in Cuban jail.

Speculators were willing to pay at 70% premium AFTER the price of the underlying companies had moved higher by 10% to 15% on the news.  A premium on top of a premium–a lesson of what NOT to do.   Questions?

If anyone in this class does that, then this awaits: No Excuse

Going DEEP into Deep Value (Course on Value Investing)

Deep value cover

My Idea:

This is an experiment to see if a group of serious students of value investing can learn from each other and an in-depth reading of the course materials to become better investors.   If you send me your email to aldridge56@aol.com (DEEP VALUE COURSE) in the title, I will send you the course materials (Thanks to a reader for contributing!).   There is a catch however. You are expected to do the readings and comment/participate in the discussion in the comments section. So don’t seek unless committed to being an active participant. Since there will be supplementary readings for each chapter of the book (see chapter titles below), we will take one to two weeks per chapter.  You may have homework or be asked to research investment questions further.   I won’t think any less of you if you decide to pass–this course is only for fanatics.  Course will start a week or two into the New Year. 

Description of the book below (also type in DEEP VALUE) in the search box of this box and view some of the videos on deep value and the author, Toby Carlisle. Also, go to www.greenbackd.com and look at the past ten posts.

Book blurb from Wiley:

Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations is a must-read exploration of deep value investment strategy, describing the evolution of the theories of valuation and shareholder activism from Graham to Icahn and beyond. The book combines engaging anecdotes with industry research to illustrate the principles and methods of this complex strategy, and explains the reasoning behind seemingly incomprehensible activist maneuvers. Written by an active value investor, Deep Value provides an insider’s perspective on shareholder activist strategies in a format accessible to both professional investors and laypeople.

The Deep Value investment philosophy as described by Graham initially identified targets by their discount to liquidation value. This approach was extremely effective, but those opportunities are few and far between in the modern market, forcing activists to adapt. Current activists assess value from a much broader palate, and exploit a much wider range of tools to achieve their goals. Deep Value enumerates and expands upon the resources and strategies available to value investors today, and describes how the economic climate is allowing value investing to re-emerge. Topics include:

  • Target identification, and determining the most advantageous ends
  • Strategies and tactics of effective activism
  • Unseating management and fomenting change
  • Eyeing conditions for the next M&A boom

Table of Contents

Chapter 1 The Icahn Manifesto 1

Chapter 2 Contrarians at the Gate 19

Chapter 3 Warren Buffett: Liquidator to Operator 35

Chapter 4 The Acquirer’s Multiple 53

Chapter 5 A Clockwork Market 77

Chapter 6 Trading in Glamour: The Conglomerate Era 99

Chapter 7 Catch a Falling Knife 119

Chapter 8 The Art of the Corporate Raid 151

Chapter 9 How Hannibal Profits From His Victories 169

Chapter 10 Applied Deep Value 187

More DEEP VALUE (Video of Toby Carlisle at the Googleplex)

Debt Piecture

The Money Game by Adam Smith:

We are at a wonderful ball where the champagne sparkles in every glass, and soft laughter falls upon the summer air, we know at some moment the black horsemen will come shattering through the terrace doors, wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no one wants to leave while there is still time, so everyone keeps asking, ‘What time is it?’ But none of the clocks have hands.

This link provides an excellent video of deep value or contrarian investing; See it!

http://greenbackd.com/2014/12/29/deep-value-at-authorsgoogle/

I am still waiting on a reader to send a copy of Deep Value. Then we can go into a close analysis of the book.

More:

2014-Year-in-Review-Collum  from a long-term investor.

Line between rational speculation and market collapse

HAVE A HAPPY AND PROSPEROUS NEW YEAR!

Buy Hatred and Fear: Kinross (Russian assets for practically free)

CEF_041114

Gold Sentiment (CEF)

The above shows the extreme negativity in the gold market. You can buy the Canadian Closed-End Fund (CEF) at a 10% to 11% discount to gold (60% of assets) and silver (40%) approximately.  Gold and silver have no counter-party risk. Such is the world of closed-end funds.  Note the 20% premiums during bull runs!

KINROSS

The absurdity of gold stock valuations is illustrated by Kinross. Consistently improving operations with $5.30 book value and with no value attributed to their Russian mine. Net-debt-to-EBITDA of 1.28 with their debt covenants being 3.5xs to 1. Cash of $879 million. 1.14 billion outstanding shares. 27 cents of operating cash flow this quarter share, up 22%. A 2.6 to 2.7 million gold equivalent oz. producer. $698 cash costs and $919 All-in Sustaining Cash Cost.  They can survive at $1,000. Below $1,000 operations would be reduced.  Of course, Kinross represents a trifecta of hatred: poor past acquisitions (declining stock price), the gold market, and some Russian assets.

Basically, the market is heavily discounting their assets because the market is assuming sub-$1,000 gold. No value given to their Russian mine.

KINROSS RESULTS 3Q 2014

110514 kinross reports 2014 third quarter results

kinross141106

You should listen to the  Kinross conference call

Mining is a crappy business

Miners at or near ALL-TIME (past 90 years) low of stock price to gold price. Part of the reason for the decoupling is the time to find new deposits and place them into production has gone from five to six years out to ten years. Mining costs hve not been kept in check until recently. Past mining managements made poor capital allocation decisions. A mine is a depleting asset! But the market has had four years to replace managements and adjust.

sa71

Current sentiment in the gold miners ZERO (0). The recommended allocation is Zero. Contrarians take note but you better have a strong stomach in the near-term.

bpgdm7year021114

But what you need to focus on is not so much the nominal price but the REAL price of gold.  15% or more of the costs of a mine are energy based.

gold to oil

That said, do your own thinking and use this as a case study of where to look for negative sentiment.   The question is…..are you being paid enough for the risks?

Can gold go to $800? Sure and Kinross and other miners will be closing down many of their operations or even going bankrupt. But consider what $800 gold would mean in a world choking on debt! Perhaps stocks might not hold up in a deflationary bust!  It is not just the gold price but the real gold price that matters to miners.  However, nominal gold prices in US dollars matter to miners that have debt denominated in US dollars.

Just never buy one miner because of the risks to any one company. Use the EXTREME price volatility to your advantage. Don’t buy the stock all at once. If you need to diversify and have limited capital, then SGDM might be a choice–IF you think owning miners is the lowest cost way to participate in either a deflationary bust or inflationary response by the Fed.  Otherwise, CEF (above) might be a cheap form of insurance to monetary mayhem.

Miners in a capitulation phase–crashing on huge volume–after four year price decline. Folks have had enough. Money managers in forced liquidation?

GDX

Some history

Just remember that you are trying to buy assets at extremely low prices since this is not a franchise. A mine is a DEPLETING asset.   How much money goes into a mine versus what is sold discounted by your cost of capital.

Obviously, with a cyclical asset you will find losses and the widest spread between price and financial operating metrics because a trough occurs in a bear market of declining product prices.  The reverse occurs at the top of a cycle–huge revenues and profits during the boom. So you MUST sell–this is a “burning” match not a franchise. Burn this into your brain.

What could go wrong with financial assets?

Paul Singer grits his teeth while holding gold during a monetary delusion

Paul Singer on “illogical” market trends: http://www.valuewalk.com/2014/11/paul-singer-q3-2014-letter/

I disagree with Mr. Singer because the bubble in confidence in central planning by the Fed means extreme trends.   For example, massive printing of money will cause LOWER gold prices because the market sees perpetual support of financial assets. Why own gold when equities will NEVER drop more than 10% in our lifetimes.  Thus, massive monetary intervention is bearish for gold. Of course, house prices could NEVER fall nation-wide and the Internet Bubble ushered in a new normal.  Timing is impossible. 

THIS IS WHAT IT FEELS LIKE TO OWN MINERS THIS PAST MONTH–Please no women or children to click on this link! http://youtu.be/82RTzi5Vt7w?t=1m52s

Gold, Inflation Expectations and Economic Confidence

Wednesday November 05, 2014 11:29

Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 2nd November 2014. Excerpts from our newsletters and other comments on the markets can be read at our blog: http://tsi-blog.com/ 

As a result of what happened during just one of the past twenty decades (the 1970s), most people now believe that a large rise in “price inflation” or inflation expectations is needed to bring about a major rally in the gold price. This impression of gold is so ingrained that it has persisted even though the US$ gold price managed to rise by 560% during 2001-2011 in parallel with only small increases in “price inflation” (based on the CPI) and inflation expectations. The reality is that gold tends to perform very well during periods of declining confidence in the financial system, the economy and/or the official money, regardless of whether the decline in confidence is based on expectations of higher “inflation” or something else entirely.

Inflation expectations are certainly part of the gold story, but only to the extent that they affect the real interest rate. For example, a 2% rise in inflation expectations would only result in a more bullish backdrop for gold if it were accompanied by a rise of less than 2% in the nominal interest rate. For another example, a 1% decline in inflation expectations would not result in a more bearish backdrop for gold if it were accompanied by a decline of more than 1% in the nominal interest rate.

Other parts of the gold story include indicators of economic confidence and financial-market liquidity, such as credit spreads and the yield curve.

That large rises in the gold price are NOT primarily driven by increasing fear of “inflation” is evidenced by the fact that the large multi-year gold rallies of 2001-2006 and 2008-2011 began amidst FALLING inflation expectations. These rallies were set in motion by substantial stock market declines and plummeting confidence in central banks, commercial banks and the economy’s prospects. Even during the 1970s, the period when the gold price famously rocketed upward in parallel with increasing fear of “inflation”, the gold rally was mostly about declining real interest rates and declining confidence in both monetary and fiscal governance. After all, if the official plan to address a “price inflation” problem involves fixing prices and distributing “Whip Inflation Now” buttons, and at the same time the central bank and the government are experimenting with Keynesian demand-boosting strategies, then there’s only one way for economic confidence to go, and that’s down.

Since mid-2013 there have been a few multi-month periods when it appeared as if economic confidence was turning down, but on each occasion the downturn wasn’t sustained. This is due in no small part to the seemingly unstoppable advance in the stock market. In the minds of many people the stock market and the economy are linked, with a rising stock market supposedly being a sign of future economic strength. This line of thinking is misguided, but regardless of whether it is right or wrong the perception is having a substantial effect on the gold market.

For now, the economic confidence engendered to a large extent by the rising stock market is putting irresistible downward pressure on the gold price.

Steve Saville
http://www.speculative-investor.com/new/index.html

Buy What is on Sale! CEF Discounts

PITSelling today in the pits-gold and silver

CEF BIG

Above is a chart of CEF, Canadien Gold (60%) and Silver (40%) bullion closed-end fund trading at a 6.5% discount today. ON SALE!  I have no clue if tomorrow the price will be higher or lower.

http://www.cefconnect.com/Details/Summary.aspx?Ticker=CEF

Note the premiums as high as 10% and currently 6.5% discount.

4-Gold-sentiment-data

Learn more about interpretating sentiment indicators: www.acting-man.com

Long term sentiment

gold Sent 1

Silver Sent 1

HYGI Sent

A Great blog, Down the Rabbit Hole: http://biiwii.com/wordpress/2014/09/10/sentiment-shifting-gold-bugs/

Though, I like miners more, but now is a good time to pick up tangible money at a discount. Pay 94 cents and get a dollar of gold and silver today–I will take it.  SOLD!  Miners make money on the arbitrage between their input costs and output prices. You don’t need a rising nominal gold price; you need a rising REAL gold price.

gold.cci_-600x264 (2)

Gold commodities

Now is the time for me to post on Yamana (by this weekend, I pray) because it is at a price $7.33 that I have purchased in the past and it may be a reasonable choice for a BASKET of miners.

Also, you want to see analysts pile-on negatively AFTER price has fully dicounted the news. I am not being contrarian or cynical, it is just how markets work–they DISCOUNT.

Yamana Gold suffers rash of stock price target cuts • 12:58 PM

Carl Surran, SA News Editor
  • Yamana Gold (AUY -1.2%) is lower after Morgan Stanley, Credit Suisse and Raymond James cut their price targets on the stock to $10.70, $10.50, and $10, respectively.
  • In the case of Morgan Stanley, the lower target still implies upside of more than 40%; AUY has said the Pilar mine in Brazil has shown improvements with output increasing M/M, but the ramp up is tracking modestly below expectations, thus the firm’s tempered outlook.
  • An update on Canadian Malartic and meeting quarterly expectations are potential catalysts expected over the next 6-8 weeks.

Read comments

Read the link below and the link within it to gain more understanding on gold and miners.

http://www.acting-man.com/?p=32809 

Munger Discusses Blue Chip Stamps

Blue Chip

A case study of Warren Buffett and Charlie Munger’s investment in and management of Blue Chip Stamps. Includes:

If you find any errors or have any other contributions, make a pull request or contact me through the Twitter handle @maxolson.

GO HERE: https://www.gitbook.io/book/maxolson/blue-chip-stamps

PS: On the road, but I haven’t forgotten about Yamana. I wouldn’t buy above $8.00.

If gold is down because the market thinks the Fed will raise rates and end QE, then those assumptions are based on fantasy. HOW can the FED EVER stop QE without the house of cards collapsing?  What does history say:  http://www.zealllc.com/2014/goldrrf.htm

 

Here is the Argentina Peso in free-fall:

Peso Monthly

HAVE A GREAT WEEKEND!

 

Searching For Special Situations; The Petro-Dollar

nq140620

 The market, like the Lord helps those who help themselves. Unlike the Lord, the market does not forgive those who know not what they do. –Warren Buffett

A business that must deal with fast-moving technology is not going to lend itself to reliable evaluation if its long-term economics. Did we foresee thirty years ago what would transpire in the television-manufacturing or computer industries? Of course not. Why, then, should Charlie (Munger) and I now think we can predict the future of other rapidly-evolving businesses? We will stick instead with the easy cases. Why search for a needle buried in a haystack when one is sitting in plain sight.

SPECIAL SITUATION WORKSHOP PRESENTATION

Zack-Buckley-The-Road-Less-Traveled-Presentation Motivated students can download the financials of the companies mentioned and check the authors assumptions/work.

Creating Value Through Corporate Restructuring Course-1

 

The Current Situation with Our Petrodollar

http://usawatchdog.com/iraq-about-us-dollar-hyperinflation-trouble-in-2015-gordon-long/

 

TREASURE CHEST!

Hashtag

INFLATION

http://www.acting-man.com/?p=31075  Note the ZIRP-induced distortion in the production structure.

production-capital-and-consumer-goods-ann

Fed and Stocks

BB

bPKW

PKW is a buy-back ETF which only chooses companies that will buy back at least 5% of their shares per year.

Treasure Chest 

Lecture Links  Thanks to a generous contribution! Let me know what you learn.