Category Archives: Valuation Techniques

Buffett’s Search and Analysis Techniques; Economic Fitness

investor-trait

Wise Thoughts from Buffett on Finding Stocks

  1. I started at page one [of these manuals-Moody’s and Value-Line] and went through every company that traded, from A to Z. When I was done I knew something about every company in the book.
  2. I like businesses that I can understand. Let’s start with that. That narrows it down by 90%. There are all types of things I don’t understand, but fortunately, there is enough I do understand. You have this big wide world out there and almost every company is publicly owned. So you have all American business practically available to you. So it makes sense to go with things you can understand.
  3. First, you need two piles. You have to segregate businesses you can understand and reasonably predict from those you don’t understand and can’t reasonably predict. An example is chewing gum versus software. You also have to recognize what you can and cannot know. Put everything you can’t understand or that is difficult to predict in one pile. That is the too-hard pile. Once you know the other pile, then it’s important to read a lot, learn about the industries, get background information, etc. on the companies in those piles. Read a lot of 10Ks and Qs, etc. Read about the competitors. I don’t want to know the price of the stock prior to my analysis. I want to do the work and estimate a value for the stock and then compare that to the current offering price. If I know the price in advance it may influence my analysis. We’re getting ready to make a $5 billion investment and this was the process I used.
  4. You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map – way off the map. You may find local companies that have nothing wrong with them at all
  5. Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.
  6. I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.
  7. If we were to do it over again, we’d do it pretty much the same way. The world hasn’t changed that much. We’d read everything in sight about businesses and industries we think we’d understand. And, working with far less capital, our investment universe would be far broader than it is currently.

7 Gems from Buffet on Analyzing Stocks

  1. You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”
  2. There’s nothing different, in my view, about analyzing securities today vs. 50 years ago.
  3. We favor businesses where we really think we know the answer. If we think the business’s competitive position is shaky, we won’t try to compensate with price. We want to buy a great business, defined as having a high return on capital for a long period of time, where we think management will treat us right. We like to buy at 40 cents on the dollar, but will pay a lot closer to $1 on the dollar for a great business.
  4. Munger: Margin of safety means getting more value than you’re paying. There are many ways to get value. It’s high school algebra; if you can’t do this, then don’t invest.
  5. If you’re going to buy a farm, you’d say, “I bought it to earn $X growing soybeans.” It wouldn’t be based on what you saw on TV or what a friend said. It’s the same with stocks. Take out a yellow pad and say, “If I’m going to buy GM at $30, it has 600 million shares, so I’m paying $18 billion,” and answer the question, why? If you can’t answer that, you’re not subjecting it to business tests.
  6. Capital-intensive industries outside the utility sector scare me more. We get decent returns on equity. You won’t get rich, but you won’t go broke either. You are better off in businesses that are not capital intensive.
  7. No formula in finance tells you that the moat is 28 feet wide and 16 feet deep. That’s what drives the academics crazy. They can compute standard deviations and betas, but they can’t understand moats. Maybe I’m being too hard on the academics.

7 Nuggets from Buffett on Valuing Stocks

  1. When Charlie and I buy stocks which we think of as small portions of businesses our analysis is very similar to that which we use in buying entire businesses. We first have to decide whether we can sensibly estimate an earnings range for five years out, or more. If the answer is yes, we will buy the stock (or business) if it sells at a reasonable price in relation to the bottom boundary of our estimate. If, however, we lack the ability to estimate future earnings – which is usually the case we simply move on to other prospects. In the 54 years we have worked together, we have never foregone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions.
  2. In 1986, I purchased a 400-acre farm, located 50 miles north of Omaha, from the FDIC. It cost me $280,000, considerably less than what a failed bank had lent against the farm a few years earlier. I knew nothing about operating a farm. But I have a son who loves farming, and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be. From these estimates, I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.
  3. Intrinsic value is terribly important but very fuzzy. We try to work with businesses where we have fairly high probability of knowing what the future will hold. If you own a gas pipeline, not much is going to go wrong. Maybe a competitor enters forcing you to cut prices, but intrinsic value hasn’t gone down if you already factored this in. We looked at a pipeline recently that we think will come under pressure from other ways of delivering gas [to the area the pipeline serves]. We look at this differently from another pipeline that has the lowest costs [and does not face threats from alternative pipelines]. If you calculate intrinsic value properly, you factor in things like declining prices.
  4. Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.
  5. We use the same discount rate across all securities. We may be more conservative in estimating cash in some situations.
  6. Just because interest rates are at 1.5% doesn’t mean we like an investment that yields 2-3%. We have minimum thresholds in our mind that are a whole lot higher than government rates. When we’re looking at a business, we’re looking at holding it forever, so we don’t assume rates will always be this low.
  7. The appropriate multiple for a business compared to the S&P 500 depends on its return on equity and return on incremental invested capital. I wouldn’t look at a single valuation metric like relative P/E ratio. I don’t think price-to-earnings, price-to-book or price-to-sales ratios tell you very much. People want a formula, but it’s not that easy. To value something, you simply have to take its free cash flows from now until kingdom come and then discount them back to the present using an appropriate discount rate. All cash is equal. You just need to evaluate a business’s economic characteristics.

More Reading

Most of these quotes came from Buffett FAQ which contains the Q&A from shareholder meetings and goes beyond what you’ll find in the annual letters.

Just from these small selection of quotes, you can see how Buffett manages to dance in zone 4.

Take his words to heart and let’s join him on the dance floor because the sweet spot is where we belong. Read more: http://www.oldschoolvalue.com/blog/investing-perspective/warren-buffett-analyze-value-stocks/#ixzz3iofOBNF9

Economic Review & Fitness

Boot Camp  A good resource for students

Consequence of ZIRP

What is money?

Economic Conversations

How the economy works by Ray Dalio

Sentiment

Crude-Oil-Returns

oil Sentiment

oil carnage

Oil headed to $10 a barrel

HAVE A GOOD WEEKEND!

Boom Bust in Coal (Alpha Natural Case Study)

Alpha Stock Bubble

Pop Goes ANRZ

This post and article captures the investing world we live in.

By David Stockman (Please read: http://davidstockmanscontracorner.com)

If you want a cogent metaphor for the central bank enabled crack-up boom now underway on a global basis, look no further than today’s scheduled chapter 11 filling of met coal supplier Alpha Natural Resources (ANRZ). After becoming a public company in 2005, its market cap soared from practically nothing to $11 billion exactly four years ago. Now it’s back at the zero bound.

This article by David Stockman perfectly illustrates that capital DESTRUCTION or mal-investment occurs DURING the boom phase.  The bust which is what Alpha and the entire coal industry are going through creates the healing process as assets are redeployed to their higher uses and supply is re-balanced to meet changed demand. 

From 2006 to today during the greatest coal boom in history, Alpha has lost almost $5 billion for its shareholders.   At the peak of its earnings, the market cap (not including debt) traded at 25 times and during the insanity at over 50 times.  Investors were destroying their capital and the company was mis-allocating its shareholder’s capital DURING the boom phase.   Now is the cleansing process. Ditto for many coal companies.   So ask yourself why do reasonably intelligent management teams and Board of Directors make such a CLUSTER of errors and why do investors pay stupid multiples on peak earnings? A combination of central bank distortion and psychology and momentum chasing?

Alpha Case Study See spread sheet xls.

Yes, bankruptcies happen, and this is most surely a case of horrendous mismanagement. But the mismanagement at issue is that of the world’s central bank cartel.

The latter have insured that there will be thousands of such filings in the years ahead because since the mid-1990s the central banks has engulfed the global economy in an unsustainable credit based spending boom, while utterly disabling and falsifying the financial system that is supposed to price assets honestly, allocate capital efficiently and keep risk and greed in check.

Accordingly, the ANRZ stock bubble depicted above does not merely show that the boys, girls and robo-traders in the casino got way too rambunctious chasing the “BRICs will grow to the sky” tommyrot fed to them by Goldman Sachs. What was actually happening is that the central banks were feeding the world economy with so much phony liquidity and dirt cheap capital that for a time the physical economy seemed to be doing a veritable jack-and-the-beanstalk number.

In fact, the central banks generated a double-pumped boom——first in the form of a credit-fueled consumption spree in the DM economies that energized the great export machine of China and its satellite suppliers; and then after the DM consumption boom crashed in 2008-2009 and threatened to bring the export-mercantilism of China’s red capitalism crashing down on Beijing’s rulers, the PBOC unleashed an even more fantastic investment and infrastructure boom in China and the rest of the EM.

During the interval between 1992 and 1994 the world’s monetary system—–which had grown increasingly unstable since the destruction of Bretton Woods in 1971——took a decided turn for the worst. This was fueled by the bailout of the Wall Street banks during the Mexican peso crisis; Mr. Deng’s ignition of export mercantilism in China and his discovery that communist party power could better by maintained from the end of the central bank’s printing presses, rather than Mao’s proverbial gun;  and Alan Greenspan’s 1994 panic when the bond vigilante’s dumped over-valued government bonds after the Fed finally let money market rates rise from the ridiculously low level where Greenspan had pegged them in the interest of re-electing George Bush Sr. in 1992.

From that inflection point onward, the global central banks were off to the races and what can only be described as a credit supernova exploded throughout the warp and woof of the world’s economy. To wit, there was about $40 trillion of debt outstanding in the worldwide economy during 1994, but this figure reached $85 trillion by the year 2000, and then erupted to $200 trillion by 2014. That is, in hardly two decades the world debt increased by 5X.

To be sure, in the interim a lot of phony GDP was created in the world economy. This came first in the credit-bloated housing and commercial real estate sectors of the DM economies through 2008; and then in the explosion of infrastructure and industrial asset investment in the EM world in the aftermath of the financial crisis and Great Recession. But even then, the growth of unsustainable debt fueled GDP was no match for the tsunami of debt itself.

At the 1994 inflection point, world GDP was about $25 trillion and its nominal value today is in the range of $70 trillion—-including the last gasp of credit fueled spending (fixed asset investment) that continues to deliver iron ore mines, container ships, earth-movers, utility power plants, deep sea drilling platforms and Chinese airports, highways and high rises which have negligible economic value. Still, even counting all the capital assets which were artificially delivered to the spending (GDP) accounts, and which will eventually be written-down or liquidated on balance sheets, GDP grew by only $45 trillion in the last two decades or by just 28% of the $160 trillion debt supernova.

Here is what sound money men have known for decades, if not centuries. Namely, that this kind of runaway credit growth feeds on itself by creating bloated, artificial demand for materials and industrial commodities that, in turn, generate shortages of capital assets like mines, ships, smelters, factories, ports and warehouses that require even more materials to construct. In a word, massive artificial credit sets the world digging, building, constructing, investing and gambling like there is no tomorrow.

In the case of Alpha Natural Resources, for example, the bloated demand for material took the form of met coal. And the price trend shown below is not at all surprising in light of what happened to steel capacity in China alone. At the 1994 inflection point met coal sold for about $35/ton, but at that point the Chinese steel industry amounted to only 100 million tons. By the time of the met coal peak in 2011, the Chinese industry was 11X larger and met coal prices had soared ten-fold to $340 per ton.

coal prices bbg_0

And here is where the self-feeding dynamic comes in. That is, how we get monumental waste and malinvestment from a credit boom. In a word, the initial explosion of demand for commodities generates capacity shortages and therefore soaring windfall profits on in-place capacity and resource reserves in the ground.

These false profits, in turn, lead speculators to believe that what are actually destructive and temporary economic rents represents permanent value streams that can be capitalized by equity owners.

Jeremy Grantham points out the unusual increase in China’s coal demand:

After every historical major rally in commodity prices, there has been the predictable reaction whereby capacity is increased. Given the uncertainties of guessing other firms’ expansion plans, the usual result is a period of excess capacity and weaker prices as everyone expands simultaneously. The 2000 to 2008 price rally was the biggest in history, above even World War II. It was therefore not surprising that the reflex this time was the mother of all expansions and excess capacity. This was further exaggerated by a sustained slowdown in demand from China, which is still playing through. The most dramatic example of this was in China’s use of coal, which had grown from 4% of world use in 1970 to 8% in 1988 and to 50% in 2013, the world’s most remarkable expansion in the use of anything since time began. And yet this remarkable surge was followed in 2014 by a reduction in China’s use of coal! And that in a year in which China was still growing at over 6%. See:price-insensitive-sellers-and-ten-quick-topics-to-ruin-your-summer

Continued…..But as shown below, eventually the credit bubble stops growing, materials demand flattens-out and begins to rollover, thereby causing windfall prices and profits to disappear. This happens slowly at first and then with a rush toward the drain.

ANRZ is thus rushing toward the drain because it got capitalized as if the insanely uneconomic met coal prices of 2011 would be permanent.

Needless to say, an honest equity market would never have mistaken the peak met coal price of $340/ton in early 2011 as indicative of the true economics of coking coal. After all, freshman engineering students know that the planet is blessed (cursed?) with virtually endless coal reserves including grades suitable for coking.

Yet in markets completely broken and falsified by central bank manipulation and repression, the fast money traders know nothing accept the short-run “price action” and chart points. In the case of ANZR, this led its peak free cash flow of $380 million in early 2011 to be valued at 29X.

FREE CF

ANRZ Free Cash Flow (TTM) data by YCharts

Self-evidently, a company that had averaged $50 to $75 million of free cash flow in the already booming met coal market of 2005-2008 was hardly worth $1 billion. The subsequent surge of free cash flow was nothing more than windfall rents on ANZR’s existing reserves, and, accordingly, merited no increase in its market capitalization or trading multiple at all.

In fact, even superficial knowledge of the met coal supply curve and production economics at the time would have established that even prices of $100 per ton would be hard  to sustain after the long-term capacity expansion than underway came to fruition.

This means that ANRZ’s sustainable free cash flow never exceeded about $80 million, and that at its peak 2011 capitalization of $11 billion it was being traded at 140X. In a word, that’s how falsified markets go completely haywire in a central bank driven credit boom.

As it happened, the full ANZR story is far worse. During the last 10 years it generated $3.2 billion in cash flow from operations——including the peak cycle profit windfalls embedded in its reported results.   Yet it spent $5 billion on CapEx and acquisitions during the same period, while spending nearly another $750 million that it didn’t have on stock buybacks and dividends.

Yes, it was the magic elixir of debt that made ends appear to meet in its financial statements. Needless to say, the climb of its debt from $635 million in 2005 to $3.3 billion presently was reported in plain sight and made no sense whatsoever for a company dependent upon the volatile margins and cash flows inherent in the global met coal trade.

So when we insist that markets are broken and the equities have been consigned to the gambling casinos, look no farther than today’s filing by Alpha Natural Resources.

Markets which were this wrong on a prominent name like ANRZ at the center of the global credit boom did not make a one-time mistake; they are the mistake.

As it now happens, the global credit boom is over; DM consumers are stranded at peak debt; and the China/EM investment frenzy is winding down rapidly.

Now comes the tidal wave of global deflation. The $11 billion of bottled air that disappeared from the Wall Street casino this morning is just the poster boy—–the foreshock of the thundering collapse of inflated asset values the lies ahead.   See: Pop Goes the Alpha Bubble.

So I have bought coal companies like FELP, CLD, HNRG, BTU because IF there exists a coal industry, the best reserves, lowest costs, and well-capitalized companies should thrive on the other side of this HEALTHY bust.  Yes, BTU does have a heavy balance sheet but it does have world-class reserves, operations and low-cost structure.  However, Austrian economics teaches that the bigger the boom, the greater the bust.  The TIME and DEPTH of the depression in coal will probably be underestimated by all, including me.  One has to keep your positions diversified and small enough to sleep at night.   I don’t see a turn before the next 18 to 24 months at least. Cyclical stock require a five to seven year horizon, perhaps longer. But NO ONE really knows until well after the bust when it is over. We must live with uncertainty.

Where is the next BUST. Capital is BEING DESTROYED TODAY:

biotech destruction

The same phenomenon that is driving Biotech to unsustainable valuations (ON THE WHOLE) is what has caused coal stocks to collapse:

biotech coal

Stay careful my friends.

http://ceo.ca/2015/08/04/find-companies-with-great-assets-and-mediocre-management-carl-icahn/

HIGHER RETURNS WITH LESS RISK? http://www.universa.net/video.html

Pop QUIZ

curve

An ode to the end of a con

How long can deception go on?

When prices are set by banks printing debt

All trust in the “markets” is gone!

QUIZ

Two businesses, each earns $10.

Company A: Has $50 in net assets and produces $10 in earnings.

Company B: Has $1,000 in net assets and produces $10 in earnings.

  1. Which is the better business?
  2. Which is the better value?
  3. What is the difference in value between the two companies?

Anyone who doesn’t pass this quiz meets my Ex (Hoping won’t help; prayin’ won’t do you no good!

Capitulation Selling-A Real-Time Case Study

T-XAU-SP

The chart above shows an index of gold and silver miners relative to the S&P 500, breaking now to a new extreme.  Will the world need to produce and find more minerals and metals or will the world just need health care and bio-tech?

letter-jul-19-gold

The read line is the co-basis that is rising as the dollar rises relative to gold. This indicates rising demand for physical and more futures selling. Bullish.

So who is selling?

The Fed’s decision to restock the rate toolkit has got the gold market very nervous,” George Zivic, a New York-based portfolio manager at OppenheimerFunds Inc., which oversees $235 billion, said by phone. “We have already seen that gold did not perform as a safe-haven investment. There is not a single motivating reason to own gold.”

CKT5wyiUYAAopBy

Who knows, perhaps money managers are funding their long equity positions with short gold positions.

“It looks like the end of an era for gold,” said Howie Lee, analyst at Phillip Securities in Singapore, adding that China had been grappling with oversupply after importing a record volume in 2013.

wmc150720b

Money managers (a few of them) finally see gold as undervalued.

Gold_Valuation1

Gold_CoT_Chart1

Gold_Specs

GLD_Sentiment

I am posting this so as to have a record of certain market events.  I seek out where the most marginal or urgent seller is operating AFTER a long decline (four years).

NUGT_Sentiment

Reversion to the Mean and Using History as a Guide

What’s going to happen is, very soon, we are going to run out of petroleum, and everything depends on petroleum. And there go the school buses. there go the fire engines. The food trucks will come to a halt. This is the end of the world. Kurt Vonnegut, Jr. in Rolling Stone (August 2006)goldOil

 

 

 

 It is very difficult to predict energy markets. In thirty-five years in the industry, I have never seen a forecast of the future that has been right. Jim Rogers, CEO of Duke Energy “U.S. Boom Won’t Hurt Australian LNG, Says Duke” (The Australian, 26th February 2013)

Gold is headed to $700. When will gold crash again and natural-gas-natural-gas-natural-gas

ung chart

gold to nat gas

People who purport to foresee, in other words, characteristically “see” the future exclusively through the lens of the present: if today it’s sunny and warm, then they’re upbeat and anticipate that tomorrow’s weather will be even more pleasant; but if it’s presently storming and cold, they are downcast and expect that the gloom will persist and worsen.

On May 6th, 2008, when the price of Brent crude was $125 per barrel and had doubled during the previous 12 months a Goldman Sachs analyst:

“I would suggest that the likelihood of that happening sooner has increased tremendously … sometime in summer,” Jeffrey Currie told an oil and gas conference in the Malaysian capital, referring to oil at $150 a barrel.

Goldman Sachs, the most active investment bank in energy markets and one of the first to point to triple-digit oil more than two years ago — a once unthinkable level — said last month oil could shoot up to $200 within the next two years as part of a “super spike.” Oil to $150 to $200 a barrel, May 2008

Quite the contrary: during 2009 it collapsed below $50–and within a few years it doubled. oil

Don’t take “expert” opinion seriously and the blunt truth is that neither you nor I nor anybody else can know the economic and financial future.  Yet investors must ACT TODAY in light of their expectations–however misplaced–about tomorrow.  So what do we do?  What’s happened historically can OCCASIONALLY (not always) provide credible clues about what might subsequently occur.

To learn more,  a must read: jul15_newsletter RTM. 

The author combines a fundamental understanding of the supply/demand dynamics of oil (inelastic supply/demand) and the past history of oil prices. It is that COMBINATION that helps with expectations.

Take the time to understand his analysis of RTM in the oil market. It is an expectation not a prediction.  A supplement to this might be: Pzena on oil 4th Q 2014 (the marginal cost producer in oil).

My attempt at gold: Estimating Where Gold will go using history as a guide and Historical-Gold-Prices

Gold prices are, in my mind, more difficult to analyze since the production of gold does not influence price because the stock to flow ratio is so high (180,000 tones to 2,500 tons per year). The reservation demand for gold is what drives the price. Does gold mining matter? For an analysis of gold: In Gold we Trust 2015 – Extended Version (e)

Also, see gold-when-will-it-crash-again  The author believes that gold is a commodity that went into a bubble and, like 1980, will decline 65% to below $700.

gold chart

fear chart

Have a great weekend!

Ask the Right Questions

Market_cycle

 

cfa-society-of-chicago-june-2015-final  Note pages 16 through 18 on Grainger and Fastenal.   GWW_VL Jul 2014  and Fast VL.   Since the prices are high and their gross margins are way above the competition, what can change that?  Ask the right questions.

 

Hallador Energy, Inc. (HNRG) Valuation Attempt

carlisle_o0c0971

A Reader Writes:
John, Here’s my quick and dirty for Hallador:
Currently not screaming cheap.
Hallador has traded to .6 book before. Current 1.2x. Highest is 4.4 or 30.36 ($4.14-$30 2015 TBV)
ev/ebitda 3mth op. inc + depr = 22341000/.25 to annualize = 6.9

industry multiple (still using the same from CLD) is 8.91

for approx 58.65 – 61.8  TBV is 6.8. Current price is 8.42.

It is making money (not a pure coal company; has oil/gas assets). From VL, it has cash flow after capex, 10% cap of 6.5 for no growth value.
It’s not a bad coal company after buying sunrise coal. The negative thing is its coal is high sulphur whereas CLD has all <1% SO2 coal (some <.5%). China recently announced a ban on high sulphur content coal. Existing shipments from Australia and South Africa in China cannot be used.
It does not break down its international shipments, but gauging CLD exports, its not much. around 4.7mt total shipments.
The thing I need to look into is how the coal companies booked their profits. Using newcastle 2014 price? Currently it is 59.6.
Hallador has good average per ton cost.
2 main areas of coal in the US. East and West.
East is higher while West is lower (CLD is lower because of transportation cost). Hallador has a 11.9 margin per ton with avg cost/ton at 31.43 and price/ton 43.3 as its mine are in the Eastern zone.
As a comparison, ANR’s 2014 Eastern cost/ton is 61.66. And Western 11.5. CLD still lowest but they have only mines in the West.
There was a report earlier in the week about POSCO in talks with Peabody about asset sales or product sales. They may be talking to others. One of the miners in Mongolia announced sales contract to Seoul today. Mongolia coal has a low sulphur too; however, after the Oyu Tolgoi deal recently, top 20 stocks there had a momentum run, and are not cheap. Another market I will look at is Indonesia. The government there has announced plans to remove mining export ban that they blamed on excessive nationalism. Indonesian coal has poor BTU but low sulphur. Also, these things will take a long time to sort out. Maybe next year. Just some things to keep an eye on. There is a special situation SGX catalist stock I’m waiting to see. It has become the parent company of a mongolian miner (2.6x book so not cheap anymore after the run up) and intend to hold other Mongolian coal assets. Will write when I know more.
Looking forward to seeing your write up.
Thank you,
HAVE A GREAT WEEKEND

Valuing a Coal Company, Step 1: Will the Industry Survive?

02-06-u.s.-coal-producers-656x437

Is the Coal Industry Dead?

The key point is to try to disprove your thesis. Seek out the negatives and the counter-arguments, then make a reasoned decision to invest, not invest, short, stand-aside and wait, or dig further.

Lots of bad news hitting the coal industry: China slow-down, EPA Rules, falling natural gas prices, falling met and steam coal prices, President Obama says he will put coal out of business (supposedly)  http://www.washingtonpost.com/blogs/fact-checker/wp/2014/10/08/the-repeated-claim-that-obama-vow

HARD TIMES for US-coal-producers/

Coal five year

met coal

Nat Gas

2015 is the reckoning for coal: http://www.oilandenergydaily.com/2013/11/22/coal-2/

EPA Regulations Hit Economic Reality:  https://www.scribd.com/doc/266957890/Walker-May-2015-Letter

Will there be a coal industry over the next few decades in order to determine whether to use liquidation or going-concern value?

We seek to buy cyclical assets when there are NO REASONS to buy, the companies in the industry have depressed profits or large losses, and there seems to be no hope for the industry (Remember Airlines 9/11). However, we wish to avoid investing in Canal companies during the advent of the steam locomotive because then there is a permanent decline in asset value because long-term cash flows are driven by capacity constraints and customer demand changes.  Thus, we first try to answer this post’s question.

Let’s break down the energy producing statistics.

According to the Independent Statistics and Analysis Energy Information Administration, here’s how the nation’s electricity was generated in 2014:

  • ■ Coal: 38 percent
  • ■ Natural gas: 27 percent
  • ■ Nuclear: 19 percent
  • ■ Hydropower: 6 percent
  • ■ Other renewables: 7 percent, including
  •       — Biomass: 1.7 percent
  •       — Geothermal: 0.4 percent
  •       — Solar: 0.4 percent
  •       — Wind: 4.4 percent
  •       — Other gases: 1 percent

So let’s take the 38 percent of coal production out of the mix. Where’s the energy going to come from? It’s not. Therefore, we’re left with nothing but periods of darkness.

http://www.craigdailypress.com/news/2015/may/29/us-would-blackout-without-coal/

Global-coal-use-growing-faster-than-any-other-energy/

Books on the Coal Industry and Coal’s History

Big Coal

Long dismissed as a relic of a bygone era, coal is back — with a vengence. Coal is one of the nation’s biggest and most influential industries — Big Coal provides more than half the electricity consumed by Americans today (2006) — and its dominance is growing, driven by rising oil prices and calls for energy independence. Is coal the solution to America’s energy problems?

On close examination, the glowing promise of coal quickly turns to ash. Coal mining remains a deadly and environmentally destructive industry. Nearly forty percent of the carbon dioxide released into the atmosphere each year comes from coal-fired power plants. In the last two decades, air pollution from coal plants has killed more than half a million Americans. In this eye-opening call to action, Goodell explains the costs and consequences of America’s addiction to coal and discusses how we can kick the habit.

Coal WarsThe Moral Case for fossil fuels

We need fossil fuels

Current policies to supplant fossil fuels with inferior energy sources need to incorporate a deeper understanding of the transformative role of energy in human society lest they jettison the wellsprings of mankind’s greatest advance.

The thesis of this paper is that fossil fuels, as a necessary condition of the Industrial Revolution, made modern living standards possible and vastly improved living conditions across the world. Humanity’s use of fossil fuels has released whole populations from abject poverty. Throughout human history, elites, of course, have enjoyed comfortable wealth. No more than 200 years ago, however, the lives of the bulk of humanity were “poor, nasty, brutish and short,” in the words memorably used by Thomas Hobbes.

This paper aims to articulate and explain some startling, but rarely acknowledged, facts about the role of energy in human history. Energy is so intimately connected to life itself that it is almost equivalent to physical life. Virtually everything needed to sustain the life of a human individual—food, heat, clothing, shelter—depends upon access to and conversion of energy. Modern, prosperous nations now access a seemingly limitless supply of energy. This cornucopia, however, is a very recent advance in mankind’s history. Fossil fuels, methodically harnessed for the first time in the English Industrial Revolution, beginning in the 18th century and taking off in the 19th century, have been a necessary condition of prosperous societies and of fundamental improvements in human well-being.

Adequate treatment of this topic is a daunting task for anyone. The unprecedented stakes in today’s contentious energy policy debates about carbon, however, make it a morally necessary topic. As a former final decision-maker in a large environmental regulatory agency, I urge current officials and concerned citizens to reflect on energy policies within a broad but fundamental context: human history and the physics of material lives.

My research was initially inspired by a comprehensively researched monograph by Indur Goklany titled “Humanity Unbound.” His paper took me to a dozen books and twice as many academic papers. With gratitude, I acknowledge the books listed below as the most enlightening, persuasive guides on the topic. And I highly recommend them for more thorough analysis than allowed by the confines of this paper. May those policymakers entrusted with the authority to make binding decisions about energy consider these books as “a look before an unreflective leap” that could unravel mankind’s greatest achievement—
the potential enjoyment of long, comfortable, healthy lives without the gnawing hunger of subsistence poverty.

moral case for FF Epstein

CRITICS

Yes, fossil fuels have fueled our progress through the industrial revolution into the information age. But we have over-used them and fouled our nest. We could and can shift rapidly to renewables, but big oil greed obstructs us.  (Really?) As Pope Francis says, we have made the earth into “an immense pile of filth.” Own it.

The first big flaw that tragically happens to be the binding of the entire book (and in the title) is his thesis that fossil fuels is what causes human flourishing. No. INDUSTRIALIZATION is the underlying mechanism hat has created the exponential increase in human progress. Fossil fuels was just the first way of converting potential energy to mechanical energy. And it was a good one, but we need to move on to a more advance potential energy source. Luckily exponential growth in renewables and other advanced technologies has just started to gain heavy heavy steam.

By Donald Prothero on February 8, 2015

As an actual Ph.D. geoscientist who HAS WORKED for oil companies, written textbooks in geology of oil, and also done actual published research in climate change in peer-reviewed journals, I can say this work is pure garbage. Epstein cherry-picks climate data he doesn’t understand (as the review by Kathy Moyd pointed out), denies the conclusions of an entire scientific community who are NOT paid to shill for industry, and denies the obvious evidence of climate change going on worldwide. Then he distorts the benefits of fossil fuels and neglects or underplays the problems. The biggest problem of all is that (as all of us who are in the industry know so well), we’re past the peak of Hubbert’s curve and oil isn’t going to be cheap for the uses he brags about much longer.    (CSInvesting: Whether fact-based, true or untrue, all this critic asserts is not backed up with evidence–an assertion is not an argument.)  Appeal to authority argument–I’m in the industry and brilliant, you’re an idiot, so listen up!

Once the Saudis stop flooding the market with cheap oil to drive out the competition, it will pick up again to the levels of demand that anyone in the oil futures business knows so well, and we’ll be unable to use it for cheap plastics, fertilizers, pesticides, and all the other stuff that we wasted nearly all the planet’s oil heritage on. The moral case is clearly that we need to wean ourselves OFF of using up the last remaining oil so quickly before it reaches its true levels of scarcity, and it’s irresponsible to encourage people to use it up faster.
As all of my co-workers in the oil industry (and the students I trained who are now high in the business as well) know, oil is getting scarcer and scarcer, and the last thing we need to do is use it up faster and crash the global economy. Most of my colleagues in oil also agree that climate change is a serious problem–even though the bosses at ExxonMobil and Koch are bankrolling the climate denial lobby. Before you believe garbage by an industry hack with no actual training in the field, listen to those of us INSIDE the industry and INSIDE the climate science community. Our future is at stake when we make bad decisions based on crummy books like this!   (CSInvesting: I am an expert, therefore all my assertions are correct.   What’s to argue?  What better way to move to renewable energy than to let the free market decide to price oil at $1,000 a barrel–therefore making nuclear or hydro power more economic).

Environmentalists are evil: George Reisman-

Here’s David M. Graber, in his prominently featured Los Angeles Times book review of Bill McKibben’s The End of Nature: “McKibben is a biocentrist, and so am I (See video of debate below). We are not interested in the utility of a particular species or free-flowing river, or ecosystem, to mankind. They have intrinsic value, more value—to me—than another human body, or a billion of them.… It is cosmically unlikely that the developed world will choose to end its orgy of fossil-energy consumption, and the Third World its suicidal consumption of landscape. Until such time as Homo sapiens should decide to rejoin nature, some of us can only hope for the right virus to come along.”

And here’s Prince Philip of England (who for sixteen years was president of the World Wildlife Fund): “In the event that I am reincarnated, I would like to return as a deadly virus, in order to contribute something to solve overpopulation.” (A lengthy compilation of such statements, and worse, by prominent environmentalists can be found at Frightening Quotes from Environmentalists.)

There is no negative reaction from the environmental movement because what such statements express is nothing other than the actual philosophy of the movement. This is what the movement believes in. It’s what it agrees with. It’s what it desires. Environmentalists are no more prepared to attack the advocacy of mass destruction and death than Austrian economists are prepared to attack the advocacy of laissez-faire capitalism and economic progress. Mass destruction and death is the goal of environmentalists, just as laissez-faire capitalism and economic progress is the goal of Austrian economists.

And this is why I call environmentalism evil. It’s evil to the core. In the environmental movement, contemplating the mass death of people in general is no more shocking than it was in the Communist and Nazi movements to contemplate the mass death of capitalists or Jews in particular. All three are philosophies of death. The only difference is that environmentalism aims at death on a much larger scale.

Despite still being far from possessing full power in any country, the environmentalists are already responsible for approximately 96 million deaths from malaria across the world. These deaths are the result of the environmentalist-led ban on the use of DDT, which could easily have prevented them and, before its ban, was on the verge of wiping out malaria. The environmentalists brought about the ban because they deemed the survival of a species of vultures, to whom DDT was apparently poisonous, more important than the lives of millions of human beings.

The deaths that have already been caused by environmentalism approximate the combined number of deaths caused by the Nazis and Communists.

If and when the environmentalists take full power, and begin imposing and then progressively increasing the severity of such things as carbon taxes and carbon caps, in order to reach their goal of reducing carbon dioxide emissions by 90 percent, the number of deaths that will result will rise into the billions, which is in accord with the movement’s openly professed agenda of large-scale depopulation. (The policy will have little or no effect on global mean temperatures, the reduction of which is the rationalization for its adoption, but it will have a great effect on the size of human population.)

It is not at all accidental that environmentalism is evil and that its leading spokesmen hold or sanction ideas that are indistinguishable from those of sociopaths. Its evil springs from a fundamental philosophical doctrine that lies at the very core and deepest foundations of the movement, a doctrine that directly implies the movement’s destructiveness and hatred of the human race. This is the doctrine of the alleged intrinsic value of nature, i.e., that nature is valuable in and of itself, apart from all connection to human life and well being. This doctrine is accepted by the movement without any internal challenge, and, indeed, is the very basis of environmentalism’s existence.

As I wrote in Capitalism, “The idea of nature’s intrinsic value inexorably implies a desire to destroy man and his works because it implies a perception of man as the systematic destroyer of the good, and thus as the systematic doer of evil. Just as man perceives coyotes, wolves, and rattlesnakes as evil because they regularly destroy the cattle and sheep he values as sources of food and clothing, so on the premise of nature’s intrinsic value, the environmentalists view man as evil, because, in the pursuit of his well-being, man systematically destroys the wildlife, jungles, and rock formations that the environmentalists hold to be intrinsically valuable. Indeed, from the perspective of such alleged intrinsic values of nature, the degree of man’s alleged destructiveness and evil is directly in proportion to his loyalty to his essential nature. Man is the rational being. It is his application of his reason in the form of science, technology, and an industrial civilization that enables him to act on nature on the enormous scale on which he now does. Thus, it is his possession and use of reason—manifested in his technology and industry—for which he is hated.”

Thus these are the reasons that I think it is necessary for people never to describe themselves as environmentalists, that to do is comparable to describing oneself as a Communist or Nazi. Doing so marks one as a hater and enemy of the human race.

Climate Change Caused by Man? List_of_scientists_opposing_the_mainstream_scientific_assessment_of_global_warming

For and Against Fossil Fuels

Valuing a Coal Company: How Do We Start?

hALLODOR

From a reader: Hi John,

Thank you for the library access to VL. Responses about Value-Line from the group have been underwhelming. Got zero replies for discussion about coal or other topics. Most people just ask for certain industries (REIT, Insurance, Chemicals), so I tried to make it interesting by asking for a “quick and dirty” valuation in return for VLs, but I did not get the promised short write ups. So I have stopped uploading to the group for now.

John Chew: Sorry to hear that, but, on the other hand, most folks are too busy and distracted to do the hard work–therein lies our opportunity.

I’m trying to value Cloud Energy and am not sure how to go about it. Its proven and probable reserves are 1.1billion tons. With an average margin of $3.2 since 2010 (selling price per ton – average cost per ton), this works out to 1.1×3 or 3.3 total value of coal. But the variation low is about 2.24. Cloud makes money and is able to service debt. It is also trying to cut cost. The coal value works out to 3.3/61mil sh outstanding or about 40-$51/sh.  The highest it has traded is half this value. I understand the problems with coal now (cheap oil, natural gas, environment, competition from other suppliers), but would like to know what it is worth.

I’ve looked on your blog for examples for asset type companies, but you have not posted some like RGLD, FNV, SLV etc. The case studies on CRR and other nuggets like determining the per unit value and spread (for gold) were helpful. Could I get your write up for coal and gold?

John Chew: Ask what would you need to know to own a coal company outright? If this was one of your lifetime investments what would you look for?

If I wanted to buy a coal company outright, I would want a productive asset. How much coal is it selling, price, what it costs them to dig it out of the ground and get to market, and how much it has left, whether it is sustaining itself and has costs under control.

CLD operates ok and management is doing what it can to cut costs to weather the industry downturn.

EV/EBITDA is 4.54, almost half 8.9 industry EV/EBITDA multiple. This works out to about 38.25-40.5.

Tangible Book Value is around 17.2.  Price is significantly below. I’m surprised it went so much below tangible book.

John Chew: So why is the market pricing CLD at $4.50? (June 17th 2015). What is the market implying by the current price?

There is even cash flow and decreasing capex, So 2.4-.31 with no growth and 10% return req is about $20.

Margin between cost to mine of 10-10.19 and sell price of 13 is 2.81. Taking off tax considerations, leaves 1.9 approx. With no growth, I would pay 19. It’s 4.5 now.

Its per ton cost is 10.2 and 2015 sell price is estimated 12+ to 13. The 3.5 mines it owns are productive. Thermal coal is 44/ton but using their 10.2 sale price is more relevant. Sales to Asia seems to be the demand driver.

Vulture funds also seem to be waiting for some industry consolidation (which has not materialized yet) before buying.
http://www.smh.com.au/business/coal-vultures-await-further-pain-before-pouncing-on-assets-20150616-ghotux.html

Thank you. Appreciate your help.

John Chew: You ask the right questions.  If we buy a coal company we have to know how much (in total on a sustaining basis) does it take to find, mine and replenish reserves. What influences the customer’s decision to buy?  What does the demand and supply of coal look like in the past, present and what might influence the future?

Let’s start by:

1. getting an overview of the coal market

http://www.peabodyenergy.com/content/107/about-coal

Search out all the negatives on coal like: Obama’s War on Coal https://youtu.be/a-wCC0Szx4g

Coal-Financial-Trends-ETA

To survive in an industry consolidation/shakeout, you must find the lowest cost producers on the cost curve:  http://www.fool.com/investing/general/2013/09/21/oil-and-coal-stock-valuation-what-youre-missing.aspx

Despite the hysteria of pension fund divestitures, cheap natural gas, global warming, what is actually going on?

Primary energy consumption continues to grow and will be dominated by fossil fuels and nuclear power for many years, but renewables continue to post the highest growth rates by far. In 2014, renewables comprised 2% of primary energy consumption, with hydropower adding another 7%. Nuclear power accounted for 4% of the world’s primary energy consumption, while oil continues to be the world’s leading primary energy source at 33% of overall consumption. Coal is responsible for another 30%, while natural gas makes up 24% of the world’s primary energy consumption. See statistics:

http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html

Also, http://www.eia.gov/coal/

Also, review the past annual reports and presentations of:

Arch coal, Peabody, Consol Energy, Cloud Peak Energy.

Thoughts on valuation of mining companies: http://www.avoidglasses.com/valuing-a-mining-company-using-net-present-value/

Valuation_of_Metals_and_Mining_Companies

Also, an EXCELLENT annual report on the operations of Hallador Energy:

http://media.corporate-ir.net/media_files/IROL/98/98288/CorpOverview_Shareholders_Meeting_04232015.pdf

HNRG_VL

HNRG_VL 2013

CLD_VL

ANR_VL

The Gloves Are Off in Mining

We probably need to look at a history of met. coal prices (Newcastle) for the past 20 years and various Thermal Coal prices and compare how companies did.

We want companies that will survive/thrive in this chaos.   Right now the coal market is suffering a cascading amount of bad news: pension fund divestitures, low natural gas prices, China not importing as much, unknown environmental laws, impending bankruptcies, and falling stock prices.

Ask who is on the other side of the trades?

By next week, let’s lay out the financials and operating metrics of both Hallador Energy (HNRG) and Cloud Peak Energy (CLD).   Are we at the trough of the cycle and how long would it take for a peak in the cycle based on history?

If you use EV/EBITDA don’t forget to also deduce maintenance capex or the capex needed to sustain operations.  Since coal is a bulky/low cost product, the cost of shipping to the customer may be a major part of the final cost to the customer, so where are the mines located in relation to the customer?

What are our companies worth in various scenarios: Bad Cast, Base case, Good case?  

What is the cure for low prices of coal?  What signs to look for?

WEDNESDAY, APRIL 11, 2007 http://stockmarketnotes.blogspot.com/2007/04/costton-is-appropriate-measure.html

Cost/Ton is the Appropriate Measure to Compare Coal Companies

The Wheel of Fortune: Mean Reversion (Part 1)

graves

Last post on Chapter 4 in Quantitative Valuehttp://csinvesting.org/?p=10730 . Let’s get back to our course on Deep Value.

Let’s go back to DEEP VALUE, Chapter 5: A Clockwork Market: Mean reversion and the Wheel of Fortune.

As a value investor you are doing either:

  1. Buying a franchise, where barriers to entry allow for profitable growth, before mean reversion sets in or
  2. Buying assets where the normalized earnings’ power of those assets is below norm (Asset value = Earnings Power Value) and earnings’ power will mean revert to normal.

Therefore the concept of Regression to the Mean is powerful.  By putting the words, “Many shall be restored that now are fallend and many shall fall that now are in honor” on the facing page of Security Analysis, Graham gave the most prominent position in his seminal text to the idea that Fortuna’s wheel turns too for securities, lowering those that have risen and lifting those that have fallen.  The line, from Horace’s Ars Poetica, echoes the phrase spoken by the wise men of legend who boiled down the history of mortal affairs into the four words, “This too will pass.”  This is regression toward the mean. (p. 79).

The more extreme the initial price movement, the greater will be the subsequent adjustment in the opposite direction. There tends to be a price trend before reversal. The reasons are manifold, but the most obvious is that the trials aren’t independent—our own trading decisions are affected by the buying or selling preceding our trade.

Keynes discussed this phenomenon here:

https://www.marxists.org/reference/subject/economics/keynes/general-theory/ch12.htm or John Maynard Keynes and his life as an investor, Keynes as an investor

Two economists known for research into both market behavior and individual decision-making, Werner De Bondt and Richard Thaler, theorized that it is this overreaction to meaningless price movements that creates the conditions for mean reversion. Note page 800 in the link Does Stock Market Overreact—  the loser and winner portfolios.  Losers win out.

In a second study, Further Evidence of Inv Overreaction Thaler, Thaler and De Bondt revisited the research from a new perspective.  They hypothesized that the mean reversion they obserbed in stock prices in the first study might have been caused by investors focusing too much on the short-term. this fixation on the recent past and failure to look beyond the immediate future would cause investors to miscalculate future earnings by failing to account for mean reversion.  If earnings were also mean reversing, then extreme stock price increases and decreases might, paradoxically, be predictive of mean-reversion not just in stock prices, but in earnings too.  A stock price that has fallen a great deal becomes a good candidate for subsequent earnings growth, a vice versa for a stock price that has gone up a lot.  As you can see from the two research reports that the undervalued portfolio delivered better earnings and price performance.

The above research stand the conventional wisdom on its head and show compelling evidence for mean reversion in stocks in a variety of forms.

Buffett Discusses Mean Reversion in the Stock Market

Buffett_on_1999_Stock_Market_-_Fortune_Article & 2008 Market Call and a MUST READ: A Study of Market History through Graham Babson Buffett and Others

In the 1964 to 1981 period, Buffett wrote, U.S. GNP almost quintuples, rising 373 percent. The market, by contrast, went nowhere.

The evidence is that valuation, rather than economic growth, determines investment returns at the market and country level. Research suggests that chasing growth economies is akin to chasing overvalued stocks, and generates disappointing results. See

The growth illusion

Alas, this is not the case. Work done by Elroy Dimson, Paul Marsh and Mike Staunton at the London Business School established this back in 2005. Over the 17 countries they studied, going back to 1900, there was actually a negative correlation between investment returns and growth in GDP per capita, the best measure of how rich people are getting.  In a second test, they took the five-year growth rates of the economies and divided them into quintiles. The quintle of countries with the highest growth rate over the previous five years, produced average returns over the following year of 6%; those in the slowest-growing quintile produced returns of 12%. In a third test, they looked at the countries and found no statistical link between one year’s GDP growth rate and the next year’s investment returns.

Why might this be? One likely explanation is that growth countries are like growth stocks; their potential is recognised and the price of their equities is bid up to stratospheric levels. The second is that a stockmarket does not precisely represent a country’s economy – it excludes unquoted companies and includes the foreign subsidiaries of domestic businesses. The third factor may be that growth is siphoned off by insiders – executives and the like – at the expense of shareholders.

Paul Marson, the chief investment officer of Lombard Odier, has extended this research to emerging markets. He found no correlation between GDP growth and stockmarket returns in developing countries over the period 1976-2005. A classic example is China; average nominal GDP growth since 1993 has been 15.6%, the compound stockmarket return over the same period has been minus 3.3%. In stodgy old Britain, nominal GDP growth has averaged just 4.9%, but investment returns have been 6.1% per annum, more than nine percentage points ahead of booming China.

What does work? Over the long run (but not the short), it is valuation; the higher the starting price-earnings ratio when you buy a market, the lower the return over the next 10 years. That is why buying shares back in 1999 and 2000 has provided to be such a bad deal.

High Growth Depresses Future Stock Returns

Why does high growth seem to depress stock market returns and low growth seem to generate high stock market returns?  The market ALREADY recognizes the high growth nation’s potential, and bids the price of its equities too high. Market participants become overly optimistic during periods of high growth, driving up the prices of stocks and lowering long term returns, and become too pessimistic during busts, selling down stocks and creating e conditions for high long-term returns.  More research on that here:

  1. Jay_Ritter_paper_14_August Economic Growth and Stock Returns
  2. value-vs-glamour-a-global-phenomenon
  3. Blinded by Growth

I will finish this chapter in the next post. If you do not have DEEP VALUE or Quantitative Value, then join the deep value group found here: http://csinvesting.org/2015/01/14/deep-value-group-at-google/ and I will send.

If you only understand one concept besides Margin of Safety in investing then let it be Reversion to the Mean.