Chanos Chims In

                               VS.                      

The famed short-seller, Jim Chanos, recently spoke at the Value Investors Congress in New York. As the largest short fund (bets on the stock price of a company going down) in the world with assets of 6.7 billion, he is the king of the bears. Chanos, is worth listening to. He has been "pounding" the table on several areas where he sees problems. He spoke about "value traps" in Chinese banks (and most other things China related), commodity companies dependant on one large consumer - like China, Brazil, large integrated oil companies like Exxon (XOM) and digital distribution of media (blockbuster gone bust, with more to follow) and lastly, for profit education companies.

His mention of oil companies is very interesting considering I have just taken a position in a large integrated oil (Total SA at $45-$46) which I wrote about here. The crux of his arguement is that the finding and development cost of a barrel of oil has increased from $5 in 2000 to $22. Also, the cost of production has tripled from $5 to $15/barrel. Not to mention increased SG&A. This has squeezed the oils into "paying up" for reserve replacements. He cited, XOM's huge purchase of XTO for $31B in 2009. Exxon is betting on the future of natural gas and paid a hefty price for that bet. XOM's balance sheet has suffered going from $25B in net cash in 2007 to net debt of $6B now.

I don't know if Chanos is bearish on all integrated oils (or talking his book - he could be short XOM) but I'd agree that many of the North American oils are expensive, with some like XOM trading at 2.5x book value and 1x NAV. However, at the risk of opposing Chanos - not all the oils are expensive. The European oils (TOT, BP, RDS.A, STO) are much cheaper with more "bad" news priced and therefore provide a greater margin of safety. You can buy some the Euro oils for 6x's earnings with hefty dividend yields and 0.75 of NAV (based on $80 oil). If history is any indicator, then if the cost for oil has risen that significantly, then commodity prices should only trade at a small premium to that marginal cost of production. So that means, $140 oil (2007) is not likely to return soon nor is $30 oil.

Twist and Shout

The Fed recently launched the $400 Billion operation twist. A program, also used in the early 1960's, where the Fed will sell $400B in short-term treasuries and buying an equivalent amount of longer dated bonds. The result is a flattening of the yield curve. The chart below shows how the curve flattened slightly after the fed announcement - with more to come. The Fed is helping homeowners and businesses by lowering long-term borrowing costs to incentivize longer dated asset transactions ( buying a house or building a factory with borrowed money ). However, this program doesn't come free. The net interest margin for banks will be under pressure and insurance companies with long-dated bonds to match their long-dated liabilities will be squeezed. So now what? Well, some argue that with rates already quite low, Twist will have minimal impact.
I agree. I'll sit tight and monitor the results of the financial companies I own, focusing on capital levels to ensure that twist doesn't squeeze too hard. It may take longer for the financials to turn the corner.


source: Bloomberg

I own positions in BAC,WFC,MFC

Baffled In Beijing

I just returned from a very special trip. My family and I were in China for over 2 weeks helping with some charitable work for two causes very close to our heart. We chronicled our trip, which if you're interested, you can read about it here. Although our charitable work was the primary focus of the trip, I couldn't help but to keep an eye out as to what's happening in China's economy. I noticed a tremendous amount of growth since my last trip in 2003. China is a country that is in a hurry. The building of roads, bridges, airports and buildings continues at a feverish pace. During our visit to 3 "smaller" cities ( populations of 2-3 million each ) Changsha, Datong and Changzhi I saw a total of approximately 125 ( yes, 125 ) high rise condominiums under construction. And, that's only in the areas of those cities I was in. A few of the sales centres indicated that over 90% of the units are unsold - based on the broken English of the sales reps I met in Changzhi. Prices are high and supply is coming on strong. I wouldn't be a buyer of Chinese real estate right now. However, on the flip side, the economy there is big and growing. There is great demand for metals, coal and all things agriculture related (corn, soy and vegetables). There is a growing middle class that want North American products. I noticed several brands that have a good foothold in China including, Coca-Cola, Pepsi, Kraft, GM, VW, Caterpillar, Audi, Starbucks and Kraft (I love the orange/mango oreo's). Owning stock in some of these brands-but not at any price, going forward, is a good way to participate in China's growth without the worry/risk of directly owning Chinese stocks. There is a lot of room for efficiency in the Chinese economy. That will happen over time.

Being in China for a better part of August's major market pull-back was a blessing. Having no CNBC, BNN or North American newspapers insulated me from the overwhelming negative tone. While there are concerns about the economy and issues in Europe, stocks have generally priced those issues in already. There has been significant indiscriminate selling of equities, as evidenced by the record mutual fund redemptions in August. The herd is selling when they should be buying. Several sectors have become very cheap over the summer. These sectors include technology, retail, energy and agriculture (too a lesser extent). Energy is probably the one stand-out sector. Since the market sell-off, oil has come down from $100 in July to $80 at the August lows ( now approaching $90 at time of this post ). This pull-back is minor, considering oil bottomed out at $47/barrel in March of 2009. The market is telling us that demand is still there, and no double-dip recession is on the horizon - contrary to what the headlines indicate. However, oil stocks, particularly the large integrated oils (in U.S. and Europe), have sold off much more. Many of the large European integrated oils have been double-whacked, compounded by the debt crisis in Europe. These European oils are very well capitalized and have access to the cheapest capital in Europe and abroad, so the debt crisis is only a minor irritation to these companies. The market is pricing the European oils as if they will NEVER grow earnings in the future - that's a postion I'm willing to bet against. The following European oils are "pound the table" cheap: British Petroleum (BP), Royal Dutch Shell (RDS-A), Total SA (TOT). These companies are trading at close to book value with hefty ( 5%+) dividend yields and single digit P/E's. While one could argue they do deserve a slightly lower valuation than our large Canadian oils, due to lower reserves (oil in the ground) and production growth, the valuation gap is just to big. On the flip side, one could argue that the European oils deserve equal valuation due to their exposure to emerging markets and experience/success in growing reserves in politically difficult areas like Africa. Which would you buy?

                                                                     P/Book            P/E*         Div Yield

Canadian Natural Resources (CNQ)               1.7x               10x          1.0%
Cenovus (CVE)                                              2.8x                15x         2.3%
Suncor (SU)                                                    1.3x                9x          1.5%

British Petroleum (BP)                                     1.1x                5x           4.6%
Royal Dutch Shell (RDS-A)                             1.2x                7x           5.1%
Total SA (TOT)                                               1.1x                6x           7.0%
                         
* I used forward P/E's, which I don't normally put much weight on. However, using trailing P/E's, which reflects recessionary earnings, gives a false indication on the valuation of these companies.

As I've written in previous posts, it's a good time to pick away at cheap stocks on down days. It's a good time to upgrade your portfolio. Many high quality companies with good dividends are on sale. If you can ignore the daily noise and look 3 years out, the market is cheap, and you will be well rewarded.

Disclosure: I own TOT

Now What???

As the markets take a turn off of Greed Street on to Fear Avenue (which started in April ), it's time to pull-over to the slow lane and watch the traffic jam. People are running for the exits. The S&P downgrade has spooked the market. It's important to note that the other rating agencies like - Fitch and Moody's don't feel the same as S&P. The CBO ( Congressional Budget Office ) has commented that S&P has made a 2 Trillion dollar "mistake" in their 10 year calculations. But S&P's downgrade/outlook is for the next 2-3 years -what gives? You would expect the rating agencies to have a longer-term outlook for a sovereign like the U.S.  At the end of the day, you have to ask yourself if the companies in your portfolio are really worth 15%-20% less now, then a couple of months ago. In most cases they are not. It's also interesting to note that Carlos Slim ( currently the richest guy in the world ), made his mark by buying  businesses AFTER the 1982 Mexico debt default (not downgrade, but actual default). Businesses still have value that on the whole, will increase over time. As I wrote recently, it's good to have cash. There are now many high quality companies available at discount prices. But, you have to move slowly, as not to get run over. So now is not the time to go "all in" but just pick away. With the current market conditions, it is also a good reminder why it's important to have an unlevered ( little or no borrowings against your portfolio ) account. It's time to sit tight, with no bothersome calls from your broker's credit department, and pay close attention to the price your paying for stocks. There is no hurry - move slowly.

Remember Buffett's quote: " the market is there to serve you, not instruct you"

Mid-Summer Gyrations



uncle sam



You have no doubt heard by now that the U.S. debt ceiling deal has been passed. For interest sake, the debt ceiling has been raised 78 times over the past 50 years. Many of those previous deals never made the front page news. This time, it hit the front page of every news paper around the world as the U.S. struggles with chronic deficits. As a bottoms up ( looking at individual companies ) investor, I don't spend much time trying to figure out what's happening in the overall economy. I just look for good cheap stocks. It reminds me of the famous investor Peter Lynch's quote:

  

 "Predicting the economy is kind of like trying to predict the weather.  Yes, you can get close
      but very rarely are you completely right."



After all, how many people accurately predicted the 2008 financial collapse? Not me.
However, the pessimism that has gripped the markets for the last while, has created opportunity.
I recently wrote, that it's a good time to have cash. Well, now it's a good time to start deploying that cash - but slowly. But remember, we are only 5-7% off of all-time highs, so you have to be very price sensitive as not to overpay. But there's value for long-term buyers of equities. I've recently added to CSCO, BAC and BIG.

There's also value in FFH.TO, WFC, MFC

Disclosure: I own FFH.TO, WFC, MFC, CSCO, BAC, BIG

Say What?

Famed value investor - Bruce Berkowitz has been under fire lately for the "poor" performance of  his flagship Fairholme fund. The fund has experienced $2.5 Billion in redemptions (still has $14 Billion under management)  in the last 3 months alone. Retail investors, in their short-sightedness, have run for the exits. This behaviour proves why markets are not perfectly rational - as some think. The market as a whole is impatient and cycles back and forth from optimism to pessimism and back again. I have been an avid reader over the years of anything Berkowitz related - he is a great teacher. His is truly one of the great investors of our time. Since inception of the fund in 1999, he has returned 13.90% compounded annually, while the S&P 500 has returned approximately -1% over the same time period (see chart below - WOW!- sorry for the small chart). He was named manager of the decade (last year) by Morningstar, for good reason - he has clobbered the indexes. The herd/short-term mentality will continue to hurt mutual fund investors as they try to move in and out of funds with precision. They usually end-up selling or buying at precisely the wrong time.  If you own mutual funds, study the manager's track record, style and investing framework. Then, if it suits your style and temperament, buy for the long-haul. Berkowitz is a BUY.

 

Click here for Fairholme Fund Chart -stretch out time frame to 10 years.

Just About Time

Here is the cover of this week's Time magazine. This reminds me, although to a lesser extent, of the famous Business Week cover from 1979 - published just before the start of the greatest bull market in history - 1979 to 1999.






It's important to note that these publication are not wrong in the data they present. In fact they are basically right on, with respect to the problems the economy faces both then and now. The problem is their timing - they are out of sync with the market. They are reporting on issues and events that are already discounted in the market. The current soft patch is baked into the cake. So, anyone reading this cover would get the idea that it's time to sell. Remember the market looks out 6 to 12 months. The recovery is happening, just not at the brisk pace that everyone expects or wants. The S&P 500 is down 7.1% over the past 6 weeks. The TSX is down 9.1%. Prices are more reasonable now then 6 weeks ago - but you still have to be selective. My crystal ball is no clearer than yours, but lower prices are good - for buyers. It's good to have cash now, for those down days when you can pick away at good & cheap stocks. There's value in BIG, CSCO, BAC (bought some today @ 10.61) and BRK-B. It's just about time - to buy.