Activist In Gear - AIG

News broke this past Wednesday that famed activist investor Carl Icahn has built a position in insurance giant AIG - our 3rd largest holding - thanks Carl! Icahn, in a letter  to AIG, is suggesting the company break its self up into 3 smaller firms. He thinks that AIG is too big to succeed, and would be able to improve their competitiveness against their better run rivals. We find it hard to disagree... Is it worth $100/share? We will see. We will continue to sit on our hands and watch the developments with interest at AIG.











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Yellen Yell'In

Federal Reserve Chairwoman, Janet Yellen's recent remarks about "quite high" equity prices in the U.S. and the risk that poses to the broader economy. In Fed speak, she is saying; as prices rise, so too does the tendency of market participants to take on ever greater risk. She is right on - remember 2008?  Risks are present, however they always are...so just how expensive is the market and what do we do?

Note: This chart excludes the 2008/09 meltdown, where earnings dropped significantly and P/E's went through the roof. Normally you would see a spike on this chart in late 2008 and early 2009.

It's not hard to tell from this chart that the market is not dirt cheap or priced wildly high. You can see that from 1935, we have basically seen a trough of 10X and a peak of 22X. It should be noted that interests rates were much higher at almost any point prior to 2008. With record low interest rates, it appears that their is still room for the averages to move higher. However, any move higher will likely be in a choppy fashion, as the market continues to worry about interest rate hikes, GDP growth, and unemployment.  Bargains are harder to find, but as the famed Canadian investor Peter Cundill once said - "there's always something to do". There are still pockets of value. Sectors including U.S. money center banks, industrials (auto's, engineering firms), large cap technology and energy offer value. But remember, always have a margin of safety! A black swan can appear at anytime. If indices move higher, we will continue to harvest our holdings and raise cash. Bull markets generally mature on optimism and die on euphoria - we don't see any euphoria.
 




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Citi Streamlines

Citigroup (C), one of our long-time bank holdings, has recently offloaded sub-prime lender One Main. Citi will sell One Main to Springleaf for $4.25B. Citi expects to book a pre-tax gain of $1.0B on the deal. While One Main is a profitable business for Citi, it's also a risky business for the bank. Citi seems to be stepping back from consumer banking and focusing on corporate and commercial banking. This transaction should free up capital backing One Main - allowing Citi to increase dividends or share repurchase or deploy the capital elsewhere. The bank can also use some of it's $50B in deferred tax assets against the transaction. In a similar move, the bank just today, announced another sale of non-core assets. Citi sold it's 9.9% stake in Akbank ( Turkish retail bank ) for $1.15B. The bank will continue to operate in Turkey through it's security clearing and settlement transaction business.

 

Citi continues to move in the right direction and remains undervalued at <10X next year's earnings and 0.8X book value. We think Citi is good value <$50.

 

 

 

2014

With 2014 behind us, it's time for my usual post-mortem review on my portfolio. With a return of 3.4%, I trailed the TSX return of 10.8% and the S&P 500 return of 13.8%. I don't fret about any 1 year's return, it's the five year returns I'm interested in. I'm still well inside my comfort range on the 5yr (mid-teens %) returns.

Figuring out what worked and what didn't this year was easy. Here's a look at several of the S&P 500 sub-sectors:

Winners                                   Losers

Financials    +13.5%               Energy      -10.3%

Technology +21.1%                Industrials +7%

Utilities        +26.7%               Basic Mat. +2.7%

Healthcare   +25.3%               Telecom    -0.1%

Exposure to financials and technology was a huge contributor to my 2014 return. Without that exposure, 2014 would have been a down year. Energy and materials were a major headwind in 2014.

I under estimated the floor on oil, thinking we would not see less than $65-$70/barrel. As you know oil is currently under $50. Some energy companies may become financially unstable if oil continues to languish. If you owned U.S. stocks in 2014, then the falling Canadian dollar (CAD) also provided a tailwind. Weak commodity prices will likely continue to weigh on the CAD going forward. The Canadian economy will also suffer.

Looking ahead to 2015, there's still value in the financials. The large money center banks like Bank of America and Citigroup are finally moving past the huge legal challenges ( and monetary settlements ) they have endured over the past few years. As recently as last week, investors dumped bank stocks as they continue to worry about NIM's ( net interest margins ) thanks to falling bond yields. While lower NIM's may hurt BAC and C, in the short-run, we think these banks have tremendous earnings power going forward. We'd add to both BAC and C now.

Other areas of value include technology, where I continue to add to the mega-cap tech companies that have improving fundamentals - Oracle (ORCL) to name one. Industrials also offer value, as they were poor performers in 2014. Specifically, there's value in the auto makers and steel companies.

 

While we don't know what's in store for the markets in 2015, it's sure to be full of surprises. There are still cheap stocks - we are cautiously optimistic. All the best for 2015!

 

 

 

 

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Tight Credit & Cross Currents

 

A recent news story surfaced, highlighting just how tight credit conditions still are in the U.S.

Former Federal Reserve Chairman - Ben Bernanke, the top dog at "America's Bank", the one who poured trillions into the economy after the 2008-2009 financial crisis, recently tried to refinance his $670K mortgage with little success. If America's top banker can't refi, than who can? The pendulum on lending standards have clearly swung too far. Tight credit might explain the slower than normal economic recovery south of the border. Housing, which also has recovered, albeit at a slower than normal pace, could benefit from less stringent lending. I'm sure that when the Bernanke news hit the wires he received several offers for a refi on his Washington home.

 

In other news, energy prices continue to slump dragging energy companies along with them. The fall of some energy names has been truly amazing - considering many are hedged and have solid or improving balance sheets. News recently surfaced that Oklahoma wildcatter - Harold Hamm, CEO/founder of Continental Resources proclaimed that there is no oil glut. Hamm is known as a outspoken risk taker, but this time he has put his money where is mouth is. He recently, cashed-out of some $4 Billion worth of oil hedges (@$98 hedges), netting a cool $470M. Hamm's case rests on his theory that there has not been much of a change in the global supply/demand picture. Continental, now un-hedged, will benefit significantly if oil prices rise. Hamm's recent move runs directly against the street's current outlook on oil and just might give him the last laugh.

 

We continue to pick away at our depressed energy holdings with a view to better days ahead. However, our overall energy exposure has fallen over the past 6 months, with our sale of Hess Corp (HES) at an average price of $89.



Drill Baby Drill!!! - YPF SA

News quietly emerged this week from Argentina that the federal government has agreed to amend a 1967 energy bill in the cash strapped South American country. The revisions will allow foreign and domestic oil companies, like YPF (which we've owned since 2012), to export some quantities of oil into international markets. Argentina, under the current leadership of Christina Fernandez de Kirchner, has been quite restrictive allowing only a few foreign players into the domestic oil patch - under onerous conditions. Kirchner, since expropriating YPF from Spanish oil giant Repsol in 2012, has realized they need foreign expertise to develop the massive Vaca Muerta shale oil/gas fields - as the country has been struggling with falling production and stubbornly high development and production costs. YPF has recently signed partnerships with U.S. based Chevron and Petronas - Malaysia's state oil company. Why all the fuss over oil/gas in Argentina? Well, the Vaca Muerta fields, the size of Belgium, hold the worlds fourth largest shale oil and the second largest shale gas deposits - some 27 billion barrels of oil equivalent and 800 Million TCF of nat gas. Despite the political and economic uncertainty (including 8 debt defaults since 1894) we think the value of YPF's oil in the ground will likely remain relatively constant - which is currently north of $50/share of YPF, well above the current stock price. We are also pleased to learn that legendary hedge fund manager George Soros's family office, is new owner of YPF, with a 3.5% stake valued at some $450 million. We would add to YPF on a meaningful pull-back in the low $30's.

 

Citi Settles & A New Stock

Regular readers will know we've been a fan of the U.S. Mega-banks for some time. Citigroup (C) is no exception, we've owned it since 2010. It's possibly the most hated bank in America now - right up our alley. Although C is out of favour with the street - there is still value - here at $49. The company has recently settled a court case with the Department of Justice (DOJ) - related to the bundling and selling of mortgages that went sour during the financial crisis. Many expected the settlement to reach $10 billion - Citi settled for $7 Billion. Citi also is recovering from a fraud case at a Mexican subsidiary - Banamex. Finally, Citi this past spring, failed a review conducted by the government on Citi's books. We didn't expect them to fail the review - nor did the street. I'd expected Citi will be extra cautious on the next review. Passing the government's review will allow C to raise the dividend and buy back stock. Both will be welcome by the markets. Citi still trades at a meaningful discount to it's tangible book value and at less than 10X next year's earnings - Citi is cheap. We're not adding, but will continue to hold for full value.




While the markets have steamed ahead the past few years, we are still able to find pockets of value.
We look in areas that are out-of-favour, un-loved and under stress. Our search reminds me of one of my favorite quotes from the famous investor John Templeton - "stocks are rarely popular and cheap at the same time".

Our search has led to an industry that boomed from 2002-2007, and is now un-popular and cheap.
Many companies in this industry are well capitalized, operate globally and pay healthy dividends.
Subscribers to the www.roi-report.com know that we have started a position in a mega-sized company in this industry.

If you are interested, you can check out www.roi-report.com

Enjoy the rest of your summer!