Monthly Archives: November 2014

Buffett, Duracell and Proctor and Gamble (PG)

November 14, 2014 By in Current Market Thoughts, Portfolio management, Trading Tags: , , , , , , , , Leave a comment

Warren Buffett’s company, Berkshire Hathaway (BRK), is buying Duracell from PG for $2.9 billion.

The deal is a little more complex than that, though:

structure:  PG will inject $1.8 billion in cash into Duracell prior to the sale.  It will then swap the enlarged company for BRK’s 52.8 million share holding in PG.  This makes the headline number for the deal $4.7 billion.

a win-win

PG has been interested for years in offloading Duracell, which it acquired through its purchase of Gillette in 2005.  Duracell has gone ex growth, as today’s mobile devices like smartphones use rechargeable batteries, not disposables.  Complicating the issue is the fact that Duracell is on the books at the price Gillette paid for it in the 1980s.  So a sale for cash would presumably trigger a big capital gains tax.

With this deal, PG gets rid of a no-growth brand that no trade buyers were beating down the door to get.  It avoids taxes.  It accomplishes a share buyback at the same time and takes out a large seller whose activity would depress the stock price, to boot.  So, for PG the deal is a big winner.

BRK offloads its entire holding in PG at once.  I estimate the task would take three months in the open market, during which time PG shares would doubtless be depressed as the news hit Wall Street’s trading floors.  BRK also avoids taxes on a position that’s on its books at the cost of Gillette convertible bonds it bought in 1989.

On the surface, it appears that BRK doesn’t make out so well.  It has aguably swapped a slow-growth dog for money plus a no-growth cat.  But let’s look at the numbers.

Let’s say sale of the PG shares in the open market would bring in $4.7 billion but trigger taxes due of $1.2 billion (a number I just made up).  So the net to it is $3.5 billion.  By doing this deal instead, BRK gets $1.8 million in cash plus 100% ownership of a company that generated $400 million+ in cash over the past year.  This means BRK only needs Duracell to stay afloat for four more years to recover the price it’s paying.  In addition, PG disappears from the portfolio everyone watches (as a 100% holding, Duracell never makes it in). Looks like a good deal.

what catches my eye

I hadn’t realized before, but I’ve read in the Financial Times and the Wall Street Journal that this is the third such deal BRK has done in the past year.  This looks a lot to me like portfolio housecleaning.

Warren Buffett’s trademark has long been to buy consumer-oriented stocks with strong brand names, superior products and excellent distribution networks.  All are “moats” that defend against competition.  However, all these competitive advantages are being steadily eroded by generational and technological change.

It looks to me like a big (and overdue) strategy shift may be underway at BRK–one that the company, understandably, wants to keep under wraps for as long as possible.

 

 

technical analysis: double bottom

November 13, 2014 By in Casinos, counter-trend movements, earnings conference calls, Energy, Hong Kong, Macau, major changes in market direction, market bottoms, Technical Analysis Tags: , , , Leave a comment

Regular readers will know that I’m not a particular fan of technical analysis, at least as a primary tool in determining the investment attractiveness of the equity market or of individual stocks.  A hundred years ago–maybe even sixty years ago–it was the tool, because there was nothing else.  Before the SEC, company financials were a joke, and they weren’t easily available in a timely manner.  Watching the trading patterns of the “smart money” was arguably the best an average person could do.

Nowadays, the SEC’s Edgar site has all US-traded companies’ filings available for free the instant they’re made.  Most companies also have extensive libraries of their own available on their sites.  Firms now webcast their earnings conference calls for all to hear.  If you don’t feel like listening, transcripts are available for free soon afterward from Seeking Alpha.  

So it isn’t so much that technical analysis is bad per se.  It’s just that like the horse-drawn cart it’s been replaced by fundamental information that’s quantum leaps better.

support/resistance

Still, there are some aspects to technical analysis that I find useful.  One is support/resistance.  This is the idea that price levels where there has been significant past trading volume, preferably over an extended period, will act as floors to support stocks as they fall, as well as ceilings to impede their advance.  Both holding at and breaking through these levels are often significant events.  In particular…

double bottom

When the market has been declining for an extended period of time, or has dropped particularly sharply (the “magic” numbers technicians use are typically losses of 1/3, 1/2 or 2/3 of the prior advance), it often stabilizes for no apparent reason and begins a significant upward bounce (+10%?).

The fact that prices are now going up isn’t enough by itself to establish they have reached an important low.  In almost all cases (March 2009 was, on the surface at least, a significant exception–see below), stocks begin falling again within a few weeks and find themselves approaching the previous low.  If the market touches–or almost touches–the previous low but begins to rebound again (in the US, the market may briefly trade lower than the previous low–we’re daredevils, after all), this is often a strong sign that resistance is forming at the old low.  This revisiting of the low is the necessary second part of the double bottom.

There can be a triple bottom, too.  More often, in my experience, the market begins a new, upward pattern of higher highs and higher lows after the second bottom.

Fundamental conditions must also be in place for this bottoming to happen.  Stocks have to be cheap; investor pessimism must be high; the downtrend must be protracted enough for at least some investors to think that conditions won’t get worse.

In essence, what the double bottom tells us is that intense negative emotion that has been driving prices sharply (often irrationally) lower has begun to play itself out.

current examples

Double bottoms happen with individual stocks and stock groups, too.

Look at the Macau casinos traded in Hong Kong.  Some, like Galaxy Entertainment, have lost half their value over the past ten months.  But the group appears to have bottomed in late September-early October.   The stocks bounced off their lows, returned near them several weeks later and appear since then to have established a new upward pattern.

I haven’t looked carefully at energy stocks–but the oils are a group where I’d be looking for similar behavior.

the March 2009 case

The S&P 500 appeared to me to be bottoming in early 2009.  As is usual during recessions, government programs were being put in place to stop the economic bleeding.  Anticipating this, investors had pretty much stopped selling.  However, in late March investors were horrified to hear that Congress failed to pass the proposed bank bailout bill/  Some (Republican) Representatives were even saying they would prefer a rerun of the Great Depression to a bank bailout.  The S&P fell more than 7% on the news, but recovered all its losses when the bill was passed the following day.  If we erase those two trading days, early 2009 exhibits a “normal” bottoming process.

 

 

Pandora (CPH: PNDORA) and the dollar

November 12, 2014 By in currency effects, Current Market Thoughts, EU financial crisis, Stock ideas, stock market, Strategy Tags: , , , , , , , , Leave a comment

This is one case where it’s easier to write the name than the symbol, which includes its principal trading market, Copenhagen.

Pandora is the jewelry company that burst on the scene early in the decade with an innovative line of charm bracelets.  It IPOed to much fanfare in Copenhagen in 20111   …and almost immediately collapsed as its product began to be knocked off by established jewelry chains.

The company has since rebuilt itself.  The stock is now about 10x the price at its nadir almost exactly three years ago.  I’m still learnings the story–and this is not a stock I feel comfortable enough with to recommend that anyone else buy it.  But the turnaround seems to have been accomplished with better management, stronger control of inventories and the introduction of a line of rings, which are harder to knock off.

There are more pluses to the story, like development of the company’s own retail channel and increasing e-commerce presence, which is boosting purchases by men.  But the knockoff issue still exists:  here in the US, for example, Signet Jewelers’ Jared sells Pandora; its lower-end but much larger sibling, Kay, sells its own knockoff line.

 

Two ideas attracted me to Pandora a few months ago:  the rings, and the possibility that continuing economic weakness in the EU would force people to trade down further–meaning that a company like Pandora might increasingly be in the sweet spot for jewelry.  My main worry is that I’m very late to the party, as the stock chart illustrates.

 

The main reason I’m writing about Pandora, though, is not to highlight the company but to point out a fact about the dollar.  In Danish kroner, I’m up by 11% since buying the stock in August.  In US$, however, I’m up a tad less 3%.  Yes, I’ve wildly outperformed European stock indices but I’ve given almost all of it back in losses on the currency.

My point:  that’s what’s been happening to every US company that has a presence in Europe (or in Japan, for that matter) since May.  Of course, not all of them have sales that are way above average for Europe, so they generally have US$ losses on operations.  On the other hand, the biggest of them will have hedging operations that temper the near-term effects of currency fluctuations.

Given that about a quarter of the earnings of the S&P 500 come from Europe, it seems to me that the combination of weak economic performance there plus weak currencies represents the biggest threat to earnings growth facing the S&P 500 today.

I don’t think this issue is a reason to sell US stocks across the board.  It’s more a reason to reposition away from firms with European exposure.  Upcoming earnings reports from companies like Tiffany will give us more information.

Conversely, European currency weakness is setting up another opportunity to buy Europe-based multinationals with significant dollar exposure, just as we had several years ago.  Typically, the negative effects of currency depreciation are factored into stock prices first, and the positive effect on earnings only with a lag.

 

PS.  On December 3, 2014, in kroner I’m up about 22%, in US$ about 12%.

 

net neutrality

November 11, 2014 By in Cable, Entertainment, internet, Technology Tags: , , , , , , , , Leave a comment

Happy Veterans Day!!!

On Monday, President Obama made a strong statement in favor of net neutrality, maintaining that the provision of internet access should be a utility service like the provision of water and electricity.  Personally, I think this is common sensical and correct, and it’s the way we should do things if we were starting from scratch.

His statement comes a few days before the Federal Communications Commission will release its newest version of internet rules, one that will likely allow internet service providers to continue to charge extra to big services like Netflix.  Mr. Obama is now on record as opposing what the head of the FCC, Tom Wheeler, is about to do.

I can’t help thinking that the statement is more than a little disingenuous.  It comes just after the election, so voters don’t have a chance to weigh in on the issue.  It also comes less than a year after Mr. Obama appointed Mr. Wheeler, who spent his career working in and lobbying for the biggest ISPs, the cable companies, to head the FCC. (Wikipedia says Mr. Wheeler is in the cable industry Hall of Fame–wireless HOF, too.)  What did Obama expect Wheeler to do?

I don’t have a solution for the net neutrality issue, but I think know where the problem lies.

Government creates utilities when the public interest is best served by having only a small number of companies providing a capital-intensive service.  Certain firm are granted monopolies or near-monopolies in given service areas.  To prevent abuses, the firms’ business focus is restricted and profits are regulated.  Profit growth is (almost always) tied to the increases in new capacity the utility brings into service.

Consumers are charged by the amount of the service they use; utilities are chomping at the bit to provide more and better service.

Almost none of this applies to the cable companies, whose profits, in the short term anyway, can be maximized by doing the opposite–providing the worst service at the highest price (think:  Comcast or Time Warner Cable).  Yes, both the cable companies and their mobile brethren, ATT and Verizon, have the advantage of being able to build their internet presence using their monopoly cable/telephone infrastructure.  But that in itself doesn’t make their ISP services monopolies.

I don’t see any quick fix.  The orthodox economic solution in a case like this is to encourage competition–that is, prevent further consolidation among existing ISPs and provide incentives to new entrants.  Let’s see if Mr. Obama speaks out against the proposed Comcast-TWC merger, which would be his next logical step if he means what he said on Monday.

 

 

 

offshore contract drillers when the oil price is sinking

November 10, 2014 By in Energy, Industry Analysis, offshore contract drilling Tags: , , , , , , , Leave a comment

Last Friday, offshore contract  oil and gas driller Transocean Ltd (RIG) announced that in its September quarter earnings statement it would be taking an impairment charge of close to $2.7 billion, or more than a quarter of the stock’s market capitalization.  The reason:  deterioration of its business prospects caused by the recent sharp decline in the world oil price.

Despite this bad news, the stock closed down less than a percent on the day  …a trading session in which the S&P 500 ended basically unchanged.

Why the muted reaction?

Offshore contract drilling is a very capital-intensive business.  It can easily cost over half a billion dollars to build a state-of-the-art semi-submersible rig.  Contract drillers rent their rigs out under long-term contract to oil exploration and development companies at rates of tens of millions of dollars a year.

In good times, meaning when the oil price is rising,  rental rates go up as well.  Contract drillers tend to sink all their cash flow (often plus all they can borrow) into building new rigs.  This, of course, keeps both financial and operating their leverage high and eventually leads to overcapacity (as is the case in any capital-intensive commodity business).

In bad times, i.e., when the price of oil is falling, demand from the big oil companies wanes and rental rates fall.  Worse than that, customers seek to renegotiate down rental rates for rigs already under contract, or simply announce they don’t need the rigs any more and, contract or no, stop paying and return them.  Ouch!

The key variable in all this is the oil price.  Because of this, the stock market takes the spot price of oil as a leading indicator of the drillers’ future profits and trade on that rather than waiting for reported earnings.  Again, this is common in other commodity-like industries, as well.

The message I take from Friday’s price action is that, for the moment at least, the market expects the oil price to stabilize around current levels. Monday’s earnings announcement and conference call by RIG (I’m writing this on Sunday night) will be a further indicator of whether my view is correct.