Sunday, May 25, 2008
Crude Oil Prices
Next week, I plan to start lightening up on some of my energy holdings. There are both bullish and bearish arguments on future crude oil prices, but I think the bearish case may soon start to win out. Some of the recent price appreciation is merely a reflection of the weak US dollar, but a lot of the move is also due to speculative sentiment. There have also been erratic price moves as many crude oil forward months have moved from backwardation to contango back to backwardation again.
Let's start with some of the bullish arguments-
1) "The trend is your friend". There is no question that most momentum-based trading models are long crude oil and will stay long unless there is a sharp correction.
2) A Goldman Sachs analyst has forecast higher prices.
3) There are periodic stories about long term supply problems.
4) Long only commodity funds are causing a lot of the move which may not be over yet.
But here are some very strong potential bearish arguments, some of which can have a sharp negative impact on the crude oil price:
1) Raising the margin requirements: It is easy to make the case that the margin requirement for the crude oil futures contract has simply not kept up with the price increases. Each crude oil contract represents 1,000 barrels. At around $132/barrel, one contract is worth $132,000. But the maintenance margin is only $7,250. That’s over 17 to 1 leverage. The commodity exchanges are sensitive to pressure from Congress, and will most likely raise the margin requirements in the near future. This could have a dramatic downward effect on prices.
(Remember silver and the Hunt Brothers in 1980).
2) Lower limits on the number of contracts any single institution can buy.
3) Pass legislation to limit commodity swaps that bypass commodity futures contract limits.
4) I'm starting to read that more countries are reducing subsidies of crude oil prices. This will soon lead to a decreased demand from parts of the world where consumers have been shielded from the higher prices. Many of these countries have huge populations (e.g. India, Indonesia etc.).
5) The US dollar has been weak because of the previous interest rate cuts. But the cuts seem all but over now. The rest of the world will soon need to cut interest rates to catch up with the US. This will lead to a stronger US dollar and weaker crude oil prices in dollar terms.
By the way, a good free web site for following crude oil and other commodity prices is http://www.ino.com/
Let's start with some of the bullish arguments-
1) "The trend is your friend". There is no question that most momentum-based trading models are long crude oil and will stay long unless there is a sharp correction.
2) A Goldman Sachs analyst has forecast higher prices.
3) There are periodic stories about long term supply problems.
4) Long only commodity funds are causing a lot of the move which may not be over yet.
But here are some very strong potential bearish arguments, some of which can have a sharp negative impact on the crude oil price:
1) Raising the margin requirements: It is easy to make the case that the margin requirement for the crude oil futures contract has simply not kept up with the price increases. Each crude oil contract represents 1,000 barrels. At around $132/barrel, one contract is worth $132,000. But the maintenance margin is only $7,250. That’s over 17 to 1 leverage. The commodity exchanges are sensitive to pressure from Congress, and will most likely raise the margin requirements in the near future. This could have a dramatic downward effect on prices.
(Remember silver and the Hunt Brothers in 1980).
2) Lower limits on the number of contracts any single institution can buy.
3) Pass legislation to limit commodity swaps that bypass commodity futures contract limits.
4) I'm starting to read that more countries are reducing subsidies of crude oil prices. This will soon lead to a decreased demand from parts of the world where consumers have been shielded from the higher prices. Many of these countries have huge populations (e.g. India, Indonesia etc.).
5) The US dollar has been weak because of the previous interest rate cuts. But the cuts seem all but over now. The rest of the world will soon need to cut interest rates to catch up with the US. This will lead to a stronger US dollar and weaker crude oil prices in dollar terms.
By the way, a good free web site for following crude oil and other commodity prices is http://www.ino.com/
Monday, May 19, 2008
XINYUAN REAL ESTATE (XIN)
Most of my recent posts have been a bit on the boring side- (closed end funds and solid blue chip companies) so I thought I would write about a more speculative China stock today, similar to my SSRX post of a few months ago.
Xinyuan Real Estate (ticker: XIN) is a residential real estate developer that focusses on building large scale quality residential projects for the middle class. They typically build multi-layer apartment buildings together with auxiliary services and amenities, such as retail outlets, leisure and health facilities, kindergartens and schools.
Here are some of the reasons I like XIN as a longer term investment:
1) The stock seems pretty cheap. The forward PE ratio is only five times earnings. The 5 year PEG ratio is only 0.12, but this is only based on one analyst.
2) The upcoming Expo 2010 Worlds Fair in Shanghai should be bullish for China stocks in general, and should help companies like XIN. I was fortunate to attend the 1964 NY World Fair as a child and it left a lasting impression on me. I checked the returns of the Dow Jones Averages for 1963 and 1964:
1963: +17% 1964: +14.6% (not bad)
3) Many China stocks are coming off a sharp correction early this year and may be poised for another bull run heading into the 2008 Olympic Games followed by the Shanghai Worlds Fair in 2010.
4) The recent earthquake in China has created more of a need for real estate construction companies.
5) XIN reported strong growth in the first quarter and will be reporting their second quarter results on June 3. I expect the stock to do well heading into the earnings announcement.
Full Disclosure: I have a small starter position in XIN and plan to add more shares on price dips.
Xinyuan Real Estate (ticker: XIN) is a residential real estate developer that focusses on building large scale quality residential projects for the middle class. They typically build multi-layer apartment buildings together with auxiliary services and amenities, such as retail outlets, leisure and health facilities, kindergartens and schools.
Here are some of the reasons I like XIN as a longer term investment:
1) The stock seems pretty cheap. The forward PE ratio is only five times earnings. The 5 year PEG ratio is only 0.12, but this is only based on one analyst.
2) The upcoming Expo 2010 Worlds Fair in Shanghai should be bullish for China stocks in general, and should help companies like XIN. I was fortunate to attend the 1964 NY World Fair as a child and it left a lasting impression on me. I checked the returns of the Dow Jones Averages for 1963 and 1964:
1963: +17% 1964: +14.6% (not bad)
3) Many China stocks are coming off a sharp correction early this year and may be poised for another bull run heading into the 2008 Olympic Games followed by the Shanghai Worlds Fair in 2010.
4) The recent earthquake in China has created more of a need for real estate construction companies.
5) XIN reported strong growth in the first quarter and will be reporting their second quarter results on June 3. I expect the stock to do well heading into the earnings announcement.
Full Disclosure: I have a small starter position in XIN and plan to add more shares on price dips.
Monday, May 12, 2008
RMR Asia Real Estate (RAF)
I've noticed that many discounts of closed end funds have narrowed over the last few weeks. But one fund that still looks attractive is RMR Asia Real Estate (ticker:RAF) which is selling at a 16% discount from NAV at today's close.
The IPO for RAF was in May 2007, and I think the large discount to NAV is larger than normal now because of tax loss sellers. Investors who bought at the IPO price paid $20, and RAF closed today at 14.02, so the loss is around 30%. Just another example that shows why it almost never pays to buy a closed end fund at the IPO price. The initial investors in the RAF IPO are way underwater and many are likely are selling before one year is up to realize a short term capital loss.
RAF is unleveraged and has an annual expense ratio of 1.40%, so the discount/expense ratio is about 11.5 times which is not bad. (For this ratio, anything over 100 is good and the higher the better). The fund does not trade much, and the distributions have been modest thus far.
RAF invests in high quality real estate companies throughout the Asia Pac region. Here is the country breakdown:
Hong Kong/China (45%), Japan (33%), Singapore (11%), Australia (4%), Malaysia (3%), Philippines (3%).
The top four individual holdings are: Mitsubishi Estate (13.8%), Sun Hung Kai Properties (12.8%), Mitsui Fudosan(6.0%) and Hang Lung properties (5.7%).
Because of its discount and reasonable fund management, RAF should be a good way to invest in Asian real estate longer term. But there may also be short term opportunities to take advantage of narrowing of the discount for those who own it in tax deferred accounts.
Full Disclosure: I am long RAF.
The IPO for RAF was in May 2007, and I think the large discount to NAV is larger than normal now because of tax loss sellers. Investors who bought at the IPO price paid $20, and RAF closed today at 14.02, so the loss is around 30%. Just another example that shows why it almost never pays to buy a closed end fund at the IPO price. The initial investors in the RAF IPO are way underwater and many are likely are selling before one year is up to realize a short term capital loss.
RAF is unleveraged and has an annual expense ratio of 1.40%, so the discount/expense ratio is about 11.5 times which is not bad. (For this ratio, anything over 100 is good and the higher the better). The fund does not trade much, and the distributions have been modest thus far.
RAF invests in high quality real estate companies throughout the Asia Pac region. Here is the country breakdown:
Hong Kong/China (45%), Japan (33%), Singapore (11%), Australia (4%), Malaysia (3%), Philippines (3%).
The top four individual holdings are: Mitsubishi Estate (13.8%), Sun Hung Kai Properties (12.8%), Mitsui Fudosan(6.0%) and Hang Lung properties (5.7%).
Because of its discount and reasonable fund management, RAF should be a good way to invest in Asian real estate longer term. But there may also be short term opportunities to take advantage of narrowing of the discount for those who own it in tax deferred accounts.
Full Disclosure: I am long RAF.
Sunday, May 04, 2008
Lockheed Martin Covered Calls (LMT)
Lockheed Martin (ticker:LMT) looks attractive here, but given the recent market runup it may be safer to use protect the position by writing covered calls against it. Sometimes I'll write call options with two different strike prices against the same stock position. The lower strike price is for defensive purposes at a call price level where I would be comfortable owning more of the stock. The higher strike price is at a sell target price where I would not mind if the stock is called away. Lockheed Martin closed at 106.93 on Friday.
Right now, I would be willing to buy at 100 and would be comfortable selling at 120. So if I were long 1000 shares of LMT, I would write 5 call options with a 100 strike price and 5 call options with a 120 strike price. I usually use longer term (but liquid) options to minimize slippage and commissions, so I would use the Jan. 2009 leap options which are fairly liquid.
Here are some reasons I like LMT:
1) Lockheed Martin is the leading aerospace company in the US and has had good earnings growth, but its PE ratio is lower than average for its industry.
2) Strong cash flows.
3) Return on equity (ROE) is about 43% which is well above average for the aerospace group.
4) Strong sponsorship: I checked the stockpickr.com web site, and some savvy investors are large LMT owners: Renaissance Technologies, Ken Fisher, Al Frank and Lou Navellier.
5) I like investing in the F-22 Raptor fighter plane. The F-22 is claimed by many to be the world’s most effective fighter aircraft. Lockheed recently reported a big success at the recent Joint Expeditionary Force Experiment 2008 (JEFX 08)- "Lockheed Martin was excited about the Air Force's decision to demonstrate the value of sharing F-22 ISR data with other fighters and back to the Combined Air Operations Center," said Larry Lawson, Lockheed Martin Aeronautics Company executive vice president and F-22 general program manager. "This is the first time in history that F-22 sensor data was down-linked to the Combined Air Operations Center (CAOC) using a tactical network." This should lead to increased F-22 business going forward.
Full Disclosure: I am long a small "starter" position in LMT, but am planning to buy more shares and write covered calls against them.
Right now, I would be willing to buy at 100 and would be comfortable selling at 120. So if I were long 1000 shares of LMT, I would write 5 call options with a 100 strike price and 5 call options with a 120 strike price. I usually use longer term (but liquid) options to minimize slippage and commissions, so I would use the Jan. 2009 leap options which are fairly liquid.
Here are some reasons I like LMT:
1) Lockheed Martin is the leading aerospace company in the US and has had good earnings growth, but its PE ratio is lower than average for its industry.
2) Strong cash flows.
3) Return on equity (ROE) is about 43% which is well above average for the aerospace group.
4) Strong sponsorship: I checked the stockpickr.com web site, and some savvy investors are large LMT owners: Renaissance Technologies, Ken Fisher, Al Frank and Lou Navellier.
5) I like investing in the F-22 Raptor fighter plane. The F-22 is claimed by many to be the world’s most effective fighter aircraft. Lockheed recently reported a big success at the recent Joint Expeditionary Force Experiment 2008 (JEFX 08)- "Lockheed Martin was excited about the Air Force's decision to demonstrate the value of sharing F-22 ISR data with other fighters and back to the Combined Air Operations Center," said Larry Lawson, Lockheed Martin Aeronautics Company executive vice president and F-22 general program manager. "This is the first time in history that F-22 sensor data was down-linked to the Combined Air Operations Center (CAOC) using a tactical network." This should lead to increased F-22 business going forward.
Full Disclosure: I am long a small "starter" position in LMT, but am planning to buy more shares and write covered calls against them.
Monday, April 28, 2008
Dreman/Claymore Dividend & Income (DCS)
I recently purchased shares of Dreman/Clayman Dividend & Income (ticker:DCS). It is a closed end fund that invests in dividend-paying common and preferred stock. Some of its top holdings are: Altria, Fannie Mae Preferred 8.25%, Conoco Philips, Washington Mutual, Devon Energy.
This is mainly a discount reversion play. DCS closed on Friday at a 15.28% discount to NAV which is at the higher end of its range. Its expense ratio of 1.42% is a bit high, but the fund offers leverage of 29% which allowed it to pay out an annual distribution of 8.44%. I think it is a good holding for an IRA or other tax-deferred account.
DCS uses auction rate preferred securities for leverage. They use five securities totalling $425 million with current interest rates varying from 3.97% to 4.15% which is not bad, and well below what they earn from the portfolio. The asset coverage ratio on these preferreds is 294%.
This is mainly a discount reversion play. DCS closed on Friday at a 15.28% discount to NAV which is at the higher end of its range. Its expense ratio of 1.42% is a bit high, but the fund offers leverage of 29% which allowed it to pay out an annual distribution of 8.44%. I think it is a good holding for an IRA or other tax-deferred account.
DCS uses auction rate preferred securities for leverage. They use five securities totalling $425 million with current interest rates varying from 3.97% to 4.15% which is not bad, and well below what they earn from the portfolio. The asset coverage ratio on these preferreds is 294%.
Thursday, April 24, 2008
The Do-Over Option
Just last week, I wrote about hedge funds that terminate after a bad year to avoid having to work their way back to breakeven. I just read a story about a hedge fund portfolio manager, Greg Coffey, who works at GLG Partners (ticker:GLG) and manages $7 billion in emerging market funds. He recently resigned from the firm and will be walking away from about $250 million in unvested shares and cash awarded to him as "golden handcuffs".
Coffey's main fund is GLG Emerging Markets earned a 60% in 2006 and 50% in 2007. These returns are quite good, but many emerging market mutual funds did just as well in that period, especially those invested in China.
But Coffey's fund has got off to a bad start in 2008- down about 15% year to date. So Coffey has decided to launch his own hedge fund using the "do-over" option, to make the 15% shortfall go away. I would hope that investors moving from his GLG Partners fund would be smart enough to negotiate an arrangement where the first 17.5% in appreciation is free from incentive fees, but I doubt it will happen.
When you look just at the percentages, Coffey's record looks pretty good even after the 15% drop. But most likely his assets under management in 2005 and 2006 were fairly small and grew rapidly going into 2008. So looking at dollar weighted returns, it is quite possible that Coffey actually lost money overall, or made very little.
Coffey's main fund is GLG Emerging Markets earned a 60% in 2006 and 50% in 2007. These returns are quite good, but many emerging market mutual funds did just as well in that period, especially those invested in China.
But Coffey's fund has got off to a bad start in 2008- down about 15% year to date. So Coffey has decided to launch his own hedge fund using the "do-over" option, to make the 15% shortfall go away. I would hope that investors moving from his GLG Partners fund would be smart enough to negotiate an arrangement where the first 17.5% in appreciation is free from incentive fees, but I doubt it will happen.
When you look just at the percentages, Coffey's record looks pretty good even after the 15% drop. But most likely his assets under management in 2005 and 2006 were fairly small and grew rapidly going into 2008. So looking at dollar weighted returns, it is quite possible that Coffey actually lost money overall, or made very little.
Wednesday, April 16, 2008
Sysco Covered Call (SYY)
Given the rocky market over the last six months, it doesn’t hurt to have some solid longer term positions to help weather the storm. I recently purchased shares in the leading food distributor, Sysco (ticker:SYY) and wrote a long term covered call against part of it (Jan 2010- 35). Here are some reasons I like Sysco, along with one potential negative:
1) Sysco has a high A+ quality rating from S&P. Using a football analogy, Sysco is like Bronco Nagurski, the legendary Pittsburgh Steeler running back who would grind out first downs by gaining three to four yards at a time. Here is a Nagurski story I like- One day, Bronco charged toward the goal line, head down, shoving tacklers out of the way, and ran passed the end zone and smacked his head into the surrounding brick wall at Wrigley Field. When he came back to the bench, he told coach George Halas, "That last guy gave me quite a lick!"
Take a look at Sysco's long term quarterly numbers for revenues and earnings. There have been steady increases over the last 5 years, and increasing dividends, but the stock price has stagnated in the 30 range because of P/E contraction.
Revenues (Bill)
2003 26.1
2004 29.3
2005 30.3
2006 32.6
2007 35.0
Earnings Per Share
2003 1.18
2004 1.37
2005 1.47
2006 1.35
2007 1.60
2008(est) 1.79
2) Sysco has consistently generated returns on equity of 25% or more. Here are the ROE numbers for the last eight calendar years (quite impressive): 31.6, 29.1, 36.1, 38.1, 35.9, 32.1, 30.5, 28.5
3) Gaining market share- Sysco has a 15% market share in food distribution. Two of its biggest competitors recently were acquired and have been closing plants. U.S. Foodservice has about an 8% share and is currently owned by private equity firms Clayton, Dubilier & Rice and Kohlberg Kravis Roberts after being sold by former parent Royal Ahold in mid-2007. Performance Food Group was acquired a few months ago at a 43% premium by Blackstone Group and Wellspring Capital Management. Given the recent credit crisis, I feel that private equity firms are no longer such strong players. They will be looking to cut costs and sell out at a profit. Sysco should be able to pick up considerable market share over the next few years.
4) Roll-up strategy: From its inception through end of 2007, Sysco has acquired 141 companies or divisions of other companies.
5) Share repurchases: In Fiscal year 2007, Sysco re-purchased 16.2 million shares. As of January, they have re-purchased 13.1 million shares in 2008 with remaining authorization of 10 million shares.
6) One potential negative that may explain why SYY is currently available at a good price is
high gasoline prices. But this also affects Sysco’s competitors, and the higher fuel prices will eventually be passed along to customers.
I like SYY at this price level, but I don’t see a huge upside. That is why I wrote some Jan. 2010 covered leaps (strike price 35) against a portion of my long position. Given Sysco’s 3% dividend, I wouldn’t mind so much if the stock gets called away at 35.
1) Sysco has a high A+ quality rating from S&P. Using a football analogy, Sysco is like Bronco Nagurski, the legendary Pittsburgh Steeler running back who would grind out first downs by gaining three to four yards at a time. Here is a Nagurski story I like- One day, Bronco charged toward the goal line, head down, shoving tacklers out of the way, and ran passed the end zone and smacked his head into the surrounding brick wall at Wrigley Field. When he came back to the bench, he told coach George Halas, "That last guy gave me quite a lick!"
Take a look at Sysco's long term quarterly numbers for revenues and earnings. There have been steady increases over the last 5 years, and increasing dividends, but the stock price has stagnated in the 30 range because of P/E contraction.
Revenues (Bill)
2003 26.1
2004 29.3
2005 30.3
2006 32.6
2007 35.0
Earnings Per Share
2003 1.18
2004 1.37
2005 1.47
2006 1.35
2007 1.60
2008(est) 1.79
2) Sysco has consistently generated returns on equity of 25% or more. Here are the ROE numbers for the last eight calendar years (quite impressive): 31.6, 29.1, 36.1, 38.1, 35.9, 32.1, 30.5, 28.5
3) Gaining market share- Sysco has a 15% market share in food distribution. Two of its biggest competitors recently were acquired and have been closing plants. U.S. Foodservice has about an 8% share and is currently owned by private equity firms Clayton, Dubilier & Rice and Kohlberg Kravis Roberts after being sold by former parent Royal Ahold in mid-2007. Performance Food Group was acquired a few months ago at a 43% premium by Blackstone Group and Wellspring Capital Management. Given the recent credit crisis, I feel that private equity firms are no longer such strong players. They will be looking to cut costs and sell out at a profit. Sysco should be able to pick up considerable market share over the next few years.
4) Roll-up strategy: From its inception through end of 2007, Sysco has acquired 141 companies or divisions of other companies.
5) Share repurchases: In Fiscal year 2007, Sysco re-purchased 16.2 million shares. As of January, they have re-purchased 13.1 million shares in 2008 with remaining authorization of 10 million shares.
6) One potential negative that may explain why SYY is currently available at a good price is
high gasoline prices. But this also affects Sysco’s competitors, and the higher fuel prices will eventually be passed along to customers.
I like SYY at this price level, but I don’t see a huge upside. That is why I wrote some Jan. 2010 covered leaps (strike price 35) against a portion of my long position. Given Sysco’s 3% dividend, I wouldn’t mind so much if the stock gets called away at 35.
