Invest Bottom Up

Inflation Protection VIC Plays

2009-02-08T15:54:00.005-05:00

The mainstream media and the FED are focused on one thing these days, deflation. The FED is using all of its power to pump money into the economy to ward off deflation and reflate the economy. Deflation fears have presented the opportunity to buy inflation protection on the cheap.

There has been a good amount of recent VIC write-ups presenting inflation-protection ideas. The following three are the most recent ones:

Interest Rate Caps by humkae848

Gold Miners Index (GDX) by biv930

Short Treasuries (TBT) neo628

The TDBU blog has, since its start, been bearish on the stock market and bullish on gold. While we believe their are a great deal of bargains out there with large margins of safety, we do not believe that the whole market is spectacularly cheap. However, we are very bullish on gold, as we believe the Dow/Gold ratio should continue to fall back to its steady state around 5.

With the ratio at about 9, would could see gold jump to over $2000 an ounce. This is a similar conclusion reached by biv 930 in his GDX write up. To gain this inflation protection, we plan on adding the GDX index to our portfolio on monday, and making it around a 5% position.

Also, a great leading indicator that its time to buy inflation protection is below:

Fed's Yellen sees dynamics similar to Depression

Meanwhile, Yellen told reporters the Fed needed to fight back against the notion that its liquidity efforts would inevitably lead to higher inflation and higher interest rates, terming the notion "ludicrous."

UPDATE: 1700 shares of GDX were bought at $34.4

Contango Oil & Gas VIC write up

2009-02-08T10:02:00.001-05:00

There is currently a VIC write up posted by mpk391 that explains the current investment thesis in MCF. It can be found by clicking the link below.

MCF VIC write up

Baltic Dry Index Up 100% in 2009

2009-02-06T18:33:00.002-05:00

The Baltic Dry Index is up to 1642, after rising for 13 consecutive days.

Bloomberg article on BDI

This is a positive sign that the economy is bottoming and we continue to believe that stocks are extremely attractive right now. If now is not the time to buy, than when is it the right time?

ZMH sold

2009-02-02T15:52:00.001-05:00

Fortescue Says Iron Ore Market Bottoming

2009-02-01T23:39:00.003-05:00

Iron Ore Market May Have Bottomed, Fortescue Predicts (Update2)

Fortescue is a large position for LUK and a major iron ore producer. They are seeing a comeback in iron ore prices, which is key in signaling a recovery in the global economy.

The article also points out that the Baltic Dry Index has been moving up from its lows. This is the best representation of global trade and a bullish sign things are bottoming worldwide.

BDI Chart

Selling WTM (Holder Position); Buying ZMH

2009-01-29T12:46:00.002-05:00

The portfolio is selling its 250 share position in WTM, a holder position. This will raise around $70,000 for purchases. The first purchase will be of ZMH (Zimmer Holdings), an orthopaedic medical equipment company. A write up will follow on ZMH.

Other stocks on the watch list include:

OSK, TXT, ATN, WFC/USB

KHD Humboldt VIC write up

2009-01-29T12:00:00.003-05:00

Britt12 recently wrote a VIC write up on KHD Humboldt Wedag, a stock owned by the TDBU portfolio. The portfolio bought KHD at $8.70 and the write up is written up at $9.70 a share. The jist of the valuation follows:

1. $5.95/share in net cash
2. $1.40/share in preferred stock of former parent Mass Financial (ticker: MFCAF)
book value is $2.80/share, we haircut by 50% given underlying liquidity.
3. $3.28/share in royalty interest of iron ore deposit

So you are getting the operating business, slated to do $2.74 a share in EBIT for 2009, for free.

Link to VIC write up

Link to TDBU write up

We valued the royalty interest at only $1.63 per share, due to the use of the long term average selling price. We valued the preferred at $1.95 per share. And our value of net cash minus purchase obligations was 12.63-7.41, for a net net cash position of $5.22.

Our write up got an NAV not including the operating business of $8.80 versus the VIC write up's $10.63. An average of these would approximate where the stock is trading for today. This means we are still essentially getting the operating business for free.

Waters Q4 Earnings: Record Free Cash Flow

2009-01-28T14:41:00.004-05:00

Waters Reports Fourth Quarter 2008 Financial Results

Conference Call Highlights

-Despite the lower than originally anticipated sales volume the strength of our business model enabled to us maintain our operating profitability and we finished the year with record annual free cash flow.

-Other customer segment dynamics of interest in the quarter include continued strong uptick of instrument systems for food safety testing in Asia and for medical diagnostic applications.

-Before passing you on to John I'd like to comment on our overall financial and operating performance in 2008. For the full year we achieved 20% adjusted EPS growth, accompanied by free cash generation at record levels. Our ability to post these results in light of an obviously tightening global economy and following a 2007 performance where sales grew by 15% and where EPS also grew by 20% clearly indicates the strength and resiliency of our business strategy. Our new product flow was strong particularly in mass spectrometry technology and our application focus in areas such as food safety testing, clinical diagnostics and life science research allowed to us solidify strong foundations in business segments with high growth potential. Geographically we continue to expand in our developing markets in Asia and Latin America and in these markets we've made investments to provide better service and support in a rapidly growing base of customers.

-We finish the year with a strong balance sheet as we used our cash flow to reduce our net debt, execute a share repurchase program and continue M&A effort. Our M&A activity is consistent with our strategy and we added complimentary product lines to our existing operating division.

-Now I would like to comment on our non-GAAP financial performance. Gross margin remained strong this quarter. It came in at 58.9% versus prior year, margin expanded by about 50 basis points. Additionally, product cost reductions continue to favorably impact margins this quarter. SG&A expenses declined slightly compared to prior year as a result of favorable foreign translations. R&D expenses declined modestly

-On the balance sheet, cash and short term investments totaled $428 million debt totaled $536 million, bringing to us a net debt position of about $108 million.

-On the stock buy back front, we continued to purchase our shares in the open market and during the fourth quarter we purchased 635,000 shares of our common stock for $26 million. For the full year 2008 we purchased 4.1 million shares for $235 million.

-We define free cash flow as cash from operations less CapEx plus any non-cash tax benefit from FAS 123R accounting excluding unusual non-recurring item. For full year 2008 free cash flow was up 13% over 2007 and a record high of $369 million after funding $69 million of CapEx and adding back $7 million of FAS 123R benefits and excluding a $12 million payment associated with transition from the pension plan to a 401k plan in the US

2009
-Therefore, on a reported basis, we are expecting sales to decline by 3% to 8% for 2009.
Moving down the P&L we expect gross margins to be down about 150 basis points versus 2008 where favorable effects of higher consumables volumes and favorable currency effects from our UK based production are more than offset by a less favorable manufacturing variances from lower production volumes and a higher proportion of service sales at a 50% margin

Waters currently has an EV of $3.915 Billion and TTM FCF of $369 billion. WAT is currently trading at an EV/FCF ratio of 10.60. They have had a 10 year FCF growth rate of around 14% with an ROA of 16.6% and an ROE of 58.5%. The business has very high margins, with a Gross Margin of 58% and an Operating Margin of 25.3%. WAT has paid down a substantial amount of debt and plans to continue to buy back their shares very cheaply. WAT is an extremely well run company and the executive team owns around 6% of the common stock.

DOW refusing to close ROH deal; wants more time

2009-01-27T18:18:00.002-05:00

AP DOW News

In an significant change of course for the CEO of DOW, Andrew Liveris has stated that doing the ROH deal with put both companies a perilous position. ROH has since sued DOW and is trying to get the court to force DOW to close on the deal.

Andrew Liveris now says that he is looking to do the deal at a much later date and that he will look into dividend cuts. While the dividend might be cut, it should still be a significant yield and I plan to hold DOW in the TDBU portfolio.

Top Down: Dow/Gold Ratio down to new low (9.33)

2009-01-23T13:01:00.004-05:00

As we have spoken about on this blog for over 2 years, we believe the Dow/Gold ratio will continue to fall. With the billions of dollars being pumped into the market, an inevitable harsh inflation will occur down the road. When we started this blog, the Dow/Gold Ratio was at 15.4 and now it is at 9.33

I continue to believe this ratio will fall to around 5.

Sold Loews (Holder Stock);added to EBAY, MCF, KSWS & DOW

2009-01-22T17:48:00.005-05:00

L (2500 shares) was sold for $24.43

I added 300 shares of MCF at $45.93
1500 shares of KSWS at $10.04
1500 shares of EBAY at $11.86
and 800 shares of DOW at $14.46

This leaves the TDBU portfolio with only $5000 in cash. I will be selling place-holder stocks to raise capital for new stock purchases. My typical position size will be 5%.

Ebay reports full year earnings: FCF of $2.32 B

2009-01-22T16:12:00.003-05:00

EBAY Full Year 2008 Earnings release

Ebay reported full year free cash flow of $2.32 billion. This is in line with their previous forecasts. EBAY is one of the cheapest wide moat stocks out there right now. Its got a fortress-like balance sheet with over $3 billion in liquid cash. EBAY is selling now for a depressed price of 5.3X TTM FCF. These levels are unheard of for Ebay and suggest the company is headed for bankruptcy or that their business model is broken.

EBAY is cheap even if we assume their FCF drops 50%. However, this is very unlikely as Paypal is growing 20% YoY, enabling all of Ebay to at least grow 7%. The TDBU portfolio bought more Ebay stock today, as it irrationally dropped due to missing the headline EPS forecasts. The following is Ebay's CEO, John Donahoe,from the recent conference call:

We still have a lot of work to do in our core eBay business. Our priorities are on making eBay safer and easier to use and improving value and selection remain consistent for 2009. We are making the necessary changes, tough changes, and we are doing so with focus and conviction. At the same time we have a powerful portfolio, one that I frankly believe is not fully credited in the value of the Company. And during 2009 PayPal, Bill Me Later, advertising, classifieds, StubHubs and our other businesses will continue to contribute more revenue, more earnings and more opportunities as we grow, scale and diversify the ways in which we connect buyers and sellers and monetize traffic. We are the global e-commerce leader and we intend to maintain and extend that position. The macro economic environment will continue to be extremely challenging in 2009, and we plan conservatively. But tough times create opportunities for strong companies to get stronger and we intend to do just that in 2009.

I agree with the CEO. Hopefully we can start seeing a bigger ramp up in share repurchases. They repurchased $2.2 billion in stock in 2008 and currently have $656 million in repurchases authorized. At these prices, they should be retiring stock at a tremendous rate, as they are only paying 5.3X FCF and already have a rock solid balance sheet.

A major risk with EBAY is that they will over-pay for acquisitions like they did with Skype. However, I believe Donahoe is much more fiscally conservative than Meg Whitman and will spend the cash flow wisely. Ebays acquisitions seem to be growing very fast and should add growth to their slowing auction business.

EBAY VIC write up posted

2009-01-15T12:51:00.001-05:00

EBAY VIC write up by zeke375

We agree with this write up and believe EBAY is extremely attractive due to its valuation and wide moat.

Selling BAM position; Buying EBAY and MCF

2009-01-14T15:27:00.002-05:00

Selling BAM holder position and moving into EBAY and MCF

VIC write ups on these will be available in the next 45 days and I will link to them

DOW Chemical legal action against Kuwait; Will Pursue other JV's

2009-01-06T13:17:00.002-05:00

Dow Chemical taking legal action in failed Kuwaiti venture

This is positive because it shows how DOW has many other opportunities to JV with other companies for its commodity plastics business. The rumor is that DOW will try to renegotiate the acquisition price of ROH down to around $50, from $78. I do believe that the CEO Andrew Liveris will be sucessful in acquiring ROH and continue his transformations strategy of the company.

Warren Buffett has affirmed his commitment to the take over and would likely finance more of it if DOW is unable to complete a JV in a timely fashion. With the stock currently yielding over 11%, I think DOW is a steal.

Upstream MLP Yields Plummet; Stocks Soar

2009-01-05T16:14:00.002-05:00

The Upstream MLP Sector (BBEP, LGCY, LINE, EVEP) has soared in the past week. I wrote up this sector on December 20th, and since then the yields on these partnerships have fallen significantly.

Hedged Upstream Oil/Gas MLP: Safe, High Yield Plays

LINE's yield has fallen from 20.60% to 15.7%
BBEP's yield has fallen from 36% to 23.5%
LGCY's yield has fallen from 25% to 18.9%
EVEP's yield has fallen from 24% to 15.6%

These yields are all still in the upper teens and still very attractive compared to other investments given the hedged nature of these MLP's. With oil in contango, these firms should be able to lock in profitable prices for the years 2013 and out.

Selling Y position; Establishing position in WAT

2009-01-05T14:26:00.003-05:00

I am selling the TDBU position in Y (150 shares) to raise capital for the purchase of Waters (WAT). A write up on WAT will be posted this week.

Strong Market: TDBU picks are up nicely

2009-01-02T12:36:00.005-05:00

Some recent winners

KHD +43%
BBEP +36%
EVEP +30%
LINE +24%
LGCY +16%

Some recent losers

DOW -17%

UPDATE:

Another strong day for the TDBU portfolio as the MLP's continue their move upwards.
Here are the updated tables

Some recent winners
BBEP +60%
EVEP +56%
KHD +47%
LINE +27%
LGCY +27%
GLRE +20%
FFH +11%

Altria Group: Safe 8.5% Dividend Play

2008-12-30T09:44:00.003-05:00

Altria Group (MO), which split off its international cigarette operations into Phillip Morris (PM), is currently selling for a 8.5% dividend yield with a payout ratio of 73%. Their earnings should be safe as they control half of the US cigarette market, even though the market is in decline.

Morningstar currently pegs the fair value of Altria Group at $27, for a yield of 4.7%. This seems much more in line for a company of this stature and earnings protection. At $15, MO looks like a steal.

From Morningstar:
"After a small decline of 1.8% this year, we expect Altria's consolidated revenues to be relatively flat going forward."

Altria Group is currently making $900 million in Net Income a quarter, or $3.6 billion a year. This translates to $1.75 in EPS, versus a dividend of $1.28. So earnings would have to drop more than 25% for MO to risk cutting their dividend. MO also has a 28% stake in SABMiller that they could sell and net over $5 billion. This makes the dividend really safe.

MO is a very simple play. The revenues of the company should be flat going into the future and it is a cash cow. MO is plowing that money back to shareholders and I expect it to return to a much normal valuation in the high 20's.

Accordingly, the TDBU portfolio is buying

Dow Chemical Kuwati deal falls through

2008-12-29T16:34:00.003-05:00

Dow, Rohm shares fall on concern over deal

Dow Chemical may seek lower price for Rohm & Haas

This is very surprising news. This is definately a negative for Dow Chemical and it looks like they will have to renegotiate their ROH deal. However, with a current yield of 11%, Dow is even more attractive than it was. I will wait on Morningstar to update their numbers to comment further.

Linn Energy (LINE) positive write-up in Barrons

2008-12-29T16:10:00.002-05:00

This weekend, Barrons wrote a positive article on Linn Energy that highlights most of the reasons that we mentioned here last week. The TDBU portfolio has a 5.1% position in LINE and it is up 18% on the news.

From a Drab Driller, a Welcome Gusher

"Linn's current production levels are hedged 99% for next year, 107% for 2010, 101% for 2011 and 66% for 2012 -- far greater coverage than at most rivals."

Overall, this is basically a non-event and does not change the thesis on LINE. We intend to keep this position for many years.

Cancelling DMRC buy & selling CHK and some FFH

2008-12-20T14:09:00.006-05:00

Marketocracy is not letting me purchase shares of DMRC for the TDBU portfolio. I am very bullish on DMRC but will not buy it for the fund now as I am not able to.

I am also selling the CHK position (2800 shares) due to better opportunities in the oil and gas sector (BBEP, EVEP, LINE). This should result in a 12% short term gain (~$5000 gain). CHK is just too hard to figure out its value and I do not like that the CEO overleveraged his own finances. While I feel that CHK is undervalued, the upstream MLP's are much easier to value and are considerbly less risky (hedges out to 2012), but with similar upside.

I am also selling 130 shares of FFH to raise capital for new purchases. FFH last traded for around $315 a share.

UPDATE:

130 shares of FFH sold at $310
2800 shares of CHK sold at $15.85

Hedged Upstream Oil/Gas MLP: Safe, High Yield Plays

2008-12-20T11:55:00.015-05:00

After reading an article on the Safe and Cheap blog regarding speculation as to what Seth Klarman's inflation hedge is, I found some interesting opportunities in the MLP space. Seth Klarman currently owns BBEP, LINE, and APL.

Seth Klarmans Inflation Hedge Article

Klarman recently talked about these MLP's in his Baupost Group Quarterly letter:

"Two publicly traded oil and gas partnerships, both heavily owned by lehman brothers, fell sharply immediately after Lehman's bankruptcy filing, to levels where we purchased large blocks at mid-teens or higher annual yields based on current distributions that are largely locked-in for five years through hedges, and at prices roughly half of the value of these companies' proven energy reserves"

I have found four upstream oil and gas MLP's that are currently fully or partially hedged out to 2012 selling for very attractive yields. These include BBEP, EVEP, LINE, and LGCY. These MLP's own very high reserve life and low decline rate oil and natural gas properties in the continental US. They usually hedge their production out 3-4 years to lock in future cash flow to support the required distribution of 90% of net income.

LINE
Linn Energy (LINE) is the safest of the three picks because it has a 21 year reserve life, is 50/50 split between oil and natural gas, and is 100% hedged out to 2011 at natural gas prices of around $8 per mcf and oil prices between $70 and $100 per barrel. They are 66% hedged in 2012. LINE currently yields 20.60% and that dividend looks safe out to 2011. They have also authorized a $100 million share repurchase which I think is a great move at these low prices.

Lehman was a heavy stock holder in LINE, with a position size over 10%. They had to liquidate that position which has added selling pressure to LINE. Also, Lehman was one of LINE's counterparties and currently owes LINE $68 million.

Recent LINE Investor Presentation

LINE CEO Interview with Jim Cramer

The CEO, Michael Linn owns 3.8 million shares of LINE, and recently sold around 500,000 shares because of a large tax liability. I am sure his interests are aligned with the shareholders. Other insiders have purchased around $2.1 million worth of LINE at prices ranging from $12-$23, which is very bullish.

The PV (10%) of the current dividend ($2.52) for 4 years is $8 per share. The dividend should be safe because of the extensive hedging done at much higher prices. So you are paying $4.52 ($520 million) per share for the terminal value, which would be 17 years of reserves (1.7 TCF) at current production. This doesnt take into effect the stock repurchase or reinvesting the dividends at rates higher than 10% by buying more LINE.

EVEP

EV Energy Partners is another upstream MLP that has 18.7 years of reserve life with a production profile of 58%/42% natural gas/oil. EVEP currently yields 24% and should be able to maintain its dividend for the next four years due to its hedge book. Insiders have recently been buying millions of dollars worth of stock on top of thier already large holdings, as they see a huge bargain.

BBEP

Breitburn Energy Partners (BBEP) has the highest yield of the group at around 36%. This is because they are currently getting sued by KWK due to some previous transactions. I believe that this lawsuit is completely frivolous and that KWK is just angry they sold BBEP some
great Antrim shale assets in Michigan with very low break-even natural gas prices. To get a better sense of this lawsuit, you can read BBEP's response here.

BBEP's hedge book is very good with prices way above today's that should ensure the dividend for at least 3 years. After these three years you essentially get whats left over for free. This is almost like a free inflation hedge as you get the oil and natural gas assets for free. BBEP's management has been around for four oil cycles and they seem very intelligent (Stanford undergrad and Harvard Business School) with a great focus on value. They own a significant amount of stock and have been buying up to the lawsuit filing by KWK. I believe they will continue to buy more at these levels once they are legally allowed to.

LGCY

Legacy Reserves current trades for a yield of 25% and 40% of the stock is owned by insiders and management. Their hedges should protect the dividend until 2011 and insiders have recently been buying hundreds of thousands of dollars worth of stock.

I think the best strategy here is to limit company specific risk by buying all four of these stocks. Because LINE is the safest and still offers a 20%+ yield, I will buy the most of LINE.

To do your own research, watch the recent company presenations that can be found at their respective websites. They offer great information about each company's hedge book and their oil and gas properties. This is an opportunity too good to pass up.

Accordingly, the TDBU portfolio will buy $100,000 worth of these upstream MLP's from the proceeds of the CHK and FFH sale, and from cash on hand. The portfolio will put $40,000 into LINE and $20,000 each into BBEP, EVEP and LGCY.

UPDATE:
1600 shares EVEP bought at $12.35
2300 shares of LGCY bought at $8.61
3200 shares of LINE bought at $12.67
3700 shares of BBEP bought at $5.53

Raising Cash; sold some LUK and selling some GLRE

2008-12-18T08:41:00.002-05:00

1000 shares of LUK were sold at $18.94

3500 shares of GLRE are being sold also

I am raising cash to be able to move quickly into new ideas. I plan on having around $60,000 in cash.

CEG Rebuffes BRK, Goes with EDF

2008-12-17T14:22:00.001-05:00

Constellation Energy and EDF Group Enter Definitive Investment Agreement

With CEG currently trading at $25, this could represent a very interesting risk arbitrage play. I plan to look into the details more and see if CEG is now undervalued. By the way, BRK walks off with a great deal and no risk. What a win for Buffett.