Author: Jay Unni

Value investor and occasional speculator.

Reflexivity fails to explain the latest moves in 3D Systems Corporation

On By Jay UnniIn Investing1 Comment

I am glad I exited the short at $30. 

3D Systems (DDD) has continued to make acquisitions. However, it is currently funding these acquisitions with cash on the balance sheet, rather than new equity issues. This eliminates a major component of the original long investment thesis. 

I would ordinarily take such a signal as a positive sign that the company has escaped the reflexive boom and bust unscathed, and thus is poised for the “plateau of productivity”, as outlined in my article. However, the stock still trades for a P/E of 96 (using GAAP earnings). Even if we use the company provided non-GAAP growth rate of 43%, the company trades for a PEG ratio above 2. 

This is still an overvalued company. And, as long as the company is not utilizing the high share price to fund growth, I can see no benefit to the overvaluation except an increase in risk of investment. 

It’s cash levels will not sustain acquisitions indefinitely, so it might be supposed that 3D Systems will eventually switch to leverage-funded acquisitions, but without any proof that this is occurring,  I believe it is too risky to take a long position in the company. 

Keystone Pipeline and Canadian Dollar Speculation

On By Jay UnniIn Investing1 Comment

If the Keystone pipeline is approved, the Canadian dollar (CAD) will go up because of the sales of petroleum to the United States. Thus, I am now watching the political issues surrounding the Keystone pipeline.

The CAD has fallen to a recent low on lower employment and growth numbers than expected. But this short term trend would be countered by the stronger and longer lasting effects of the pipeline.

The pipeline has virtually zero opposition in Canada, but it is running into some issues in the United States because the opposition questions the claims that it would substantially stimulate the economy. In addition, environmental groups are pushing back after the latest Arkansas oil spill, so the future for the pipeline is murky.

The former claim has some validity in the short term. There would be dueling forces of construction employment (building the pipeline) and lower oil prices (decreasing employment in the oil industry). But the longer term effects would be positive for the U.S. economy. By building the pipeline, we will, in effect, set a ceiling on gas prices. This, plus the shale oil boom, will have the same effect as a tax reduction – it will increase consumption, and thus stimulate the economy.

I do not know enough about environmental issues to substantiate the latter claim. But I do know that in political battles of environmental groups versus large industries, the industries generally win. I am biased to think that the pipeline will be passed, but I will wait to make any moves on the Canadian dollar until I am more certain of the outcome.

Bad Trading Discipline Pays Off (Sometimes)

On By Jay UnniIn InvestingLeave a comment

In my previous post, Short Term Speculation on the Yen, I outlined the reasoning behind my short Yen, long Dollar trade. I described the reasoning from the dollar perspective, but I had not described the yen perspective, as I believe the story has been better describe by people like Kyle Bass much better than I can describe it. Here is his latest video on CNBC.

The Bank of Japan has moved as I had expected. They have released an unprecedented stimulus measure of essentially doubling the monetary base. Put another way, they will print out the same amount of currency that is already in circulation.

However, I was wrong in my reasoning from the dollar perspective. I did not realize that current fundamental relationship of the dollar to the stock market is a positive correlation – global players have shifted into the U.S. markets as China and Europe have performed poorly. If the U.S. stock market fails to perform at the same pace, these global players may move elsewhere.

Because the stock market performed poorly earlier in the week, the dollar moved lower versus the Yen. There was additional pressure from the other side, as people who had shorted the Yen previously were covering because they were unsure what the BOJ would announce. This resulted in the USDJPY exchange rate hitting my stop limit of 93.70, and plowing all the way down to a low of 92.33.

However, I committed the cardinal sin in trading. I moved my stop. I set my limit down to the 91 mark set in late February. (Moving the stop limit is dangerous, because it changes the risk/reward profile of the trade. By moving down the stop, I was risking more, to gain the same potential profit).

Why? I was convinced the BOJ had been backed into a corner. There is no way out of Japan’s mess but printing money, and even this measure is not sure to work. Therefore I justified the move to myself. While it paid out in this case, it may not in the future, and moving the stop is, in general, not a good practice to adopt.

Short Term Speculation on the Yen

On By Jay UnniIn Investing2 Comments

I have established a small short term position long USD and short JPY (Japanese Yen). This is ahead of the Bank of Japan meeting April 3-4, on the expectation that they will announce a more ambitious plan to devalue the yen than the market expects.

I believe this will occur because, in the current risk-on environment, the US Dollar has been sinking. I do not believe this will last. Equities are continuing to make all time highs, however, if stocks continue much higher, they will be entering overvalued territory. I believe the markets are getting ahead of themselves.

However, the theory of reflexivity would predict that this strength in stock prices would subsequently strengthen the economic fundamentals. An advancing stock market draws foreign and domestic capital and allows companies to issue their own stock at advantageous prices to fund acquisitions and organic growth. In such an environment, the risk-on environment may continue.

The reason I am not paying attention to the reflexive implications of a rising stock market is that the positive bias that would normally accompany such a move is not there. More and more, so-called experts are questioning whether the current economic strength can continue in the absence of the Fed’s monetary stimulus, which will be coming to an end this year. If the conclusion of the Fed’s program pulled out the legs from the market, we might end up with a “sell-in-May-and-go-away” type scenario.

The government’s sequestration lends further support to the “sell-in-May” hypothesis. Economic think tanks are reducing their estimates of the impact of sequestration. I think these estimates are short-sighted. The full effects of sequestration will only be felt later in the year, and I believe they will take the market by surprise. As a consequence, I believe the stock market will suffer a pullback sometime in the coming months. I am watching the markets closely for signs of technical weakness, so that I can make an opportunistic short.

A decreasing market would lead to a “risk-off” environment, in which the US Dollar would go higher. This, coupled with the Bank of Japan’s plans to devalue the yen, should propel the USD-JPY exchange rate much higher. To help matters, there was a doji reversal in the one-day charts last week. I have set a stop limit at the bottom of this reversal, near the 93.70 mark.

Closing the 3D Systems Corporation (DDD) Short

On By Jay UnniIn InvestingLeave a comment

I closed out my 3D Systems Corporation (DDD) short position early last week. The trend has become unreliable.

As I pointed out on March 5, the downward trend was imperiled by Stratasys’s (SSYS) strong earnings. Further, rumors of an acquisition have been floating around.

Owners of manufacturing companies and conventional printer companies would like to get in on this trend, and may consider $3 billion a small price to pay for DDD’s patent portfolio, plus its future earnings. And, with a larger company’s capital at its back, DDD would no longer need to resort to equity-financed acquisitions, which put it at the risk of such reflexive boom-busts as we have just seen.

My March 2012 puts were saved in the nick of time on March 15, closing in the money before expiration. In retrospect, these were the wrong tool to use; I must remember to use puts further out into the future to avoid such a high time-value depreciation.

My May 2012 puts fared much better, and made a many-fold profit. In addition, my short equity position generated a substantial profit.

The negative trend may continue a little longer, but we are currently in a test period. There have been numerous articles recently highlighting the DDD’s fall in stock price as a bargain. This kind of positive perception is not what I would expect in a typical reflexive bust. I would expect the perception to turn increasingly more negative as the stock falls, until a true capitulation point.

I cannot predict what will happen with DDD until I see the next earnings report. If that shows a disappointing low earnings growth figure, then we will have proof that the negative perceptions have affected the fundamentals via the stock price, and it may be safe to re-engage in a short until the stock capitulates.

Given that the next earnings is not due for another couple of months, I cannot justify taking any action on DDD. If the stock reaches levels of ~$20/share, I would consider purchasing it as a long position, but until then, I am simply watching.

For more updates on my portfolio, check my blog BetterStockIdeas.com

Portfolio Review

On By Jay UnniIn Investing, Speculation, Uncategorized1 Comment

I am no longer as confident about my hypothesis that 3D systems (DDD) is in a bust phase. The better-than-expected revenue and earnings at competitor Stratasys (SSYS) has buoyed optimism in the space. I am worried that this will turn around the tide of negative perception that has driven DDD lower in recent weeks.

However, I am encouraged by the fact that 3D systems has not made any recent acquisitions. This would seem to fit with the thesis – that as the stock price declines, the ability of 3D systems to trade overpriced stock for companies with real earnings will decrease. Now 3D systems will have to be measured by its organic growth alone, which is not enough to sustain its lofty multiple – a P/E ratio above 70.

Stratasys seems to be at a different place in its own reflexive process. The results reported were better than expected partly due to a large acquisition. However, the boom has not been as strong as 3D systems’. Reflexivity plays a smaller role in Stratasys’s earnings – the company does not rely as heavily on stock sales to finance its acquisitions, thus the effect of perception on fundamentals is less direct. In addition, the organic growth rate (i.e. growth rate independent of acquisitions) seems to be larger than that of 3D systems.

For now, I am in wait-and-see mode. But I am edgy. I upped my short position on Friday, after reading 3D systems earnings report and seeing the fall on Monday at a much larger volume of transactions followed by a rise that was sustained by fewer transactions. Thus, I established that the rise was temporary, an effect of smaller-sized market participants, and the big money is still selling the stock.

In addition, I have been killed on my puts for March 14. This was a trading mistake. I never should have bought options that close to expiration, and I have paid for that lesson. The time value depreciation is much larger than the potential gain from a stock fall, unless the stock breaks $30/share before they expire. My May puts are hovering at profitability as well. In the future, I will probably steer clear of options as a tool – my type of reflexive reasoning has been better at predicting eventual results than the timing of those results. I purchased the options to take advantage of the short-sale restrictions that had been in place, and these options should have been replaced by short stock positions at a good opportunity.

As for my other positions, they are not fairing as well as I would have hoped. Though C&J Energy (CJES) finally broke its resistance at $23-$23.50, it is still testing this price, now as a support line. It remains to be seen whether the price will hold. WTI Crude has been in a steady decline for the past few weeks, so I believe that CJES holding above $23 is dependent on WTI holding above $90.

I have more confidence in Core Labs (CLB), because of its dependence on overseas operations. However, Core Labs does not offer an attractive value at this price. I would be willing to trade it for something more undervalued that is exposed to the same trends.

Bassett Furniture (BSET) has been a reliable play in my portfolio, as the housing boom seems to be continuing uninterrupted. It still has not reached a multiple of book value that I would be uncomfortable with, and the housing boom is far from over, so I am sticking with BSET for now.

The banking stocks (BNCC.pk and BBBI.ob) are relatively flat since purchase. They likely will not move much without a major announcement.

But BNCCorp’s annual statement provides an insight to a potential weakness in the company. Though it has been making a killing issuing mortgages in North Dakota, profiting off of the Bakken Shale explosion in the region, BNCCorp’s interest income has been steadily falling in an environment of low interest rates. If the mortgage banking revenue begins to fall off, the company will not be able to sustain its current level of earnings. At a 40% discount to book value, the stock is still worth owning at this point, but this is something to watch.

PGS (PGSVY) has declined significantly in recent weeks. It released fantastic earnings for 2012, however the guidance was below analyst expectations, and the stock dropped. It is sitting at an attractive price; with Price to Free-Cash-Flow ratio is sitting below 10, excluding expenditures on its MultiClient operations (P/FCF is a useful ratio to evaluate PGS because it has to depreciate those large Multiclient expenditures over time). I have confidence that PGS will be able to find buyers for its current MultiClient projects, since they are in high interest areas like offshore Africa. With Brent Crude prices above $110, offshore Africa will become more and more attractive to the big exploration and production companies. I would be willing to accrue more shares if I can get a price in the low $16 range.

As for Food Technology Services, Inc. (VIFL), I am waiting for the next earnings release and conference call to review the investment.

Investing in Undervalued Banks: BNCCorp and Bank of Birmingham

On By Jay UnniIn Investing3 Comments

I have spent so much time speculating that I have been neglecting the more long-term investment side of my portfolio. Here are two purchases that I made today to rectify that situation.

BNCCorp (BNCC.pk)

Since I wrote about BNCC.pk, a lot has changed with the company: the stock price has nearly quintupled, the assets and equity have both skyrocketed, and the company has been increasing earnings at unfathomable rates (year-over-year earnings growth was 505%). (Read the article for the whole story on this investment idea.)

BNCCorp still remains undervalued. The Price/Book ratio sits at just under .58. For such a fast growing area as North Dakota, I would expect most banks to be trading above their book values, not significantly below it. Therefore, it is probably a safe investment until it reaches .80 or so. At that point, it will begin to look significantly less attractive.

I am regretting selling out 80% of my position when the stock went up by 150%. I thought the move was largely over, and was eager to invest in other areas, but I neglected to check the real value of the company’s earnings potential and equity in relation to the market capitalization.

I am glad however, that I decided to let 20% of the position run. I have since purchased more shares, though it is always painful to buy back a stock you sold at a lower value.

The bank has increased its equity-to-assets ratio to 8.9%. Thus it is no longer a “cigar butt”, but instead is a well-capitalized bank in the fastest growing area of the nation. (For reference, Peter Lynch recommends an Equity-to-Assets ratio of more than 7.5% to qualify as a well-capitalized bank.)

North Dakota has exploded in population, and as these people settle into more permanent arrangements, the need for home loans and commercial loans will continue to be enormous. The Bakken Shale will remain attractive as an oil play at WTI prices above $80, and now that the European crisis fears are on the decline, oil prices have stabilized in the $90 range. They will likely remain high until the next financial crisis threatens global demand.

Though most of the explosion in the Bakken region is already played out, and though a large portion of the oil workers in the region have already found permanent housing situations, I expect the growth in the Price/Book multiple coupled with steady earnings (if not growing earnings) to secure the safety of this investment for the near future.

Bank of Birmingham (BBBI)

In addition, I have begun a new investment in the Bank of Birmingham (BBBI). The company has been sitting at a price/book ratio just under 1 for a few weeks, but a recent pre-announcement by the company suggests that the current Price/Book is closer to .58, suggesting the company is undervalued.

The Equity/Assets ratio is 11.1%, indicating that the bank is significantly under-leveraged.  This is a good thing: a less leveraged balance sheet makes a less risky investment. In addition, the extra equity means that the bank has significant room to expand its loan portfolio and increase earnings in the future.

With these low amounts of leverage, the bank was able to increase earnings 54% over the course of 2012 (excluding a deferred-tax asset recognition in 2011). This rapid earnings growth rate is a testament to the earnings power of this bank.

So why has this bank been growing so quickly? The answer is simple: the rebound of the car industry.

The Bank of Birmingham is located in Birmingham, Michigan, on the outskirts of Detroit, so it is dependent upon the comeback of the auto industry. As Birmingham is a wealthy suburb, it is less-exposed to pullbacks in the U.S. automotive market than urban Detroit. As long as the auto industry comeback is not derailed by a significant U.S. recession, we should expect more suburban migration and an expanding population in Birmingham, leading to more deposits, loans, and mortgages issued.

Disclosure: I am long BNCC.pk and BBBI.

The Short on 3D Systems Corporation (DDD) is Finally Paying Out

On By Jay UnniIn SpeculationLeave a comment

I was a little too eager to call an end to the twilight phase in my Seeking Alpha post two weeks ago. I did not anticipate the large run up in the stock, but probably should have. At the peak of a bubble, it is normal to see a test of the highs.

As the stock rose last week, I shorted shares, but did not add to the options positions. Risk control is easier when shorting a stock outright than in buying put options, because I can set a stop limit that is logically derived. For 3D Systems Corporation (DDD), the natural stop limit would be in the $72-73 range, because this is the all-time high for the stock. If it were to blow through this point, it will have passed a test, and the reflexive boom phase could continue for the foreseeable future.

However, it seems that this week has shifted the momentum back to the negative. I feel more secure in the short position now. In a reflexive bust, the further the stock declines from the high, the more likely it is to continue declining, until the stock reaches undervaluation territory. For DDD, I would not be interested in investing on the long side until the stock nears $30/share.

The only risk to the bust process at this phase is the upcoming earnings announcement on February 25. I suspect these earnings will show high growth rates, because the stock was so highly priced during the fourth quarter that 3D Systems Corporation could spend freely on capital expenditures and acquisitions for growth.

This alone would be a positive event for the stock price. However, the perception on the stock has already shifted. According to George Soros’s model of reflexive boom-bust processes (see model in my DDD article here), it is typical for the stock to continue declining for a significant period after the peak, even as earnings increase. That is, the peak in earnings typically follows the peak in stock price (this is due to the delay of acquisitions’ effects on earnings, coupled with the 1-2 month delay in reporting earnings). So good earnings will not necessarily de-rail the bust process.

But it pays, in the long run, to be cautious. Therefore I will likely reduce my short position before the end of next week to lower my exposure to an earnings-related upward move. But, in the mean time, I am letting my profits on the short position run, and am considering adding to it to cash in on a likely move downwards during the beginning of next week.

Disclosure: I am short DDD via stock sales and the purchase of March and May $45 put options. I am considering shorting additional shares of DDD in the next 72 (business) hours.

And the Bubble Goes “POP”!

On By Jay UnniIn SpeculationLeave a comment

So I was correct last week in assessing that we were in the twilight period for 3D systems corporation (DDD). I was wrong for not selling then.

I did not realize how quickly the bubble would deflate after it popped. And I have paid for that mistake.

Most of the profits on the trade have been lost in today’s crash. I believe stage 6 (of the stages I outlined here) is now over. I will have to reverse the position to a short as soon as possible, but short-sales have been restricted for the stock until Wednesday morning’s session. At that point, stage 7 will begin. So for the mean time, I will make a hasty exit.

Corning (GLW) Warning

On By Jay UnniIn InvestingLeave a comment

I did not realize the extent of the correlation of Corning’s earnings to the Japanese Yen. For every percentage point the yen decreases in dollar terms, Corning’s earnings for Q4 2012 (will decrease by $6mm, as the CFO stated in the last conference call. This article nicely sums up the situation.

The yen-dollar exchange rate decreased 10% through the fourth quarter, and it has become apparent to the Forex markets that Shinzo Abe will actively push for further devaluation. This means a $60mm maximum impact to Corning’s earnings.

This is a risk I am not willing to take. I want to see how the market reacts to the results, which will be announced on Tuesday. I am willing to sacrifice the profits that might be had if the stock pops on excellent results as a payment for more information on the stock. Selling a significant portion of the position on Monday.