Author: Jay Unni

Value investor and occasional speculator.

Rapid Repositioning

On By Jay UnniIn Investing, SpeculationLeave a comment

So I have not followed through on the moves suggested in my previous post; I have done things very differently.

The trading in Activision (ATVI) does not make any sense to me. In the wake of the Newtown shootings, Vice President Joe Biden has been spearheading an effort to reduce gun violence, and a discussion on gun violence in video games is in the agenda. Several media outlets specifically mentioned Call of Duty (Activision’s best selling game) when discussing the story.

This, to me, reads like negative news, which would affect perception negatively, and cause the stock to fall. However, last Friday, when the story was breaking, the stock popped instead.

I cannot find sufficient reason for why the perception would get so positive, save for perhaps the recognition of Call of Duty’s success by its infamy. I have not been enthused with the stock’s performance, and there is no blockbuster video game on the horizon. The two biggest drivers of revenue planned for this year are a Starcraft expansion and continued growth in Skylanders. A quick chart of Google trends confirms the idea that Skylanders was a huge seller this previous holiday season. The Starcraft expansion could be a hit or a miss. It is a huge question mark as to whether the Skylanders earnings boost is enough to counter the lack of other major titles during the holidays and the negative perceptions of gun violence. To avoid the uncertainty, and perhaps out of my own negative bias, I have sold the stock. It will remain to be seen whether this was the right decision or not.

There are many less risky plays. The oil price has resumed the upward climb as global demand revives from its dip. The place to be is, and has been, in international and deepwater projects. I still have no exposure to the emergence of African oil, and the ensuing consumer-products boom, which is unfortunate. I was expecting perception of African investments to grow positive throughout December and January, so I was originally planning on speculating in AFK (a broad Africa index), but the index has not performed well enough to suggest that perception is turning around. I will continue to monitor AFK, and look for more targeted ways of playing the African growth story.

C&J Energy (CJES) is now becoming dangerous. Though it remains VERY undervalued, the perception has gotten stronger against fracking. CJES has returned to the resistance point at $22-23, but I do not think it will break through. The anti-fracking movie “Promised Land” has come out, and though it has not been very successful, it should turn the perception even more negative, and depress the stock price. In addition, natural gas prices have not risen as fast or as far as I would have hoped to use up the spare fracturing fleet supply. The U.S. onshore activity (represented by the rig count) dropped throughout the 4th quarter, so I expect that competition was more fierce than the rest of 2012 for CJES’s fracturing services. So I have sold out a portion of the position.

I am unsure how much should be sold out, because 2013 will likely be a much better year for CJES. The natural gas price will probably continue to slowly rise, and oil and gas companies may begin to spend again on natural gas drilling. In addition, the price of oil is already much higher than it was during the 4th quarter, so demand for U.S. onshore oil will increase.

But the combination of a worsening perception for fracking and weak 4th quarter earnings will drive the stock down, so I must sell some of the position.

I have traded out the CJES shares for an investment in Core Labs (CLB). I respect the management of this company more than any other oil service company for their knowledge of and foresight in their industry. The company shifted to international and deepwater projects several quarters ago, so they are relatively immune to the poor 4th quarter earnings that I expect for most U.S. onshore oil service companies. While the profit margins at CJES have worsened, the profit margins at CLB have widened. CLB has a wide moat around its core analysis business, while CJES has a relatively small moat. CLB trades at $113, $2 less than what I sold it for a year ago, though the earnings have increased by 22.6%. It is one of the few companies I would buy at a P/E to growth ratio above 1 (it currently stands at 1.13), because of its excellent management, high profitability, and relative monopoly in the core analysis business.

I have invested in Corning (GLW), which is in the glass business. The TV industry has been experiencing a cyclical trough period as an after-effect of low employment. As employment picks up across the United States, the down-cycle in TV sales should end. In addition, I believe that new buyers of homes will also be likely to buy a new TV for their home. With the housing industry fully on the rebound, a pickup in the TV industry should be close behind.

LCD TV glass has been the most important driver of GLW’s earnings in the past, so the pickup in the industry should cause the fundamentals and perception to become more positive and lead to a stock price increase. As an added bonus, GLW has a near monopoly on smart phone and tablet glass, a segment which has been continually growing. The earnings for these devices is very small compared to TV glass (because of the size of the devices), but this segment should provide an additional earnings boost on top of the TV rebound.

GLW is currently trading at a cheap 9.23 Price/Earnings ratio. I think this is more than reasonable given the prospect of a TV industry rebound. I have invested a fairly large position (~10% of portfolio).

The speculation in 3D systems corporation (DDD) continues. I only wish I had more on the table. I am wary of adding to the position now, because there is really no telling when it will reverse. I will not be shy in shorting the stock when the reversal comes.

Disclosure: I am long CJES, CLB, GLW, DDD. I may sell shares of CJES in the next 72 hours.

Portfolio Overview

On By Jay UnniIn InvestingLeave a comment

The speculation on 3D Systems Incorporated (DDD) has been paying off in spades since I started it. I forgot to post my more recent article on the stock. It goes a little more in depth into the reasoning behind the conclusion that it is in a reflexive bubble.

But recently, I have noticed the trend in perception has worsened. The DDD articles on Seeking Alpha have gotten more  lukewarm recently (1, 2). Since we have already seen that Seeking Alpha articles have an effect on DDD (the Test phase in early October was sparked by these articles: 1, 2), it is not a stretch to imagine that recent articles may sway the general investor opinion in DDD.

I have not picked up any clear technical signals of a reversal, so this may be tricky. I may have to pay back some of the gains to know whether this is merely a pullback in the uptrend or whether the downtrend has started in earnest. Soros says that in a reflexive bubble there is usually a twilight phase, where people are still playing the game, but no one believes in the long thesis anymore. This may be where we are now…

I slashed my GMCR holdings in half at $41/share. I got a near-100% return so far. It still appears undervalued on a P/E-to-growth basis – the P/E is 17.6 and the growth rate is ~42% year-over-year, giving a .42 PEG. This would suggest another double could be possible if it can keep up a 30%+ growth rate. The public perception of Keurig brewers is still pretty good, and I have seen K-cup levels pretty low in the stores I have visited, though that is a very small sample size. I have seen worrying commercials for plastic generic K-cups that fit the Keurig machines recently, but it is too early to tell whether this will accumulate any substantial momentum with customers.

I also sold off my IMAX calls. I think this momentum will last for a while, but my calls were dated for the end of this month so I had to dump them. This may be a great year for 3D movies because of the many sci-fi genre films scheduled. I got a 73% gain on the position, so, not bad for a few months.

These last few trades have left me with a bit more cash to invest. I am looking at a few ideas:

I am considering a purchase in Intercontinental Exchange (ICE). I believe they got a great price on NYSE (a much-better price than their last minute bid last year), and NYSE throws off so much free cash that ICE will be in a great financial position for share buybacks or future purchases. I will admit I have a bias, I know the business model well, and I like the company. Sprecher seems to have a good eye for getting the right purchases at the right time. Once retail investors start to come back on the market, the core NYSE business will pick up, and once the European crisis is behind us, NYSE’s Liffe business will also pick up, so they got a great asset on the cheap.

I am also considering getting more heavy on my C&J Energy Services (CJES) and Halliburton (HAL) positions. I still believe these companies are best of breed in their sector, and it seems that the perception is starting to get more positive for oil among investors. However, a new movie starring Matt Damon about the environmental dangers of shale exploration has been showing in theaters. It remains to be seen whether this will have a significant impact on the public perception for the sector.

I was too eager in selling off the bulk of my BNCC position. The stock doubled again after I sold off the majority of my stake, and it is still only at 55% of the book value.

I am working on compiling some performance results for last year. It was a good year, but it will be worth it to check exactly how good.

Closing the Short

On By Jay UnniIn SpeculationLeave a comment

It is probably time to get long again. On Thursday the S&P 500 showed its indecision in continuing the trend with a doji candlestick pattern, and on Friday, the market posted a clear reversal sign – a green hammer. This is the precise opposite of the hammer that gave the signal to initiate the trade.

I delayed closing the short until Tuesday morning, because I wanted to be clear on the reasoning of the reversal – at least in public perception. I was wrong to wait, but I only lost a few percentage points. I will take my small gain.

The signs of a fundamental reversal have been appearing – the lowering unemployment, the rises in sales data, and the continuing rebound in housing. The perception about the fiscal cliff has radically improved, though it remains to be seen whether there really will be progress towards a compromise. Europe is still giving too many contradictory signs to know whether deleveraging is done in the area.

Plastic and Clouds: two boom-bust processes

On By Jay UnniIn Speculation1 Comment

Salesforce (CRM) and 3D Systems corporation (DDD) look like they are at two very different different stages of a boom cycle, and one of them actually has prospects for escaping the bust scenario altogether.  However, they both used the same means of achieving their success.
The purpose of the stock market is to raise equity for company growth. However, some companies become too dependent upon this feature as the only means to achieve growth. They enter cycles where they overspend to generate growth, fill in their cash flow gap with share issues, and achieve growth in earnings and share price, furthering the effect of future share issues, a process described in George Soros’s Alchemy of Finance.
Salesforce looks to be at the peak of such a cycle. It has used its ability to tout its stock as the forerunner in the technology surrounding the cloud, while failing to generate earnings. CRM runs at a negative free cash flow most quarters because of its high capital expenditures. It continually needs to purchase new servers to serve new customers, and it pays for these new servers by selling more of its overpriced stock.
Investors are still willing to pay high prices for the stock because it is generating revenue growth. However, eventually it will be realized that revenue growth cannot be rewarded in the absence of positive earnings. A turning point will be reached, and CRM will become a good short play. It pays to be cautious however, because positive reflexive processes tend to last longer than anyone realizes.
3D printing has been hailed as the next big thing. I personally think it stands a good chance of actually being a revolutionary technology, and its positive earnings make it a more attractive investment than CRM ever was. However, 3D systems corporation is showing classic symptoms of the boom-bust.
The cash flow is very negative (i.e. a negative number on the order of hundreds of millions, while earnings are on the order of tens of millions) because of the intensive growth investments the company is making, and it is paying for these investments by issuing shares. Perhaps this can be forgiven, because of its status as a recent IPO – after all that is what IPO’s are supposed to do: issue shares to produce earnings growth. Time will tell if the process continues into subsequent quarters.
3D systems corporation may be able to generate enough earnings growth to “grow into” its multiple. Currently its P/E is 63, but the earnings growth was over 80% year-over-year. A larger earnings growth figure than price to earnings multiple is a positive sign for a growth company.
Therefore, 3D systems warrants a look as a potential speculative investment. The stock market could pull back after the election, so I am only going to invest a small portion now, and dollar-cost average into the stock over the next few weeks.

Validating the Short

On By Jay UnniIn SpeculationLeave a comment

The market has lent some credence to my idea that U.S. stocks are overbought. The unimpressive Google (GOOG) earnings provided the pinprick the stock market needed to fall.

I would expect the fall that commenced on Friday to continue and intensify this week, with some minor pullbacks caused by positive earnings in some U.S. companies. I have therefore put on a 50% increase in my short position (SPY).

Disclosure: I am short SPY.

Further Analysis of QE3

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I hadn’t considered the effect of QE3 on oil, but inflation in the dollar will be a positive for oil, priced in dollars. American oil companies should benefit.

However, the entry of Russia into the WTO cannot be ignored. It is hard to tell which force will be greater.

Negative bets on U.S. Treasuries have hit an all-time high in the face of QE3. What Bernanke really wished was that Congress would release a stimulus. However, QE3 has, in effect, dampened the ability of Congress to do so. As investors sell treasuries, the interest rates will rise, increasing the load of U.S. debt and making stimulus action more and more expensive.

Admittedly, this effect would not be felt unless it were to continue past the current deleveraging. Deleveraging is causing the deflationary effects we are seeing, and until demand for debt increases, interest rates will not substantially rise.

In the shorter term, the low interest rates will continue to have a positive impact on stocks. This is bad news for my short of SPY. SPY has not approached my stop limit, so I am sitting tight on it, however. If headlines begin to turn more positive on the U.S. market, I may have to reconsider my position.

In my loose prediction of the future, I would guess that stocks will fall in the short term on renewed European concerns. Then we will get a post-election rally, as investors become more certain of the future and the housing rebound takes full swing on the back of QE3. Finally, in the spring, the massive decrease in government spending should cause the markets to fall substantially. I don’t expect Congress to actually decrease spending and let tax cuts expire simultaneously. However, I do expect Congress to put it off until the last minute, and U.S. stocks will not like this.

That is mere speculation, in the loosest sense of the word. Too much time and too many game-changing factors will occur between now and next spring to have a good idea of what will happen, on a macro-level, beyond the next month.

 

Disclosure: I am short SPY.

The near future for oil

On By Jay UnniIn InvestingLeave a comment

I have entered my short SPY trade as described previously. However, the global recession is causing a necessary pullback in oil prices that have gotten ahead of themselves, and I am suddenly realizing that I am far too exposed.

Oil prices have been running up, I believe, in a correlation with markets, for two main reasons: Asia, and Southeast Asia in particular, has not been as affected by the slowdown as investors are expecting – they have generated enough capital on their own to become more immune to international financing problems – and because Saudi Arabian oil production was decreased in June/July.

But now several factors are converging to hit oil prices at the same time.

Russia’s entry into the WTO, which has been well signaled for over a year, will continue to have further negative impact on oil prices, as the Russian oil will be available to more nations and more markets, increasing the worldwide supply.

In addition, Israel has publicly announced that it will not go to war with Iran. In fact, Israeli officials seem satisfied with the current level of international pressure on Iran. This removes the impetus for speculators to bet on further instability in the Middle East. Though there have been minor skirmishes related to an American video released, it is too early to tell if this will be a significant new outbreak of violence.

Without the speculative aspect, Brent Crude cannot sustain a level much higher than $100.

This is OPEC’s intended target, and they have wisely recognized that more oil is coming online and are not increasing production yet. This is one positive in the near term, however with more countries receiving Russian oil, and the possibility of Iranian oil being removed from the market being removed from the table, will provide enough negative force to push Brent to $100 or below.

The effect on WTI is less clear – the pipelines to the Gulf of Mexico have been okay-ed by President Obama, which will allow American oil to reach the world markets. However, the effects of this project will not be felt for the near future. I would expect WTI to trade roughly in correlation to Brent, though the supply/demand characteristics are completely different.

Supply in America is continuing to increase as a result of exploration and production companies concentrating on Shale oil, rather than gas. Though this will change as natural gas prices increase this winter, the glut in supply is likely to overwhelm demand in the near term, especially as unemployment remains disappointingly high.

What does this mean for my stocks?

As far as the companies themselves, I don’t expect C&J energy services or Halliburton to experience severe negative impact to earnings – exploration and production companies tend to plan on a much longer term than daily market movements. In addition, rising natural gas prices should juice earnings as exploration and production companies will likely increase their production this winter.

However, the stock prices themselves will likely be hit by the negative perceptions. Without another conference call for either company for at least a month, there will be no fundamental data to counter the negative perceptions.

The best move may be to purchase puts to hedge my investment, but I am reluctant to do so until I am sure that this will decrease my risk rather than increase it.

For the time being, I am going to sit tight, let my SPY short play out, and keep my ear to the ground for rumblings from international markets. As long as $100 forms a floor for Brent oil prices, my stocks should remain strong investments. If oil falls below $100, I will have to reevaluate my strategy.

 

Disclosure: I own CJES and HAL. I am short SPY.

Waiting for the short

On By Jay UnniIn Investing, SpeculationLeave a comment

I believe the market is beginning a pullback. Stock price action has not agreed with reality for the past few months – the fundamentals of the economy are simply not strong enough to warrant the 15% rise off of the June bottom. The looming fiscal cliff, the inability/unwillingness of banks to lend their capital, and the general global recession have taken their toll on U.S. businesses, yet stock prices are rising. 

This cannot go on. However, I am aware of the old adage, “The trend is your friend.” However Friday established a “hammer” formation on the candlestick charts, a signal of reversal, and today’s downward move signals that I may be right. I am probably going to enter the trade if tomorrow’s market action confirms we are in a downtrend. I will probably use a tight stop to limit losses if I am wrong, but I believe the market will fall at least to the 1300 area.

Portfolio Review

On By Jay UnniIn Investing, Speculation1 Comment

BNCC is now up 150% after the announcement that the private offering – which was way below the intrinsic value of the bank – has been withdrawn. I will attribute the first 50% to skill (based on high earnings for BNCC), and the last 100% to luck.

I advise selling at least half at this point – there will be a lot of profit taking going on now, but the stock still has huge growth potential.

I need more powder to load up in case of a crash, so I may need to sell more. Also, GMCR looks extremely attractive here, so I think I will buy more for a fall rally.

My remaining position in IMAX is killing me; it was a mistake to retain half of my position after the Avengers premier. I should have sold it all. I am going to sell out of my position and purchase long-dated calls for January 2013 and January 2014 – yes, I may give up a substantial amount in case of a crash, but the reward:risk is probably around 3:1 for Jan 2013 $20 calls. (I think the stock could go as high as $26 after The Hobbit – which was the level of resistance in early March, and the calls cost $2 a piece.) For 2014, I’m not quite as sure,  but the theater base will be large enough that margins will have come up by then, and there are two knockout blockbusters in late 2013 – the sequels to The Hobbit and Hunger Games.

RLD looks good for the rest of the year. Exactly as the CEO had indicated, the capital expenditures have come down as the theater base has reached saturation, so free cash flow is positive for the first time in several years. This will translate into either decreased debt load or higher cash balances.
At a price/book ratio of ~3, we can’t expect rising cash balances, and thus increasing equity, to have a major effect on stock prices.

However, if management chooses to retire debt, we could get a small boost to the net income to help year-over-year comparisons.

The pre-tax income of RLD last quarter was $7624 k and the cost of interest was $313 k, so we could get a boost to pre-tax income of 4.1%, translating to a post-tax increase of 6.5%. (The post-tax increase is way higher, due to the insane tax rate of 60% that RLD voluntarily pays, instead of taking its deferred tax assets).

Management used the free cash flow last quarter mostly for cash reserves, but devoted about 10% of the free cash flow to paying down debt and buying back shares. If management continues to do more of the last two options with future cash flow, we could get a real impetus higher for the stock. I am all for free cash flow valuation, but the P/E ratio is really what attracts new investors to a stock.

My small position in GLW was most definitely entered prematurely, however, once we see signs of TV sales increasing, it will already be too late to enter the position. I will hold, but if I do not see signs of TV sales increasing this fall, I will sell before the spring.

CJES and HAL continue to dominate a large portion of my portfolio. With oil prices near $100 and rising, I cannot see a GOOD reason for the low prices on oil service names.

The reason for the initially depressed prices for the whole sector is low natural gas prices. However, the negative feedback of these prices has caused less natural gas production, and thus, prices for natural gas are rising. This rise in natural gas prices has still not filtered down to the oil service names in a major way. However, this trend will continue into the fall. The major impetus for this sector could come in the form of an unusually cold winter. Even in the absence of that, I do see an increase of at least 20% for the whole sector by next spring, however the boon of cold weather would take the sector up an additional 20-30%.

Halliburton has another factor of course – the continuing coverage of BP’s Macondo disaster. However, as the court proceedings go on, it seems more and more likely that HAL will not bear any of the liability for the disaster, and the blame will fall squarely on the shoulders of BP, or, possibly, Transocean. Perhaps this is my own biased way of reviewing the events, but until there is more clarity, I am content to hold HAL.

I still consider CJES to be my lowest risk position. The main risk is that of EPA regulations imposing more costs on hydraulic fracturing, however the combined upsides from the inevitable oil-shale trend and its incredibly low P/E ratio make it too good to pass up. The only other concern I could think of is that the company is too good to be true – I will have to do more investigation on the operations of the business in East Texas to assuage that concern.

I sold off GOOG a while ago for more cash. Though the stock has appreciated since, and still remains at a low P/E/Growth, I feel the market overall is getting overheated, and big-cap names like this will be most discounted if there is a sell-off in the S&P 500.

I still have the VIFL I bought at 4.50 and doubled up on at 5.20, so it’s up considerably. I held it too long, I should have sold at $7, but I deceived myself by looking for a wedge pattern to the upside. Now, I must move on and accept the fact that it is tying up far too much of my capital. It is still slightly undervalued with a PEG of .84 and a cash-backed out PEG of .70, and it has an attractive free cash flow yield, however it is not as undervalued as I would like it to be for a hold. I fear I must unload some shares, at a slightly decreased price in the low $6s. An opportunity for a higher price was lost, but if I translate this sale into a better idea, like GMCR or CJES, I think I will end up glad I did.

GMCR is still terribly undervalued here, with PEG of .50. Again, if a cold winter blows through, we could get a big coffee boost, but this is not something to be counted on. Without any winter effect, GMCR is an idea that has been proven in one geography – the Northeast – and is now spreading across the continent, locking in rapid earnings growth as it spreads. Starbucks has been clear in its plan to partner with, rather than compete against, GMCR, and this is perhaps the most important coffee brand.

I am not concerned about the patent expiration, because the only competitors to release on the Keurig platform are low cost store brands. Since GMCR has a high upfront cost and typically high K-cup costs, the customers already on the system are those with disposable income who are willing to spend for high-quality, branded coffee. I would only be concerned if a more premium brand, like Peet’s or Starbucks, decided to offer their own K-cups.

The SEC investigation is ongoing, and is the biggest risk with this investment. However, the potential reward is at least 100% from the $23-24 level. The risk is hard to quantify, but probably less than 60%, so I feel comfortable deploying up to 20% of capital, though I currently hold closer to 7% of my capital in GMCR.

That is everything I hold right now. The take-aways are: Load up on cash for a potential market crash, and sell off on the least undervalued options to move into the few incredible values out there.

Disclosure: I own shares of BNCC, GMCR, IMAX, HAL, CJES, GLW, and VIFL. I may purchase more shares of GMCR in the next 72 hours.

Speculation Diary

On By Jay UnniIn SpeculationLeave a comment

No speculation yet, though I may get long the Singapore dollar if I see a good technical entry point. Cannot bet on the dollar/euro with this much uncertainty out there. AFK looks like a decent long on my general speculation that Africa will really emerge in an environment of high oil and commodity prices and a lack of other high growth emerging markets. Gold may be a good long here, but I am not well enough versed in the fundamentals of gold trading to speculate.

The S&P may be a good short in the next few days. I would have to wait for a break and an unsuccessful test of the 1400 level. The fundamentals in the United States are much worse than the market is suggesting here.