Market Position May 15, 2013

I have had some big successes in the market lately. The short yen position has been yielding truly incredible profits lately. Almost simultaneously, the long position in Tesla (TSLA) has nearly doubled. Nearly every day after the earnings announcement has given us a new breakout to higher prices. This signals that there is a big money position being established in the stock, or that short covering is occurring now. If the huge money behind these moves are capable of mobilizing so quickly to positive news, this signals to me that they will be equally quick to mobilize in reaction to negative news.

I am not sure how long this continuation move will last. Eventually there will be a pullback – that is almost certain. But I still suspect we are only in the early phases of this boom for Tesla. I expect Tesla to generate more buzz and excitement as the year goes on.

In addition, I re-established the position in 3D Systems (DDD), according to the logic outlined in my article. Events are playing out as I had expected, with upgrades in the stock, and higher prices. This lends credence to the idea that we experienced a test phase from January to March, and we are now in a phase 4 type boom. Therefore, there should be additional room to go with the DDD long.

C & J Energy  (CJES) continues to be a dead weight in both the portfolio. The bad news about the state of the hydraulic fracturing market is out, and I believe it has been priced in. I think we have put in a bottom in this range (~$18). I dont expect the stock to dip below $17 unless the market turns worse.

I expect the market to improve as the year goes on and higher natural gas prices lead to renewed excitement in dry gas plays.

I am working up a position in some dry gas E&P companies as we speak. I do not want to reveal names and tickers, as they are tiny companies, and I have to be very cautious to establish a position at the prices I would like. I have been able to find several that are trading well below book value currently, and I have reason to expect that the book value itself is artificially low, because it is based on a past price environment, where natural gas prices were much lower than today. I will write an article soon explaining the logic.

I am using my unleveraged portfolio to purchase the dry gas companies. I am selling off a previous purchase of Halliburton (HAL). Halliburton has also come to a fair valuation in the current environment. After the settlement of the Deepwater Horizon litigation, the shares have been relieved of the pressure that was depressing them. I suspect HAL will benefit if the activity in the North American gas market picks up, but I believe the benefit will be more pronounced in CJES, so I prefer an investment in the latter.

I also sold my shares in Petroleum Geo Services (PGSVY). It is a shame to sell off such a well run company, with such growth potential. It is still undervalued, and I expect that investors at these prices would do reasonably well holding this for the long term. 3D and 4D seismic technology is only becoming more and more important, and PGS has already accumulated the Multiclient studies for the vast offshore Africa fields. However, I think there are better opportunities, like BBBI.

I am slowly accumulating more shares of Birmingham Bloomfield Bancshares (BBBI). It is currently trading at a price to book of .5, and it seems to be generating earnings at a comparable pace to BNCCorp (BNCC). The deep discount offers a considerable margin of safety, and the growth, fueled by the automotive industry boom, is bound to continue for the foreseeable future.

Advertisements

Portfolio Review

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.

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

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”!

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.

Rapid Repositioning

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.

Closing the Short

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

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.