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.

Update on Longs – Activision, RealD, IMAX, C&J Energy Services, Halliburton

The market seems to be valuing many of the consumer discretionary stocks lower as participants suddenly remember the Europe situation, and begin to recognize the excesses of the first quarter bull market.

I will keep buying up shares of Activision (ATVI) as it drops below $12. It has been hovering near $12 since Monday. The market is incorrectly valuing how much money will come from Diablo 3 and the second Black Ops later this year. I had not anticipated how successful Skylanders would be. All this extra upside now adds encouragement to my original long case, thus, I am adding to the position.

Real D (RLD) is trading too low again. As its theaters approach maximum capacity in the U.S., its capital expenditures will begin decreasing and free cash flow will begin to increase. Its rate of capital expenditure has already begun to slow. Reflexivity is becoming less of a concern here because the share issuance is very little at these prices. They have been slowly wittling away cash balances, but these should begin to rise towards the end of 2012, when more big blockbusters come out.
My free cash is very limited right now, so I would wait until this becomes a better bargain. If RealD hits $10 a share, I would buy.

Imax will probably trade higher later in the year and later into 2012. Management is continually reassessing their maximum target number of screens – it currently sits at 1550, which is much higher than most analyst estimates – so these reassessments will keep raising the hopes for the future.
The bias is still negative, as analysts use last year’s income – depressed from the bad (horrible) movie slate – to value the company. The assumption is that IMAX is overvalued. However, with record numbers from Avengers, and an unexpected success with Hunger Games, the company is just beginning its run for this year. Later in the year, the Dark Knight will do extremely well, and hopefully Gelfond will recognize this in time to give it a longer run time (3 weeks or more). He is getting better about extending the run-period for the blockbusters and downplaying the movies bound to be less successful. Prometheus remains a big question mark, so my view is skeptical. Men In Black will likely do better. The Hobbit will do extremely well.
In a typical year for Imax, more than 60% of the revenues come from the top 5 movies. However, in this year, I expect the majority of revenue to come from the year’s 3 super-block busters – The Avengers, The Dark Knight, and The Hobbit.
Next year, there is another strong movie slate, with Star Trek and Man of Steel to start it off.
So I am still long. I had sold off half of my postion at $24.50 a share. The current price is below, but not enough to get me salivating again. As I said earlier, my free cash to invest is pretty low right now. I may reconsider as IMAX drops below $21.

Still, my largest position is in CJES. The drop in oil was expected, and the drop in the commodity is depressing CJES even after its announcement of earnings. I partially regret not buying as shares dipped into $16 territory again recently, but my long position is so large that I am beginning to question my own approach to risk management.

HAL remains a relatively minor position in the portfolio. The Macondo issue may prove to be bigger than I had initially realized – BP is aggressively pursuing Halliburton to push of blame for the spill. I don’t think they will have good grounds to force HAL to take on cleanup costs, but they may have grounds to pursue a suit related to a bad cement job. I do think, however, it is probable that the amount of the claims will be insubstantial compared to gigantic income of the company in the wake of the shale boom. I still believe that Halliburton remains the best positioned to take advantage of international shales. Others may disagree and point to Schlumberger as the leader internationally, and they may well be correct. However, my thesis rests on the valuation difference between Schlumberger and Halliburton remains so vast that it makes up for the cost of BP’s claims and the first-mover advantage that Schlumberger has.

 

Disclosure: long ATVI, RLD, IMAX, CJES, HAL

Overview, part 1

My funds are up significantly to-date, but so is the market.

The market feels overheated, so I am cautious, and looking to reduce my exposure where I can. Any securities that I had been holding as value investments may be approaching correct valuation, so I am going to have to re-evaluate.

Core Labs (CLB) is a position that has been great for my portfolio. Up until now, there has been a two-fold case for the investment – the undervaluing of its shares, and its position as THE dominant player in reservoir analysis and management. In addition, its perforating products had been selling like hotcakes to many of the shale E&P companies. However, there is evidence that growth in the latter is slowing, and recent reports of drilling rigs being pulled from dry gas areas may negatively impact these products performance. Core’s management has even stated that they did not expect the past levels of growth in these products to be sustainable.

Core is also approaching a good valuation for the shares. I would place a good target price at $140/share. However, the whole oilfield sector is due for major appreciation, as geopolitical risks show no signs of cooling down, and oil prices continue to rise, and a rising tide tends to lift all ships. Core will likely appreciate along with the likes of Halliburton and C&J.

Can I still justify my investment in CLB, with HAL and CJES sitting at such ridiculously low valuations? Especially with C&J, the latest quarterly report has just confirmed the trend of earnings growth, and indicates a speeding up of growth, as three new fleets will be deployed in 2012. This is a 50% growth in its fracking business, which itself brings in over 80% of its revenues. C&J is also set to grow its coiled tubing business this year.

Further, C&J is a 100% liquids play now. They have moved their last fleet out of dry gas regions, and enter 2012 with all of their fleets in liquids rich regions. The only problem that seems to be occurring with the trend is a delay further upstream – there have been well delays because of constriction of supply in drilling rigs. When demand is outstripping supply, is that not a good thing?

With over 25% of my portfolio in this single stock, I am reluctant to commit to it further. Especially because its shares have appreciated so much since my initial buy-in – I feel I missed out, and now must wait.

This is probably foolish, but I should not ignore the effect of this emotion – does it have merit? If not, I can safely disregard it, hold my nose, and continue to load up.

But it is true – CJES does not represent the same value proposition that it once did. Buying it at $22 a share is much different than buying it at $17.

But how can I value this company properly? Because it is also a reflexive process – CJES is fueling its growth through share issuance – does my traditional value measurement even apply?

It has a 13.66% earnings yield, and a P/E of 7.32. From a return on my equity, it gives 64%, similar to its ROA of 42%, since it carries no debt. A price to free-cash-flow 4.83, almost all of which is used for the new fleets.

To value it from a PEG ratio, I expect anywhere from a 50%-100% earnings growth this year, which would translate to a PEG .14 to .07.

But can a GARP approach make sense here? There is a reflexive influence. It inflated the market cap by about 10% last year – this year we might expect something similar. If that were to occur, at today’s prices, CJES would still have a P/E of 8.05, still leaving significant margin for safety.

And the reflexive relationship may decrease over time – as CJES’s operating cash flow increases, it can increase the proportion of capital expenditures financed by operating cash flow and decrease the amount funded by share issuance.

Well, at least three questions remain –

1. At what price would I stop being a buyer?

2. At what price would I be a seller?

3. How much of my portfolio am I comfortable with allocating to this one stock?

1. I don’t have an exact answer, but I believe that a P/E of 10, it would cease to be such a screaming value. The stock does carry some risk – perhaps regulations, but more likely the ceasing of the trend, caused by decreasing oil prices (a resolution to the Iran crisis, Saudi Arabia flooding the market, or extensive oil finds outside of CJES’s core areas). The resolution of the Keystone pipeline could provide another risk to this stock, by flooding the United States with new, potentially cheaper, oil.
A P/E of 10 would give a top buying price of $30, which is still 36% higher than today’s price. Wow.

But that is my top purchase price. I get a feeling that buying at any price higher than $25 would not be prudent. If I want to allocate any more of my portfolio to this position, it should be at prices below this. If it so happens that I get a flood of capital after the stock has appreciated, I will have to evaluate the current market at that time – maybe there will be an abundance of great values by that point (i.e. maybe a crash will occur before then).

2. To gauge this, I would normally use the valuation of a current oil service major. But with much of the sector depressed, current valuations of BHI and HAL seem too low to correctly gauge. And SLB and CLB, with P/E’s of 22.6 and 32.9, respectively, are given high valuations because of competitive advantages that I don’t believe are present in CJES.
The growth rate will slow as the company’s installed base increases, at the same time that every other oil service major is increasing their installed base.

3. I would be comfortable below a max allocation of 50%. Anything more would be too much in one basket.

So that is an analysis of two of my holdings. Since CJES is below my stop-buying price, and provides significant upside from here, I am going to stick with it, and move over some funds from the hot CLB.

But what about the rest of my holdings? I want to make my allocation to CJES much closer to 50% than it is currently. I will have to do a follow up post on some other stocks that look less compelling that I am holding.