Blogvesting

Share prices of companies that make industrial equipment tend to be very volatile. These companies are especially dependent on a healthy economy, and every time a new batch of economic statistics is released, the share prices of these companies gyrate wildly depending on the prevailing mood. However, to investors willing to take a longer-term perspective, the wild price swings in conservatively managed equipment manufacturers can be a source of great opportunities. One such company is Chart Industries (GTLS).

GTLS Stock Analysis:

Chart Industries is a company that makes equipment for the production, transport and storage of industrial gases. Its products include equipment such as cold boxes for liquefaction of gases and pressurized cryogenic cylinders for gas transport, and Chart Industries is the leading supplier in several of these product segments. The largest portion of their sales come from natural gas related businesses (62%), with the second largest segment being businesses that produce cryogenic gases (25%, mainly liquid nitrogen), and the smallest segment being businesses that produce medical respiratory gases (13%). About 65% of sales come from outside the US, but it is the US market that has the largest potential for growth, with the discovery of large natural gas deposits in the US and the tantalizing possibility of US energy independence.

Recently, enormous deposits of natural gas have been discovered in shale rock in Pennsylvania (the Report in New York Times). The natural gas deposits are large enough to theoretically power all cars in the US if the entire fleet is converted to use electrical power, thus ending US dependence on foreign oil. In addition, natural gas is a greener fuel than oil or coal, producing less carbon dioxide per unit energy released. The major obstacle to widespread use of natural gas is that utilization of natural gas requires expensive investment in equipment to liquefy, store and transport the gas. However, given that the alternative is funding expensive wars in foreign countries, there has been increasing talk of embarking on a large scale natural gas initiative in the US (a related report in New York Times), which, while expensive, would provide employment and energy security for the US.

Chart Industries has been consistently profitable through the financial crisis. Analysts predict that revenues will continue their decline in 2010 and 2011, though the company is still expected to be profitable. The company currently trades for $470 million, about 1x book value. I am predicting a free cash flow of $50-70 million conservatively, meaning that the company is now trading at below 10x earnings. The company has $190 million in cash, and $240 million in long term debt ($160 million due in 2015, $80 million due in 2012). I believe that the company has tangible assets (factories) and intangible reputation that is difficult to replicate, and that it will easily survive the downturn to capitalize on the growth industries of the future.

Stock Investment Risks : The company is in a cyclical industry, and is tied to commodity price swings. Share price also tends to be highly volatile due to low float.

Stock Investment Disclosure : I have a long position in GTLS.

Harvest Natural Resources (HNR) is an oil producer whose major oil producing assets are located in Venezuela, where it is subject to confiscatory taxes or outright nationalization by Hugo Chavez. Its major attraction is it cash-rich and debt-free status. HNR has approximately $2.85 per share in cash free and clear. The rest of HNR’s value derives from possible cash flow from its Venezuelian assets, as well as oil exploration projects now ongoing in other parts of the world.

HNR has been extensively written up previously (see this excellent article at Seeking Alpha, as well as writeups at Value Investing Club), and I agree with the central theses of these articles. In a nutshell, although contract law does not exist in Venezuela and cash flow is likely to fluctuate according to the whims of Chavez, it is unlikely to drop to zero. In other nationalizations that Chavez has ordered, the companies have been reasonably (but not lavishly) compensated for their losses, and have generally found it desirable to continue operations at low to moderate levels of profitability, if only to extract residual value from their now annexed assets. Chavez is a power-hungry thug, but he also understands that he needs foreign expertise to continue to extract money from Venezuela’s natural resources, and he is intelligent enough to realize that if he wants somebody to work for him, he has to pay them at some level.

My main purpose for investing in HNR is that it is a low-risk high reward way to hedge inflation risks and ride any upside in oil price. HNR should not fall past $3 due to its cash, but can possibly ride up to $10 or more depending on prevailing oil price and Chavez’s whims. I believe China will now vigorously diversify away from its huge US dollar exposure by aggressively bidding for commodities as well as commodity-producing assets. Rather than buying gold (a non-productive asset, and one in which China found impossible to accumulate holdings of any size without moving the gold price), China could stockpile crude oil (a productive asset, and one with a much deeper and broader market) and build a Strategic Petroleum Reserve much like the US has done. Stockpiling an essential input to its economy at historically cheap prices makes a lot of economic and military sense. Along the same lines, I also have positions in ZINC and MEOH, both of which are premier companies in their industries and should serve as excellent inflation hedges.

I now hold HNR at an average buy-in price of $5, and am unlikely to liquidate this position without hitting at least $8-10.

Biogen Idec (BIIB) is a biotechnology company with two major products, Avonex (an interferon), which treats multiple sclerosis, and Rituxan (a monoclonal antibody), which treats non-Hodgkin’s lymphoma. Near-term growth is likely to come from the drug Tysabri, another monoclonal antibody meant for treatment of multiple sclerosis. Tysabri was withdrawn from the market after several clinical trial patients developed progressive multifocal leukoencephalopathy (PML), but was later reintroduced into the market when FDA determined that the benefits outweighed the risks. Despite a few additional reports of PML, sales of Tysabri have grown rapidly, and the company has a robust pipeline of potential drugs. During the wave of pharmaceutical-biotech mergers that took place in 2008, BIIB’s stock was driven into the $80s as its acquisition by a major pharmaceutical company was widely anticipated. BIIB plummeted when it’s CEO revealed that there were no buyers willing to bid for Biogen. A major factor for the lack of bids is believed to be the complicated contracts covering its two main products. Both products were co-owned or co-marketed with other major pharmaceutical companies, which means that much of the value will be derived from the pipeline of drugs, which is highly uncertain. However, I believe that the decline has overshot, and based on the cash flow potential of Biogen’s 3 major drugs, even assuming a zero value for the pipeline, the stock is siginificantly underpriced. With analysts estimating an EPS of $3.70-$4.30 for the current year, and minimal 10% growth in profits year over year, BIIB is trading at a conservative PE of 11-12 at a share price $45-46. Furthermore, BIIB is in the drug industry, which tends to perform adequately even in recession. The biotechnology industry in particular is a coveted segment of the drug industry, as FDA has not provided a process for the testing and manufacture of biotechnology drugs, which are significantly more complicated to manufacture than simple chemical drugs. This makes it very likely that even off-patent biotechnology drugs will remain very lucrative, which is a major reason for the recent acquisition of biotech companies by traditional pharmaceuticals.

Fresh Del Monte Produce Inc (FDP) is a vertically integrated producer of fresh and canned fruits and vegetables. While most fruits and vegetables require minimal processing and are typically shipped directly from local farmers to supermarkets over several hundred miles, some produce (notably bananas) are shipped over thousands of miles and/or require canning and extensive processing, and therefore require an intermediary which can handle these diverse operations. FDP owns and operates ocean freighters, land trucks, distribution depots, canning/juicing factories, and of course, farms. The chief attraction of FDP is that it is in the recession-proof food business. Analysts are predicing EPS of $2.00 to $2.40 for 2009. I estimate that FDP will sustain a free cash flow of at least $1.50 per share in 2009. With a modest $150 million in LTD (1.5x annual free cash flow), FDP is trading $15-16, which is around PE 10 off my conservative estimate of FCF, and has insider trading at the $14.50 level. I have a largish position in FDP at a small loss, and intend to add more if the price drops further.

Regal Entertainment group owns the largest theatre network in USA, mainly under the Regal Cinemas and United Artists brand. I initiated this position due to the reputation of movies being a robust industry in a depression, and also because I had a price target of $15, which is a PE of 20 over its previous year’s EPS of $0.73. During the two months when I held it, the stock has underperformed the general stock market, and does not appear to be moving towards the price target. I liquidated my position for a small profit of 6% over 2 months. Perhaps the threat of Internet distribution of movies is threatening the core business of RGC, or perhaps a PE of 20 is simply too rich in this climate. I chalk this one up as a miss.

Ball Corporation is a major manufacturer of metal and plastic packaging for food manufacturers, with a minor business in aerospace and defense. Almost 80% of revenues are derived from making aluminum cans for beverages, with the remaining 20% from plastic packaging and the aerospace business. A significant amount of revenue is derived from sale of beer cans, with Ball having 30% of the US market. This is largely a mature industry, although there are small pockets of innovation and higher-than-normal profit niches, such as the introduction of vented wide-mouth cans for pouring, and cold-activated cans. Profitability is dependent on the price of aluminum and demand from major customers such as Coors and Miller.

Free cash flow in 2008 came in at around $300 million, or $3.20 per share. Analyst estimates for 2009 range from $3.70 to $4.00. Assuming an EPS of $3.50, BLL should trade at $35 at a PE of 10, $44 at a PE of 12.5, and $53 at a PE of 15. There appears to be major support at $37.50, and some resistance at $44. Given the recent improvement in economic conditions, it is likely that demand for its product will show a slight improvement. For an established company in a defensive industry, despite a moderate exposure to commodity price swings, I feel that a PE of 12.5-15 is reasonable. I have initiated a position at a price of $41.50.

To the 5 people who are still reading this blog, I apologize for not writing any posts for the past 2-3 months. I was experimenting with several new strategies incorporating a technical analysis component in my stock analysis. I felt that, as an amateur investor, I could not compete with professional stock analysts, all of whom can read the same annual reports that I can read, and have the time and resources to do back channel checks that I cannot do. My only advantage is my small size, which means I can enter and exit positions without moving the price.

Early in this experimental stage, I tried several charting techniques, but eventually found that because they were too “black magic” and did not satisfy my rational side, I did not have the confidence to take large positions with them. Eventually, I found two technical factors that were backed up by academic studies and grounded in human psychology. Firstly, the stock market overeacts to events, and corrections and pullbacks occur with a greater than normal probability. However, I found that this mean reversion effect takes place over time frames of only 1-2 days, and is really suited for automated trading rather than human trading. Secondly, runs in the stock market occur with greater length and frequency than a random walk, a phenomenon called the momentum which has been attributed to many causes, including the the herding tendency of investors and to institutional investors moving prices when they enter or exit a stock. The momentum effect is most pronounced on small cap stocks, suggesting that the role of institutional investors is dominant. I figured that if I could try and spot stocks which are starting a trend, and then use manual fundamental analysis to figure out a plausible investment thesis and thus predict where the price is headed, I could hop onto stocks just when they are making a move, and then switch to other stocks once the move is finished, maximizing my returns.

For the past 3 months, I have used a strategy where I screen stocks with the ADX technical indicator to identify stocks which are in a new uptrend or downtrend, and then manually go through them to pick out the stocks where a plausible investment thesis exists. Often, I find that due to my fundamental analysis, I am able to predict quite accurately what price level the stock is moving to (stock prices often move to round PE values). This strategy, executed in the context of a rising market, has resulted in my outperforming the stock market by a significant margin. I found that if I cut my losses within 1 month if the stock doesn’t move as I predicted and let my winners run to my anticipated targets, my profits vastly exceed my losses despite the fact that I have only a 60-70% chance of picking winners.

Because I am not a long term stock holder with this strategy, and to keep my workload reasonable, my analysis of each stock will necessarily be much shorter and shallower than my previous analyses. In the future, I will be presenting my analyses as short blurbs about specific stocks instead of the more in-depth articles that I have been writing. I also intend to devote susbtantial time to the study of human psychology and how it interacts with the stock market to present opportunities that can be taken advantage of.

The latest banking rescue has been widely panned by the punditry, with even Krugman voicing his dismay, yet was warmly received by the markets. The pundits are correct : this plan will not rescue the bad banks. Instead, the new plan will grease the flow of credit into the real economy, and lift all banks, both good and bad, along with the entire economy. In fact, I think that the new plan is a piece of genius. It finally rewards the good guys instead of the bad ones.

From the viewpoint of rescuing banks, the plan looks like a failure. It will accelerate price discovery of loans, which may cause the balance sheets of weak banks to actually deteriorate rather than improve. Banks will not tender their loans for sale if they know that the loans will fetch prices lower than their marked down value. The bad loans will stay on the books of the bad banks. What will come off the books of the banks are the good loans, those that are likely to perform well, but have been lumped together with the bad apples and now are stuck on the balance sheets of the good banks. By getting those loans off their balance sheets, the good banks will be able to do what they do well, assess credit risks and make more loans to good risks. The net effect will be an extension of credit to the economy, but in an intelligent manner, by making use of the expertise of the good bankers.

Under this plan, two groups will make out like bandits. The first group are the good banks which will be able to securitize and unload their good loans onto the markets, enabling them to make more loans. The second group are the investors in those securitized loans, who will be getting a huge government-sponsored loan on intrinsically profitable loans, leveraging their profit many times. To me, this is a refreshing change. Rather then rewarding the bad bankers who could not differentiate good credit risks from bad ones, and rewarding investors who relied on leverage to obtain eye-popping gains, the government is finally rewarding the good bankers who knew good from bad risks, and the conservative investors who did not rely on leverage and kept their powder dry.

Part of the reason why the plan has been so roundly criticized by bloggers is that the favored solution has been outright nationalization. The previous solution of extending government guarantees to loans on the books of the banks has a negative effect on the economy. It does not make the banks in question healthy enough to lend again. Instead, it is effectively a tax on the good banks to throw at the bad banks, since the bad banks are in business only because of the government guarantees. Nationalization is a possible way out of the impasse. Certainly, a nationalized bank can be made lend again, relying on the balance sheet of the government. However, this is also a tax on the good banks, because depositors and investors will prefer dealing with the government over private parties. The new Geithner plan suggests a third way out that avoids nationalization and is economically beneficial. Pump so much money into the good banks that they can now take over the bad banks. Although a bank such as Citigroup (and perhaps Bank of America) looks too large to be sold to any group, if the current plan manages to pump enough money into the good banks, there is hope that a conglomerate of the good banks can absorb a sufficient portion of Citigroup’s assets to finally solve the problem. It may seem unlikely now, but then again, mega-banks such as Wachovia, Merrill Lynch and Wachovia once looked too big to be taken over too.

The final criticism of the current Geithner plan is that it is too punitive on the taxpayer, who stand to lose too much. However, the bad loans have already been made and the losses have already been incurred. When the decision was made that bad banks cannot be allowed to collapse, it is just a matter of determining the combination of parties who should be made to shoulder the losses. Due to the magnitude of the losses, realistically speaking, the taxpayer has to shoulder the lion’s share. The only question is what mechanism to use to shift the losses onto the taxpayer. We can extend government guarantees to loans, nationalize banks, or pay private investors to absorb the losses. It seems to me that the last way is the only way which rewards the good guys, and are the least objectionable.

On 3/16 (Monday), I rebuilt a small position in GEOY at $18, in accordance with my previous estimate of GEOY’s intrinsic value at $18-$30. I sold the entire position the very next day at $19, thinking that manipulation by options traders will sink the stock price as we approached options expiration Friday. The very next day, management revealed that the delay in filing its 10k is due to immaterial accounting errors. Apparently, the market was worried that the delay was because something had gone wrong with the GeoEye-1 satellite, and relieved investors quickly pushed the stock price up to $21. I finally ate humble pie and rebuilt a position at a higher price of $20 on ops ex Friday (yesterday).

Looking forward, the company should file its 2008 10k very soon. By itself, that is a non-event, since the 2008 results are universally expected to be bad, what with the delays in the launch of GeoEye-1 last year and the accompanying loss of revenue. However, there is a chance that management will finally provide some guidance on future earnings, or perhaps even reveal additional contracts that have materialized now that GeoyEye-1 is certified and fully operational. While management had a long-standing policy of not giving guidance, there is a chance that this may change as the CEO has spent $100k of his own money on GEOY shares last December. Still, I wouldn’t bet the farm on it. Management usually has little incentive to pump up the share price unless it wants to raise cash in the equity market. Management which expects to stay on for the long-term (i.e. the kind of management you want) tend to want a low stock price so that they can issue themselves cheap options at the current low market price, and to provide a low bar for future improvements.

There is also some speculation that an acquisition of GEOY is forthcoming given its low valuation. I view that as improbable. Google, which purchases imagery from GEOY for its Google Earth product, is an unlikely acquisition partner since GEOY handles classified work for the government, and Google is likely to face an extreme amount of red tape and security checks if they were to control such a company. The other class of potential acquirers, namely the defense contractors which routinely handle classified work and already have security clearances, unfortunately have major problems of their own. The Obama presidency is likely to cut defense expenditures in order to boost domestic spending, and the share prices of said defense contractors have been dropping like a rock in recent days.

In summary, I think the GEOY is likely to trade in the range of $18-30, and a $20 entry price with a 10% downside and 50% upside presents a good risk-reward trade-off. Of course, one should always be aware of the extremely low probability of catastrophic loss of the satellite, and limit one’s investment accordingly. In the near future, I might even try selling covered calls on GEOY if the option premium is rich enough. Since I have previously advised against buying said calls, this falls squarely in the “if you can’t beat them, join them” category of behavior.

For my other posts of GEOY, please see GEOY : Liquidation and update, GEOY : Manipulation by options traders, and GEOY : Living off the government.

In recent months, I have adopted a strategy of channel trading. I pick an undervalued stock according to fundamental considerations to ensure capital preservation (strong balance sheet, valuable business franchise etc.), identify short term support and resistance levels, and then buy when the price is closer to the support level than to the resistance level. Typically, I am looking for a 3:1 gain:loss ratio based on the support/resistance levels. I sell if the price breaches either the support or resistance levels. Unlike typical technical trading, I only channel-trade the stock if it is substantially undervalued according to my estimate of its intrinsic value. I rely on the intrinsic value estimate as insurance against a permanent capital loss. Due to the increased volatility of stocks these days, I frequently find myself hitting the support/resistance levels in a matter of days, therefore this strategy is a form of short-term value investing, as advocated in the book Active Value Investing by Vitaliy Katsenelson. I have adopted this strategy because I believe that buy and hold is suitable only in a period of general economic recovery and broadly rising stock prices, and that we are perhaps 1-2 years away from such a recovery. I believe that in the meantime, the market will trend horizontally, and profits can be made in channel trading and options strategies. The channel trading strategy also protects against a general decrease in valuation multiples (my own valuation multiple has shrunk to 10 for more speculative companies, and 15 for exceptionally strong businesses). I have also abandoned my previous strategy of diversification (which did not prevent the broad-based losses from Nov 2008 through Jan 2009), and am going back to my roots of holding a concentrated portfolio, except that I now watch my positions like a hawk and am willing to liquidate at a loss if they breaks support levels. Stock research is simply too laborious for me to cover many stocks.

In the 2 months that I’ve tried this strategy, it has been modestly profitable, with gains outnumbering losses by approximately 5 to 1. And for the first time in a long while, I am finally beginning to outperform the index modestly. I have learnt several lessons.

1. There is no shortcut for fundamental research. One of my first speculative plays was Citigroup; I was unable to estimate an intrinsic value, yet decided to hold a small position. C promptly gapped through my protective stop. Thus, stops may fail, and there is really no substitute for gaining in-depth knowledge about your stocks.
2. Be equally willing to take gains and losses. Initially, I was risk averse and was quick to sell when stocks breached my support levels, but slow to take gains when they rose above resistance levels. Eventually, I found that I was taking losses repeatedly yet taking very few gains. I promptly readjusted my strategy, and everything has been okay since.
3. Monitor your strategy constantly. The greatest advantage of short-term trading over long-term buy-and-hold is that feedback is continuous. Therefore, you quickly gain an instinctive feel for what works and what does not. I also feel strongly that a trading strategy should be supported by an overall thesis (macroeconomic or otherwise). For example, I engage in channel trading because I do not think stocks are likely to make large moves upwards or downwards due to the uncertain economic climate. Once economic recovery begins in earnest, I expect the channel-trading strategy to begin to underperform a buy-and-hold strategy, and will adjust my strategy accordingly.
4. Adjust support and resistance levels proactively. The advantage of a channel-trading strategy is that one can adjust the support and resistance levels constantly, even proactively to anticipate as yet unestablished levels. I realized this when I discovered that several of my best stock ideas (GEOY, MOS, AMTD) were making higher lows and higher highs over a few months, and when I stuck to the previously established lows and highs, I was consistently missing much of the move. I decided to estimate and anticipate the constant rise in both support and resistance levels, and have done better since. Interestingly, I found that as long as the volatility is large enough, channel trading outperforms buy-and-hold after trading expenses even if the underlying stock is on a long-term uptrend. Of course, I will immediately cease to channel-trade a stock if it is approaching my estimate of its intrinsic value.

In summary, it has been educational, and its good to be making money again after the devastation that was 2008.