While I don’t own any shares of Berkshire Hathaway (although that could change), I still like to keep up with what moves Warren Buffett is making. This is especially true during the crazy first quarter of 2020. Buffett didn’t scoop up a bunch of good deals this quarter, in fact he did a lot of selling. In this post I summarize the changes in Buffett’s portfolio as described in Berkshire Hathaway’s 13F filing.
Bye Bye Airlines
The big news this quarter didn’t come from Berkshires 13F, but from the annual shareholders meeting: Buffett sold out all of his airline. Berkshire owned about 10% of each of the top 4 airlines. This includes Delta (DAL), Southwest (LUV), American (AAL), and United (UAL). During the shareholders meeting, Buffett mentioned he paid $7-8B on the investment, with the idea he would average about $1B of earnings a year.
Buffett was keen to mention that the airlines are managed well, and his decision to sell was no fault of the CEOs of the companies. The airline industry is very cyclical, which Warren understood, but he did not underwrite the economy being completely shut down. Going forward, these companies will probably take over $10B in debt, plus issue equity. Additionally, the airlines are going to have way more planes than demand for the foreseeable future. Despite the bailouts from the government, there is no indication the airlines are in the clear. Given these extraordinary circumstances, Buffett did not trim his position, but completely sold out.
A humorous point Buffett made during the shareholders meeting was that it took him months to build these large positions. However, when it came to selling, he found plenty of buyers. It is most likely folks from Robinhood.
Surprise Goldman Sachs Selling
The other major position reduction in Berkshire’s 13F is the reduction of the Goldman Sachs position by 84%. This investment was a remnant of the 2008 financial crisis, where Buffett bought preferred stock that was later converted into common shares. So far, there is no indication why Warren dramatically reduced his stake in GS. One theory is that they are venturing into online banking, so perhaps Buffett thinks they will be distracted and lose share of the investment banking business. Another potential reason is that Buffett sees Goldman as a risky operation during the COVID crisis. Or it could be as simple as this a legacy position, and Warren wants to shore up his already high cash reserves. Whatever the case, hopefully Buffett sheds some light on this sometime soon.
Small Trimmings
The rest of the Q1 Berkshire 13F shows minor position changes. Berkshire’s main purchase of the quarter was increasing its stake in PNC bank by 6%. PNC however, only makes up 0.5% of Berkshire’s portfolio so this purchase is peanuts.
Next, Berkshire exited its positions in Travelers (TRV) insurance and Phillips 66 (PSX) oil refiner. Both of these companies represented a small part of Berkshire’s portfolio at the start of the quarter, so the complete selling of shares is not very impactful. It appears Travelers shares started to be sold in Q4 2019. PSX was a much larger share of the portfolio, and has been consistently sold off since Q1 2018.
Finally, about a dozen positions were trimmed by a few percent, as seen in the table below. These companies make up a rather small part of the Berkshire portfolio. Most likely these stocks were bought, and trimmed by Todd Combs and Ted Weschler, rather than Buffett. These two manage small portfolios within Berkshire, and are more active than Buffett who typically only makes big acquisitions. I would be curious what is the rationale for selling small slivers of these companies, but there is probably not much to it.
Ticker
Name
Activity
GM
General Motors
Reduce 0.43%
SU
Suncor Energy
Reduce 0.47%
AMZN
Amazon
Reduce 0.74%
LSXMK
Liberty SiriusXM
Reduce 0.77%
AXTA
Axalta Coating Systems
Reduce 0.80%
BIIB
Biogen
Reduce 0.84%
VRSN
Verisign
Reduce 1.06%
TEVA
Teva Pharmaceutical
Reduce 1.06%
DVA
DaVita Healthcare
Reduce 1.22%
LBTYA
Liberty Global
Reduce 2.43%
SIRI
Sirius XM Holdings
Reduce 2.83%
JPM
JPMorgan Chase & Co
Reduce 3.03%
LILA
Liberty LILAC Group
Reduce 3.10%
SYF
Synchrony Financial
Reduce 3.24%
Conclusion
The first quarter of 2020 went by in a flurry, which makes looking at the Berkshire 13F so interesting. So far in Q2, the market has rallied on the belief the economy will quickly bounce back from the COVID crisis. It would seem that Berkshire’s Q2 13F will be pretty boring, just reporting the airline sales that were mentioned in the annual meeting. Perhaps the market will sell off again later this year, allowing us to pore over Buffett’s portfolio moves, and hoping he lands a big acquisition.
A good website to track super-investor portfolios is Dataroma.
To see my portfolio action in the first quarter of this year, check out:
While I always look forward to the Berkshire annual meeting, I was especially anticipating what Warren Buffett had to say about the recent economic crisis. With an empty arena, Buffett and Greg Abel (vice-chairman of non-insurance operations) gave insights to some of the pressing questions investors are wondering. I appreciated Becky Quick’s selection of questions, instead of the usual “how do I calculate the intrinsic value of Berkshire??” that someone always asks. In this post, I wanted to provide highlights of Berkshire shareholders meeting, choosing the top 5 questions and summarizing Buffett’s response.
Lender of Last Resort
In the last financial crisis, Berkshire acted as a lender of support for eight different deals. Despite the injection of expensive capital through preferred stocks and securing warrants, these companies were in fact paying for the sign of confidence from Berkshire in the midst of a crisis and that was invaluable. Today we have QE, infinity, low interest rates, and hungry hedge funds, even though the economy has deteriorated rapidly over the last few months. Why have we not acted as a lender of support?
This is an interesting question because it brings up some history lessons from the last financial crisis. During 2008, Berkshire was primarily supplying capital by means of preferred stocks and warrants, versus buying common stock over the market. These capital injections were on terms that were pretty generous to Berkshire. These companies knew that Buffett’s reputation carried weight, and Berkshire has a fortress balance sheet that could provide funding. Berkshire was literally able to do deals that no one was able to do.
Interestingly, Buffett admits his timing of deploying capital in 2008 was a bit early, that he would have been better off waiting a few months. Even the greatest investors can’t time the market.
As for the market panic in March, Buffett says the phone wasn’t ringing. The Federal Reserve quickly swooped to provide loans to support the financial system. Even marginal companies are able to access funds, so there is no need (for now) to come crawling to Berkshire. While many people are critical of these actions for various reasons, mainly because it prevented stocks to get very cheap, Buffett admits it was the right thing to do even though he got undercut. It is interesting to see Buffett support Jerome Powel’s efforts even though most investors are whining (which some of that is deserved).
COVID Impact on the Insurance Industry
Would you please help us understand the effects of COVID-19 are on our insurance businesses? Other insurance companies have reported losses from boosting reserves for future insurance claims that they expect to be paying as a result of Coronavirus. Yet in Berkshire’s 10Q released this morning, we do not appear to have reported much of these future expected losses. Can you tell us why this is the case? What kind of risks Berkshire is underwriting that allows us not to be affected by the pandemic or conversely, what we are writing that might be?
When it comes to insurance exposure to COVID19, Buffett warns there could be a huge amount of litigation. Many businesses that were forced to shut down operations are looking at their insurance policies to see if they can make a case for a payout. The potential for insurers to be liable is if they wrote commercial multiple peril (ie business interruption) policy.
Arguably, a pandemic caused business interruption. However, typically the policy relates to physical damage to a building that prevents business operations. Buffett gives the example that a strike at an auto plant would not trigger a business interruption policy. An example Warren provided where it would qualify is when a fire at a neighboring building spread to a Berkshire subsidiary building.
Luckily, Berkshire is mostly exposed to auto insurance, which should not have this problem. Buffett did mention that one large insurer had ambiguous policy language that could in fact have to cover pandemic losses. He didn’t name names, so it will be interesting to see who wrote this policy.
Thoughts on Negative Interest Rates
Interest rates are negative in much of Europe, also in Japan. Warren has written many times that the value of Berkshire’s insurance companies derive from the fact that policy holders pay up front creating insurance float on which Berkshire gets to earn interest. If interest rates are negative, then collecting money up front will be costly rather than profitable. If interest rates are negative, then the insurance float is no longer a benefit but a liability. Can you please discuss how Berkshire’s insurance companies would respond if interest rates became negative in the United States?
It is reassuring that Buffett is confounded by negative interest rates just as much as I am. He mentions his disbelief in how long negative rates have lasted in Japan and Europe. Interestingly, Buffett is surprised that these negative rates have not caused significant inflation. A humorous quip Warren gave was that if you could have negative rates, high debt, and no inflation, then civilizations would have figured this out a couple thousand years ago.
It is fascinating to hear Buffett make these comments that are along the same line of thinking as all the Perma Bears have been screaming about for years, however he isn’t whining about how the system is rigged and ripe for collapse. The only advice he gives to navigate the negative rate world is to hold equities since negative yielding bonds only serve as speculation, not an investment.
Are Buybacks Evil?
Berkshire has invested in many companies with stock buy-back programs. Recently there’s been a backlash against buy-backs. What are your views on this subject?
During the response to this question, I felt like I was repeatedly yelling “boo ya!”. Buffett opens up his remarks by saying it is politically correct to be against buybacks. Stock buybacks have gained a bad stigma because some corporations take on debt for the buyback, or use their profits to purchase stock instead of spending it on R&D or increasing wages. While I don’t want to get into the nuances of the pros and cons of buybacks in this post, the key thing is that buybacks are another form of returning cash to shareholders.
Instead of paying a dividend, businesses can buy shares from those who wish to sell their shares, thereby increasing the continuing shareholders stake in the company. An example Buffett makes is the scenario when three partners run a business that reinvests all of its profits. One partner needs cash so he asks the other partners for a dividend. But the other partners don’t want the cash from a dividend, don’t want to pay taxes on it, and want to leave that cash in the business to grow. Instead, the two partners decide to buy some shares from the other partner. Now the partner gets their cash, and the other two grow their stake in the business.
This sounds all well and good, but most companies overpay on the shares they buy back. Buffett has long stated that he loves when companies (including Berkshire) buy back its own shares when it is trading below how much the business is actually worth. This is an especially efficient way to deploy capital if there are no other better investment prospects for the company to engage in. The problem is that buybacks have become a fad. Recently corporations are doing massive buybacks at the height of a bull market instead of when their stock is cheap.
Another point Buffett makes is that it is dumb to commit to buy $X amount of stock each year. He favors being opportunistic about it, not mechanical. An analogy Warren makes is that it is like saying you’re going to buy a $5B company without knowing what you are getting.
Bad buyback policies can make the company vulnerable during a crisis. This is the situation we are seeing with the airlines, they spend a ton on buybacks and now they need bailed out. This is an example of poor capital allocation, not proof that buybacks are evil.
While I do agree that many companies botch the execution of their buybacks, Buffett summarizes my thoughts on the matter by saying: “Some do it stupid but that doesn’t make it immoral”. Mic drop.
Q1 BRK Buyback
Can you ask Warren why he didn’t repurchase Berkshire shares in March when they dropped to a price that was 30% lower than the price that he had repurchased shares for in January and February?
One thing Berkshire followers have been wondering is whether or not Buffett bought any shares during the first quarter. The price of Berkshire B shares got down to around $165 during March, where it was trading between $200-220 last year. With Berkshires large cash holding, many have been hoping Buffett would reward shareholders with a large buyback.
When asked about the matter, Buffett confirmed he did not perform any buybacks during the quarter. Even though Berkshire appeared cheap, Warren said that it is not any more compelling than it was 6 months ago. Yes Berkshire has gotten cheaper, but the value of the business has decreased as well. For instance, Buffett’s airline investments suffered a loss that materially hurts Berkshire.
Additionally Buffett believes there will be better opportunities ahead than performing share buybacks. The large cash reserve that Berkshire sits on provides optionality, which is valuable during uncertain times like these. While I do not currently own Berkshire (which could change), I would much rather see Buffett have one last glorious buying opportunity instead of boringly buyback stock.
Conclusion
In my opinion, this was one of the best shareholder meetings. Buffett answered some hard hitting questions, and was more candid than usual. While he had to be careful not to sound too pessimistic, he definitely has concerns with the economy. These were just the highlights of the Berkshire shareholders meeting, but I highly recommend watching the meeting or reading the transcripts.
Back in March, I purchased 46 shares of Simon Property Group. While I am optimistic about Simon, I feel like it needs close monitoring since it is a highly indebted company. I did a write up analyzing their debt and liquidity needs for the year, which provided some reassurance. Now that Q1 is over, I want to follow up on their debt situation, and see how the mall closures have impacted their operating income. Below are some of the highlights from the SPG Q1 2020 earnings call.
Q1 Income Statement
Now to dig into my favorite part, the financial statements! The table below shows the key income statement lines, comparing Q1 of this to last year. Revenue is down compared to 2019, however it is interesting that lease income is not contributing too much to the lower sales. The 10-K lists the various reasons that “other income” is lower in Q1 2020 compared to 2019, but I’m not going through that here.
Operating expenses were slightly lower, it would be interesting to see what Q2 expenses look like since it will capture more of SPG’s scaling back of operations. Interest expense is lower, due to lowering of variable rate debt rates and refinancing of other debts.
Finally we can see that the net income dropped, and that the business earned $0.35 less than this time last year. All in all, the Q1 income statement looks good given the circumstances, but Q2 results will sure to be uglier.
Q1 2020
Q1 2019
Total Revenue
1,353,360
1,452,834
Lease Income
1,262,232
1,289,058
Operating Expense
698,491
707,813
Interest Expense
187,627
198,733
Net Income
437,605
548,475
EPS
1.43
1.78
Current Balance Sheet
The balance sheet of SPG is something I want to keep close tabs on. While I’m not too worried about Simon’s debt load, the possibility of large operating losses requiring them to access credit is a bigger concern. First, the cash flow statement shows that Simon gained $6.45B in proceeds from debt, while repaying $3B of debts. This must be refinancing a credit facility, or paying off a bond that came due. Elsewhere in the 10-K, Simon reports they drew $3.75B from their credit facility for operating liquidity. Given the proceeds of this credit line, SPG’s cash balance at the end of the quarter was $3.724B compared to $670M at the end of 2019. Next, the total debt increased from $24B to $27.5B this quarter. To satisfy the finance nerd in me, the breakdown of SPG’s debt is as follows:
$3.0 billion outstanding under the $4.0 billion unsecured revolving credit facility
$875.0 million outstanding under the $3.5 billion unsecured supplemental credit facility
$1.0 billion outstanding under the $2.0 billion global unsecured commercial paper note program
Unsecured debt consisted of $15.8 billion of senior unsecured notes (bonds)
Total mortgage indebtedness was $6.9 billion
Based on these figures, it appears Simon has plenty lines of credit to tap into if need be. Finally, the 10-K also reported that SPG is in compliance to all of their debt covenants.
COVID Response
As the COVID crisis unfolded, Simon claims to be one of the first companies to voluntarily close all of their properties. Recently SPG has been opening properties back up with added precautions. Currently, 77 of Simon’s U.S. malls have reopened. Within the latest 10-K, Simon outlined their business response to weather COVID19:
Significantly reduced all non-essential corporate spending
Significantly reduced property operating expenses, including discretionary marketing spend
Implemented a temporary furlough of certain corporate and field employees due to the closure of SPG’s properties
Suspended more than $1.0 billion of redevelopment and new development projects
David Simon, the CEO and President elected to reduce his base salary to zero and deferred his approved 2019 bonus until the market conditions improve
Implemented a temporary decrease to the base salary of certain of its salaried employees ranging from 10% to 30%
The Board of Directors agreed to temporarily suspend payment to the independent directors of their board service cash retainer fees
In my view, these measures seem rational, and it is good to see the CEO and board eliminate their compensation. That is to say, I will be curious to see how these spending cuts affect the operating results next quarter.
Dividend Payout
One topic of interest is what SPG will do with their dividend. Simon paid a quarterly dividend of $2.10 in Q1. Interestingly, SPG has declared they will pay a Q2 dividend, however they did not say how much it would be. As a capital allocator, I would hope they would only pay a dividend if they had the operating cash flows to support it. I do not mind if they need to temporarily reduce or suspend their dividend payments, however many people are very demanding of their dividends.
Looking Forward
During the SPG conference call, David Simon did say that he expects positive cash flow this year. This is reassuring, since most people are assuming they are going to run a deficit with retailers not paying rent. But of course, we don’t really know how things will pan out. Simon did mention that some retailers have negotiated delays in rent payments. The company did not specify how many retailers they have negotiated with, or how many retailers have failed to pay rent. Therefore number of rent collected in a key figure. It appears Simon does not want to speak too specifically about this so retailers don’t use it as an excuse to not pay rent because X% of retailers haven’t paid. SPG communicated its firm position that retailers signed a contract to pay rent and must uphold that.
Since SPG closed its properties only a week or so before the end of the quarter, Q2 should be more revealing of how this crisis has impacted the company. The occupancy at the end of Q1 was down 1.1%, amounting to a total occupancy of 94%. This occupancy level seems very strong, but it is definitely something to monitor in the coming quarters. If this crisis persists, it could take a while for retailer bankruptcies to shake out.
Conclusion
All in all, I think this quarter’s results were pretty positive given the situation, and given how beat up this stock is. In the coming quarters, it will be important to keep track of the occupancy, lease revenue, operating income, and how they are deploying their credit facilities. While it is very possible SPG suffers through more pain, I am still optimistic on its fundamentals looking a few years out.
Weird things are happening in the economy now amidst this COVID19 crisis. Stocks sold off sharply, then largely recovered. Unemployment is rocketing higher and the oil market is in shambles. The chaos in the oil market appears to be offering an interesting opportunity. The oil tanker thesis has been floating around Financial Twitter, and appeared on Real Vision. This trade seemed interesting, but out of my comfort zone. I decided to investigate the opportunities from investing in oil tanker stocks, and share my findings in this post.
Current Oil Conditions
While I am by no means an expert in the oil market, there are a few interesting things going on that create this oil tanker trade. Right now there is an extreme imbalance between supply and demand in oil. Below is a chart from EIA showing global oil production and consumption. From the chart, it can be seen demand for crude has had a very sudden drop with the onset of the COVID19 crisis, where most economies around the world are shutting down or limiting travel. This type of sudden decrease in demand is unheard of.
With this drop in oil demand, you would think that producers would massively cut their production? Wrong, at the start of this pandemic, Saudia Arabia and Russia had a spat, and decided to go full steam ahead producing oil. To make matters worse, it is not trivial to reduce oil production, it is a slow process. The EIA data suggests there is an estimated 10 million barrel a day surplus of oil.
The oversupply in oil has created a bizarre reaction in the futures market. We recently saw the front month crude futures price go negative. The simple explanation of this is that there is so much oil that producers are paying people to take the crude from them because they are running out places to store it. Further out on the futures curve, the price slopes up, which is a scenario called contango. Contango means you can buy oil cheap now (or free?), store it, and sell it at a future date for a profit. Profiting from storing oil is where oil tanker stocks come in.
The Storage Problem
The massive oil glut creates a new problem: where does all this oil go? Data from the EIA states that there is about 650 million barrels of land storage in the US, with 1.2B barrels of storage globally. Below is a chart from EIA data showing the capacity utilization of US crude storage, where it can be seen storage 61% full at the latest data point.
With land storage rapidly filling up, and contango in the futures market, a scenario is created where oil tankers are being used for floating storage. As tankers are being utilized as storage, instead of transporting oil, the supply tankers available to transport crude decreases. This causes the price tanker companies charge to transport oil (called spot rate) rate to increase. Typical spot rates in 2019 were about $15,000 per day. Recently tanker companies have been charging over $200,000 a day to transport oil. Rates these high have been seen a few times in the past, but for very brief periods of time.
How Long Will the Rates Last?
It is difficult to predict how long these extremely elevated rates last. While $200k spot rates may not last for weeks or months, it seems very likely that rates will continue to surpass 2019 rates for some time. Even more difficult to predict is what magnitude these temporary increases in tanker rates factor into the full year earnings for these companies.
I believe the consensus among investors is that tanker rates settle back down to normal levels once oil production is cut, or demand rebounds. The counter to this argument is that oil producers can not flip a switch and cease production (why not). On the demand side, I’m not convinced global economies are going to immediately rebound from the COVID19 shutdowns. Basically everyone thinks oil production cuts will be swift, and we will have a V-shaped recovery in the economy. In my view, the mismatch of oil supply and demand will persist, although slowly improve throughout most of 2020.
Tankers: An Example of Operating Leverage
Now that I’ve covered the background information, let’s analyze the tanker business. Oil tanker companies are characteristically capital intensive because in order to expand, you must acquire more ships. The ships are purchased with debt, so tanker companies have high debt loads and interest expenses. Finally, tankers have high operating leverage, which can be beneficial but also pose a vulnerability.
A business with high operating leverage has a large amount of fixed costs, such as employee wages, fuel, ship maintenance, and insurance. These costs do not change much year to year. The leverage comes in when the business experiences higher revenues, while maintaining about the same operating expenses. This causes the operating income of the business to massively increase.
Oil Tanker Financial Analysis
Let’s dig deeper into the financial statements to better understand the operating leverage and estimate how much profit these tanker companies can generate. The table below shows rounded figures from Scorpio Tankers last annual report. While I’m using STNG as an example, the same analysis can be done to other tanker stocks. Between 2018 and 2019, Scorpio Tankers increased its revenue by 30%. Despite this increase in sales, the main expenses were pretty consistent year over year. This means the increase in revenue went straight to operating profits, which translated into a 12x increase from the previous year.
(Thousands of dollars)
12/31/2019
12/31/2018
Vessel Revenue
704,325
585,047
Vessel Operating Costs
(294,531)
(280,460)
Voyage Expenses
(6,160)
(5,146)
Depreciation
(180,052)
(176,723)
G&A
(62,295)
(52,272)
Total operating Expenses
(574,353)
(574,505)
Operating income
129,972
10,542
A Note on TCE
Additional concepts that need to be described are revenue days and Time Charter Equivalent (TCE). Revenue days is the total time the fleet has spent generating revenue throughout the year. Scorpio Tankers has about 115 ships in their fleet that spend most of their time generating revenue, but there are some periods where they are dry docked for maintenance. Time Charter Equivalent is a way to compare revenues from time chartering vs operating in the spot market, and is an industry standard way to measure operating results. Without going into the differences between time chartering and the spot market, the important piece is that TCE is vessel revenue minus voyage expenses. Another way to put this is that the tanker spot minus voyage expenses is the TCE rate. This is important since we want to see how the high spot rates affect the operating results of the business.
Income Statement Analysis
Using the simplified income statement in the table below, the operating income can be constructed from the revenue days and TCE. We can figure out the TCE revenue for the year by multiplying revenue days (42,000) by the TCE rate (17,000) to arrive at a TCE revenue of $714M. Voyage expenses amounting to $6M are added back to get the total revenue of $720M.
Revenue Days
42,000
TCE
$17,000
TCE Revenue
$714,000,000
Voyage Expense
$6,000,000
Total Revenue
$720,000,000
Operating Expenses
$575,000,000
Operating Income
$145,000,000
By working our way up to the total revenue, now we can go down the income statement to calculate the operating income. Operating expenses mainly consist of vessel operating costs, depreciation, and G&A. These add up to $575M, which means the operating income is $145M.
Estimated 2020 TCE Rates
The above calculations are based on 2019 figures where the spot rate/TCE are in the neighborhood of $20,000 per day. By adjusting the TCE to reflect the elevated 2020 spot rates, we can recalculate the operating income. For this analysis I’ll use an estimated yearly average TCE of $40,000 per day. This number seems modest given the spot rates of $200,000 per day, but it is hard to predict how spot rates will hold through the year. I would rather be conservative on my estimates even though there is a good chance of average TCE being significantly higher than $40,000 per day.
Income Statement Analysis Round 2
An updated income statement, with the new TCE rate, is shown in the table below. Even though we increased the TCE, the revenue days, voyage expenses, and operating expenses will stay the same since they do not vary much year to year. Multiplying the new TCE by revenue days arrives at a TCE revenue of $1.68B. Subtracting voyage and operating expenses shows an operating of 1.01B, which is almost seven times greater than the 2019 example. That’s the benefit of operating leverage when it works in your favor!
Revenue Days
42,000
TCE
$40,000
TCE Revenue
$1,680,000,000
Voyage expense
$6,000,000
Total Revenue
$1,674,000,000
Operating Expenses
$575,000,000
Operating Income
$1,099,000,000
Going further down the income statement, we can estimate the net income using the $40,000 per day TCE. The main expense after operating income is the interest expense on all the ships. This amounts to about $185M. Subtracting the interest expense from the operating income equates to a net income of $920M. The current shares outstanding for Scorpio is about 49.85M, so the earnings per share is $18.45. Compare this earnings per share to the current price of around $20, which creates a price to earnings ratio of 1.08. A price to earnings ratio this low is ridiculously cheap, therefore we should expect investors to buy up the stock to reach a more reasonable P/E ratio. Additionally, the management at the tanker companies could reward shareholders with a generous special dividend or share buyback.
Interest Expense
$185,000,000
Net Income
$920,000,000
Shares Outstanding
49.85M
EPS
$18.45
Current Price
~$20
The Trade
Since the high spot rates affect all oil tanker companies, I think the best method for investing in oil tanker stocks is to buy a handful of them. The four companies I have bought are Teekay Tankers (TNK), Frontline Ltd. (FRO), DHT Holdings (DHT), and Scorpio Tankers (STNG). These companies have a variety of fleets sizes, and composition of the fleet. Ships ranging from the largest VLCC to medium sized Suzemax tankers are represented. Since this is an industry play, where each stock should benefit equally from the higher rates, I am not looking to do in depth valuations on each business. Each one of these stocks I have allocated about $1750, which combined makes up about 8% of my portfolio.
Lack of Price Movement
While the spot rates have been elevated for over a month, and this trade has become somewhat popular on FinTwit, the stock prices for tankers have yet to respond. One reason for the lack of price movement is that oil tanker companies are mediocre, cyclical, capital intensive businesses, which means they have booms and busts. Furthermore, tanker companies are notorious for being poor stewards of shareholder capital. These factors have turned off many people from buying into these companies.
My other theory for the lack of price action is that a lot of people are watching from the sidelines, waiting for the latest quarterly earnings to come out in order to validate that these companies are raking in some cash. All four of the tanker companies I own announce Q1 earnings in May, so hopefully the catalyst will begin soon.
Plan Going Forward
My game plan is to see if these stocks readjust to a normal P/E ratio after the Q1 earnings are released. From there, I will assess the likelihood of the high earnings persisting through the year. I am not interested in holding these stocks for a long period of time, and I do not want to try to perfectly time the top of this trade. It is possible that I’ll hold these companies for a couple of quarters, but if they significantly run up during Q1 earnings then I may quit while I’m ahead.
Besides seeing what these companies are earning with these elevated spot rates, there are some other factors that I’m considering with regards to the timeline of this trade. The crude storage capacity is the key driver to this thesis, so I will be watching for drawdowns on capacity utilization. The cause of these drawdowns would stem from the supply and demand imbalance to normalize. Finally, as the country opens back up, it is possible the consumption of oil will return closer to normal.
Conclusion
Hopefully this post provides a sufficient overview of investing in oil tanker stocks, with simplified analysis of the current situation in the oil tanker industry. While trades like this are out of my comfort zone, I feel supported by the fact that the high spot rates are public knowledge, and the high profitability of these companies is not caught up in hope and dreams. However, this position could prove to be a lesson in sticking with my circle of competence, we shall see!
The March selloff provided some opportunities to buy undervalued stocks. One of the stocks I scooped up was Simon Property Group, which on the surface appears to be a risky business. However, the assumption I’m making is that the majority of tenants will continue to pay their rent through this COVID19 crisis. Since this is a big assumption, I decided to dig into Simon’s financials, model what would happen if a chunk of their tenants fail to pay rent, and try to prove why SPG won’t go bankrupt.
Estimating SPGs Finances During COVID19
Now let’s do some back of the envelope calculations to model what SPGs finances may be this year. Simon Property Group’s simplified income statement and balance sheet are shown below. In this exercise, we assume a scenario where a large portion of tenants don’t pay rent, however we have to balance being conservative with being realistic. First, let’s say that there is a 30% reduction in revenue from tenants not paying or going bankrupt. Factoring in the 30% haircut from last year’s revenue, this would mean an estimated 2020 revenue of $4B.
SPG 2019 Simplified Income Statement
(Dollars in Thousands)
Total Revenue
5,755,189
Expenses
Property Operating
453,145
Depreciation and Amortization
1,340,503
Real Estate Taxes
468,004
Repairs and Maintenance
100,495
Advertising and Promotion
150,344
Home and Regional Office Costs
190,109
General and Administrative
34,860
Other
109,898
Total Operating Expenses
2,847,358
Interest Expense
(789,353)
SPG 2019 Simplified Balance Sheet
(Dollars in Thousands)
Assets
Investment Properties Less Depreciation
23,898,719
Cash and Cash Equivalents
669,373
Liabilities
Mortgages and Unsecured Indebtedness
24,163,230
Breaking Down Expenses
Even though the revenues may be down because of the COVID19 crisis, expenses may be fairly fixed. The next line on the income statement shows SPG had operating expenses amounting to $2.9B in 2019. Operating expenses consist of property operating cost, real estate taxes, repairs, advertising, office costs, employee costs, and depreciation. Some of these expenses could be cut, but that would probably equate to a couple hundred million which won’t move the needle too much. Above all, the largest cost is depreciation, which is a non-cash expense. Depreciation spreads the cost of certain purchases over a period of several years, instead of charging the full cost upfront. Since we are primarily worried about cash flow coming in and out, we can add back depreciation, resulting in an adjusted operating expense of $1.5B.
Operating and Net Income
Now that we estimated expenses, we can find the operating income by subtracting the adjusted operating expenses ($1.5B) from the estimated revenue ($4B). This leads to an estimated operating income of $2.5B. Following the operating income are a series of line items that arrive at the net income. Examples of these items are income tax, income from unconsolidated entities, and unrealized losses on assets. For simplicity sake, let’s ignore these since they won’t change the outcome much. The last line item we care about is the interest expense, which amounts to about $800M this year.
Current Liabilities
A common metric used to judge a businesses credit worthiness is the interest coverage ratio. This is calculated by dividing the operating income by the interest expense. For instance, an interest coverage ratio below 1.5 indicates the company may have difficulties paying their interest if there is a bump in the road. Calculating the interest coverage ratio for SPG, with the estimated operating 2020 expense, yields 3.16. In short, Simon should be able to make its interest payments this year.
With the income and expenses tallied up, it is time to look at the liquid assets and liabilities on the balance sheet. So far we estimated the amount of cash coming into SPG this year, but we have to factor the cash already on hand. During the period ending in 2019, Simon has $670M in cash. There are some accounts receivables and payables, but let’s pretend they cancel each other out for simplicity.
Long Term Debt
The most important piece of info needed to judge SPGs financial strength is the amount of debt they owe. Currently, SPG has $24B in debt, with $6B of it in mortgages, and $18B in unsecured debt such as bonds, commercial. paper and credit facilities. As previously mentioned, interest on the debt is about $800M this year. Some of the bonds and the commercial paper come due this year, which means the principle needs to be repaid. Finally, the amount of debt coming due this year is $2.9B.
The big question is whether or not Simon can pay off the debt coming due this year, and make its interest payments with reduced revenue. The good news is that in March, SPG received an increase in their credit facility. They now have about $9B in credit they can tap into to pay their liabilities. Obviously it isn’t ideal to use debt to pay debt, but these are circumstances beyond their control.
Calculating SPG’s Deficit
Putting it all together, we can estimate how much of a cash surplus or shortfall SPG will have this year after paying its debts. The equation below shows that by adding the estimated operating income and the current cash balance, then subtract interest and debt coming due, Simon will approximately have a $500M deficit.
Estimated Operating Income + Cash – Interest – Debt Due = -500M
While it is not ideal that SPG will more than likely suffer a loss this year, they can easily cover this deficit with their credit facilities. Therefore, based on these rough calculations, I believe Simon Property Group will be able to weather this rough 2020.
Other things to consider are Simon’s debt covenants may be a limiting factor on how they can navigate this crisis. However, I couldn’t find much detail on their covenants. One can assume that if they had a large increase in their credit facility, then they must not be close to violating the covenants.
Simon’s Dividend
Another note is that this analysis did not take into account Simon’s dividend. REITS must payout a large portion of their profits, however I doubt Simon will be profitable in 2020. Although some investors would probably prefer SPG to maintain the dividend as much as possible, I believe the smart thing to do would be to cut the dividend if this year is indeed economically bad. In other words,I would be a bit disappointed if SPG tapped into their debt to maintain the dividend.
Conclusion
In summary, it appears that SPGs $9B credit facility can provide a life jacket during this pandemic. These calculations are based on a 30% reduction in rental income, which seems harsh but not out of the realm of possibility. If every retail company goes bankrupt or doesn’t pay rent, then I guess it’s force majeure and we must be in a depression. Therefore, in my view, there is a good amount of evidence to show why SPG won’t go bankrupt.
Let me know if I’m missing something crucial! I by no means claim to be a competent analyst.
It’s been a while since I’ve bought individual stocks, but the March sell off has me scrambling to scoop up some good deals. My aim for these discretionary stock picks is to find quality companies trading at attractive free cash flow yields. Each position I bought in March make up approximately 5% of my portfolio. So far, I’ve bought Capital One, Simon Property Group, and Emerson Electric. I believe all of these are quality businesses, however they are not without their short term troubles.
Capital One Financial
Capital One Financial Corp (COF) was the first purchase during the recent market selloff. Capital One is a diversified financial company providing consumer lending, commercial lending, and commercial banking. COF is one of the 10 largest banks based on deposits, and third largest credit card issuer. The business model is to lend money to consumers and businesses from capital received by bank deposits.
The founder of Capital One, Richard Fairbank, is still the CEO of the company. Managers that are founders is a trait I like in businesses because I believe their interests are better aligned with all the stakeholders, and are more likely to be above average capital allocators. Capital One used its strong balance sheet to make acquisitions during the 2008 financial crisis, so I have confidence they can navigate this current market turmoil.
The main risks to COF are low interest rates, which compresses the spread between the interest they receive from lending and the interest they must pay on deposits. The falling interest rate trend has impacted most bank stock valuations. During a recession, default rates and charge off rates could increase. While COF has reserves for increased defaults, it could temporarily affect earnings. Another reason for Capital One’s lower valuation is the recent data breach that occured in 2019.
The table below shows my purchase price, and some of the key metrics I use to evaluate a business. Typically I don’t use Price to Book value, but it can be useful to valuing financial companies. A stock trading below its book value, a P/B less than 1, is a sign of undervaluation.
Purchase Price
$63.25
FCF Yield
52%
P/B
0.5
D/E
0.95
RoE
9.5%
Simon Property Group
The second stock I bought in March was Simon Property Group (SPG), a mall REIT. Owning a bunch of shopping malls sounds like a terrible idea since the narrative is that brick and mortar retail is dead. While I think many malls will close, I believe this will be concentrated on the lower class malls in unattractive markets. SPG owns 204 properties, including 106 malls and 69 premium outlet malls. These properties are located in major metro areas such as Miami, Boston, San Jose, and Las Vegas. The quality properties in great markets should allow SPG to continue to provide steady cash flow to shareholders. Simon has the highest credit rating for a REIT, pays an average interest rate of 3.3% on its debt, and has a 5.3x interest coverage ratio.
SPG share price has been heavily beaten up from the Retail Apocalypse narrative, and now COVID19 fears. I believe these fears are overblown. Yes online shopping will continue to grow, but I believe brands will still want some physical locations as a showroom for their products. Since 2017, SPGs occupancy rate has only fallen 0.5%, to an occupancy rate of 95.3%. During this same period, base rents have increased. SPG is focusing on providing not only shopping, but dining and entertainment options to diversify the experience. As for the COVID19 concerns, it is possible some corporate tenants will not be able to pay their rent. However, I do not think it is likely that more than 50% of tenants are going to break their lease, or go bankrupt. It is my belief that Simon will be producing healthy cash flows two years from now despite a near term rough patch. If I’m wrong, then we are probably in the Great Depression 2.0 and have bigger things to worry about.
The table below shows my purchase price and key metrics used to judge the quality of the business. The debt to equity is high for this company because it owns real estate with mortgages. The return on equity is very high because the debt allows SPG to own a large amount of income producing assets. This debt means there is relatively low amount of equity, thereby creating a large RoE.
Purchase Price
$74.50
FCF Yield
13%
D/E
9.4
RoE
73%
Emerson Electric
Emerson Electric (EMR) is a diversified industrial company consisting of climate technologies, automation solutions, and tools & home product segments. Climate technologies include residential heating and cooling, commercial air conditioning, commercial and industrial refrigeration. The tools & home products segment makes professional tools, food disposal systems (such as its InSinkErator brand), electric water heaters, among others. Both the climate technologies, and tools & home products segments are low growth, almost commodity type products. What makes me interested in EMR is the automation segment, that provides measurement instruments, fluid control, process control, and Industrial Internet of Things solutions. This segment should provide Emerson with a runway of modest growth in the future. One application of EMRs automation products is in the oil industry, with computer controlled valves, pumps, flow rate sensors that accurately measure the transfer of oil in custodial transactions.
The main risks to EMR are a general economic slowdown, and slowdown in the oil industry specifically. While EMR is quite diversified, the shale oil recession in 2016 impacted Emersons automation segment. Going forward EMR could face near term headwinds with the economic slowdown from COVID19, as well as the collapse in oil prices. Despite this, I believe Emerson is a high quality company that is rarely undervalued.
It can be seen from the table that EMR appears to be a quality company that can produce healthy returns on equity, while having a strong balance sheet.
This past February marks the third anniversary of my first individual stock purchase. Since then, the market has been pretty boring, with record low volatility. There were a few times of drama, like the inverse VIX blow up and the market selloff Q4 2018. By the time stocks were starting to get affordable in these sell offs, the market changed course and ripped higher. Now the market is in a period of turmoil, understandably so with this pandemic crisis. With this apparent bear market, I wanted to provide my thoughts on what’s going on, and document my buys, sells, and performance on this blog.
Before I publish future posts on what stocks I’m analyzing, or how I’m allocating my portfolio, I wanted to give some background on my investing activities. So far, my portfolio has held up decent during this sell off. However, I am massively overhauling my portfolio towards value stocks. This post aims to show my past thought process for my allocation, and the changes I’m making going forward.
Past
My portfolio is currently a hodgepodge of funds and asset classes, but at one point it made sense. The allocation I was aiming for consisted of not just diversifying across a large number of stocks, but diversifying across asset classes. Multiple asset classes can help protect the portfolio through all scenarios, such as a rising or falling stock market, and a rising and falling interest rate environment. The target allocation was to split the portfolio into stocks, emerging markets (EM), commodities, and money market (MM). The rough percentage allocation I was going for is shown in the figure. These positions were spread across a 403(b) (401(k) for public employees), Roth IRA, and taxable brokerage accounts.
The stock portion of the portfolio was primarily focused on buying individual stocks through a Roth IRA and taxable account. My philosophy on stocks firmly falls into the value investing category. The stocks I bought were generally quality, low debt companies that I believed had some sort of competitive advantage. February 2017 was the beginning of my stock picking foray, and lasted until mid 2019 where I wound down my positions to buy a house.
In February of 2019, I started a new job, which provided a 401(k). The default allocation was a target date fund that I assume is mostly in US stocks. Since I was lazy, I didn’t change the allocation, so this stock allocation has steadily increased. While a large chunk of my investments are in the 403(b), this 401(k) will march on to eventually have a more important role in my portfolio.
The next stock allocation was in the form of emerging markets. At the time the S&P 500 appeared overvalued, so I was looking for alternatives. Emerging market indexes were at a lower valuation than US stocks, which was compelling to me. Additionally there is the thesis that EM countries have younger demographics than the US, Europe, China and Japan. This younger population could drive higher GDP growth than the countries with a large aging population. With faster growing economies, these countries have the potential to offer better returns compared to expensive developed markets. While this thesis makes sense, I have become more skeptical, which I may elaborate further in a separate post.
Commodities were another asset class I wanted exposure to for diversification. The thought process for this was that commodity indexes were at historical lows compared to the S&P 500. While it is impossible to value commodities like you can with a business, they appeared cheap. The bullish case for commodities is a rise in inflation. I do not believe excessive 1970’s style inflation is heading our way, but it would be nice to allocate capital to something that should keep up with inflation. Another bull scenario was China’s One Belt One Road initiative, which would be the largest infrastructure project in the world. The demand for raw materials would cause commodities prices to rise. Given the current state of affairs with the world, I’m not quite sure how far One Belt One Road will get.
A specific commodity I wanted to allocate to were gold and silver. Gold is a controversial asset because gold bugs say the financial system is going to collapse with hyperinflation, and the only savior is gold. I don’t know about all that, but gold and silver are attractive to me because they are historically cheap compared to stocks, they keep up with inflation which is nice in a world of low bond yields, and they are a safe haven asset that should provide insurance during a bear market. My precious metal allocation is rather small, and if stocks crash and metals go up, I would sell my stake to buy stocks.
Finally I allocated a rather large portion of my portfolio to money market funds. These are like savings accounts that aim to protect your principal without any risk from equities or bonds. Since stocks were overvalued, I wanted to have a stash of capital that I can rotate into equities during the next recession. While some people oppose the idea of building cash reserves during expensive markets, this allocation cushioned my portfolio during the craziness going on in the markets right now.
My one regret is that maybe I should have allocated to bonds instead. At the time I thought it was pointless to own bonds with yields so low. Now that yields have gone to a crazy 0.5%, the capital gains on the bond allocation would have been very nice. I missed the boat on that trade, but it happens. Bond prices could continue to rally if rates go negative during this recession, or maybe some inflation will show up and put a hurt on bonds. For now, bonds just seem too hard.
The last component to my investing strategy is to apply a tail hedge strategy. The idea is to pay a small premium to hedge against low probability events such as a 20% market drop. This was performed by purchasing SPY put options that were 30% out of the money. If the market sharply fell, the option would greatly increase in price based on the underlying SPY price approaching the strike price. Volatility has a key role in option pricing as well, high volatility drives up the value of the put option.
12/31/19
3/27/20
Target Date
10962.24
11316.09
Money Market
22773.67
22779.8
EM
17675.3
13633.62
Commodity
13833.7
10125.48
Precious Metals
7861
8072.6
Total
$73,105.91
$65,927.59
Contributions
3177
Return
-13.80%
Present
As I mentioned previously, the value stock part of my portfolio was liquidated in 2019. I should have reorganized my portfolio, but I never got around to it. Therefore my portfolio was kind of ugly going into the COVID19 crisis. After calculating my returns from the end of December 2019 to now, my hodgepodge portfolio still held up decently. The table below shows the market value of my portfolio holdings from the end of 2019 to present. My 401k contributions are included for clarity and are factored into the return calculation. At the 401k/403b level, my portfolio has returned -16% YTD.
This performance comparison leaves out the contribution of my tail hedge strategy. As the market began to violently react to the realities of this pandemic, I sold my put options on 2/28/20. In hindsight I was early, but the hedge did its job and I wanted to capture the gains while I could. The cost of the SPY puts were about $600 and the proceeds were $10,148. Year to date I spent $313 on SPY puts, plus I had some left over from 2019.
With this $10,000 windfall, I had the daunting task of finding good opportunities to reinvest in. The turmoil is not causing me stress (so far), but I do feel unprepared since I am lacking a list of companies I’d like to buy at the right price. My modus operandi has been to find quality stocks trading at attractive free cash flow yields. I’m trying to tactfully make purchases since I don’t want to use up all my ammo before the market bottoms out.
The three stocks I’ve bought so far are Capital One (COF), Simon Property Group (SPG), and Emerson Electric (EMR). The table shows my cost basis and current market value. I don’t want to go into my thought process on these stocks right now, I’ll do that in a separate write up. During this volatility, I fully expect a period of trying to catch falling knives. So far, the performance of my new acquisitions are reflecting that. However, my time horizon for these stocks are several years, maybe indefinitely, so I’m not worried about temporary deterioration in business fundamentals or price moves.
Company
Ticker
Cost Basis
Market Value
Change
Capital One Financial
COF
3,478.75
3,041.50
-12.57%
Simon Property Group
SPG
3,427.00
2,675.82
-21.92%
Emerson Electric
EMR
3,485.00
3,874.30
11.17%
Factoring in my retirement accounts, and the reinvestment of my tail hedge, a breakdown of the portfolio is shown in the table. The total is the sum of the portfolio values at the specified dates, while the return takes into account the 401k contributions and cash infusion into the portfolio. In total, my portfolio is down 2% YTD compared to the S&P 500 being down 21%.
12/31/19
3/27/20
Target Date
10962.24
11316.09
Money Market
22773.67
22779.8
EM
17675.3
13633.62
Commodity
13833.7
10125.48
Precious Metals
7861
8072.6
SPY Put
192.5
0
Stock
0
9591.62
Cash
0
1976
Total
$73,298.41
$77,495.21
Contributions
5677
Return
-1.9%
Future
As this pandemic and market turmoil continues, I’m trying to figure out my investing plan. While still maintaining a decent amount of emergency savings, I want to deploy some of my current and future savings into buying value stocks.
One of my first tasks is to reorganize my retirement accounts. The first action I did was to review what value funds are available in my 401(k). Based on the options, I’m going with Bill Nygren’s Oakmark Fund instead of the current target date. As for my 403(b), I’ve been procrastinating on going through the IRA rollover process. Once this is complete, the largest chunk of my portfolio will be able to be invested however I want, instead of the few funds available by the provider. Instead of the multi-asset class portfolio, I’m going to focus this IRA rollover on either individual value picks, or some value ETFs such as ZIG or QVAL.
The kind of stocks I’m looking for are quality, low debt companies at attractive cash flow yields. I’d love to find a great brand or consumer defensive company at a good price. So far these stocks aren’t cheap enough for my liking. Statistically cheap deep value stocks are an alternative if I can not find companies that fit my criteria. And of course, I could always buy some Berkshire.
Alternatively, I may pivot to Ben Graham net-nets. Right now it is difficult to foresee what the human toll, let alone the economic damage of this pandemic. If the effects cause a deep, but V-shaped recovery, then it may be wise to buy quality companies at bargain prices. On the flip side, if it turns out the economy is being shut down for months, we could be looking at the worst economic conditions since the Great Depression. In this scenario I may want to shift my focus to buying companies below their liquidation value. This may provide the best margin of safety in these highly uncertain times.
It’s taken me too long to get the wheels moving for my investing blog, but finally here we are. With the market turmoil stemming from the COVID19 crisis, I decided to expedite setting up the blog to document my thoughts and actions. This site is still work in progress, as I try to keep up with the market craziness, put out content, and learn the ropes of setting up a blog. While I have many plans for the types of content I’d like to publish, for the near term you can expect:
My thought process on the stocks I’m buying during this draw down
Updates on the performance of my portfolio
Sharing how I’m navigating, and trying to remain rational during this market volatility
I hope my content proves to be a useful contribution to the value investing community. Let me know what you think!
