Monthly Archives: November 2015

A Year of Having Portfolio Companies Go Bankrupt

This year 2 of my portfolio companies filed for bankruptcy – American Apparel and Box Ships. Both have lessons for me.

Let’s first talk about American Apparel. The company was in the news for the removal of founder, shareholder and CEO Dov Charney for several sex scandals. The CEO then struck a deal with the private equity firm Standard General, boosting Charney’s stake in the company to 43% but giving Standard General a say over a large block of stock. Standard General also owned a huge chunk of American Apparel debt. I felt that there was a high probability that Standard General would facilitate a takeover or take private deal for American Apparel. Thus, with American Apparel stock trading at bankruptcy, my downside was low but upside large. Knowing that if I was wrong the stock would be worthless, I sized the position really small. While the investment did not work out as I hoped, I believe that my process was still correct.

The second company that filed for bankruptcy was Box Ships (TEU). I bought TEU for exposure to container shipping after I remembered that Motley Fool recommended the stock back in end 2011. I definitely did not see TEU filing for bankruptcy. Ultimately, I made an investment in TEU without really knowing much about TEU itself, though I knew something about the industry. I repeated a mistake I’ve made several times where laziness cost me. I should really eradicate this habit. Thankfully, the position in TEU was also small.

 

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Recent Oil Trades

After being badly burnt in March from crude oil trading, I gained enough confidence to start trading again in September to November.

Before talking about my recent trades, I’d like to mention how I badly missed the July downtrend. From the March debacle to June, oil was basically a boring market with the contracts range bound. WTI was hovering between $58-$64 and I wasn’t sure where the market was going though fundamentally oil was in bad shape.

On July 6, oil crashed and kept falling till it reached a low of $37.50 or so in mid-late August. That was a move of more than $10! I was really kicking myself because I had previously felt that the market would fall when the BHI Rig Count report showed an increase in rigs, which it did the Friday before. The second reason for the crash was the Greece debt turmoil and later the China currency turmoil. I had second guessed myself when I saw that the rig count report showed an increase in rigs and the market didn’t move lower. As a result of my thumb sucking, I missed the move.

Eager not to repeat the mistake, I started shorting oil in the $50-$52 range in September and covering back my shorts at the $45-$46 level. This kept me busy until early November when oil fell from around $50 to $50. I did catch this move through scale up selling initially and scale down buying later. This was prudent and I made a small sum. I also bearspreaded Jan 16 v June 16 and made a small sum there.

Currently, I do not have a position in oil any longer and am waiting for oil to recover above $45 or so before starting to short again.

Weight Watchers, Oprah Winfrey, and Averaging

Weight Watchers (WTW) has been on a tear since it was announced on Oct 19 that Oprah Winfrey had bought a 10% stake in WTW and was forming a partnership with them to help promote their products. In fact, since Oct 16 close (before the news announced) and Nov 9, the shares have increased by 2.5X.

As mentioned previously, I have a signifcant stake in WTW, albeit at significantly higher prices, so this news was good for me. When the news was announced on Oct 19, the shares immediately doubled and it was very tempting to offload my position. However, I held on an was subsequently rewarded when the price increased above my average cost price on Nov 6. Since then, I’ve been doing scaled up selling, more than halving my position.

I do think that this Oprah Winfrey news is very significant. The market also seems to think so since the price has gone up so much though shareholders are actually diluted by the new 10% shares that were sold to Oprah. The potential increase in revenues is very large. This seems confirmed by WTW’s Q315 earnings release and conference call. However, I feel it is prudent to reduce my position and perhaps buy again if the stock goes to say ~$15.

Another learning point is that celebrities can have signifcant effect on companies and the stock market. This is the first time that Oprah has effectively promoted a company and partnered with one to this extent. Her success with taking obscure books to national level is an example of her star power. Thus, it is good to be kept abreast with the culturally significant celebrities such as Taylor Swift. I feel vindicated on my decision to purchase those really expensive tickets and attend her concert.

Lastly, I would have done much better here if I had continue to average down on my WTW position while it fell. Most of my position in WTW was established through short put options at the $20-$25 range with some hefty premiums received (>20% return on the cash-secured portion). WTW fell all the way to $3.67, If I had continue to average down on my position, whether through dollar-cost averaging or by number of shares, I would have done much better in this position and made far more money. Instead, I’m left with modest gains though of course I erased a huge mark-to-mark lost.

To average or not to average is always a difficult consideration. On one hand there is the fear of catching a falling knife and putting good money to chase bad money, while there is the fear of missing out on lower prices on the other hand. In the past, I’ve frequently blindly averaged down on many positions while I nowadays only average down at strategic price points. In the case of WTW, it was a particularly hard call because there didn’t seem to be any light at the end of the tunnel. In hindsight, I do think that at $4-$5, I should have averaged down a little since my cost basis was $22 at that point.

Sun Edison (SUNE), SolarCity (SCTY), and Solar

Today I decided to take the plunge and long Sun Edison (SUNE) through selling cash-secured put options. A lot of my bullishness of the stock comes from knowing that David Einhorn owns it as well as a recent write-up by John Hempton of Bronte Capital about it,

SUNE reported earnings after the close last night and they missed EPS expectations by about 21 cents. The stock is down today about 18%. Since I don’t have a position in SUNE yet, I believe now would be a prudent entry point.

I’ve decided to sell put options instead of buying the stock because of the incredible implied volatility on the 156 day options. The IV is between 100-115%! Also, because of the sharp decline in the stock, the 50% delta option is not the same as the option with the strike closest to the current price of the underlying. Thus, I’ve split my risk by selling both the 50% delta option with a strike price of $7, and the 50% price option at $5. If both expire ITM and I’m put the stock, I my effective buy price would be in the low $4, a heft 20% or so discount to the current trading price. I believe this is a perfect example of how using options could yield a better outcome than trading the stock.

I also sold put options in another solar company: SolarCity(SCTY). I consider this a lower risk investment compared to SUNE as SCTY has a vertically integrated business model, allowing the company to control its cost structure as well as benefit from economies of scale. It also has the largest residential market share and a sizable commercial market share. SCTY. SCTY has the potential of earning a moat through achieving a cost advantage over its competitors due to its size and scale. Since SCTY had a lower IV and has also fallen by a lesser degree compared to SUNE, I sized the position to be smaller than the SUNE position.

Some thoughts on Solar: I made money in 2H2011 by being short solar. That was perfect timing as the solar industry literally imploded, Solyndra filed for bankruptcy, and many Chinese solar firms have since been bankrupted. What bothers me is that I missed the lows of First Solar in May 2012, which was also literally the bottom of the down cycle in solar stocks. This allows me to hopefully not repeat my same mistake.

I totally get the thesis that solar is a very long way from becoming a mainstream electricity source. This is due to our very primitive standard of battery technology, which is still at Generation 1.0 whereas we are in Generation 5.0 for jetfighters. This means that we are unable to cost effectively store the electricity generated through solar. However, I am also very aware that solar is becoming cost-effective with traditional power generation even without subsidies in many areas of the world, not just California. This is where I think the opportunity lies, not that Solar becomes a main power source for cities, but that it becomes an important contributor to the power grid and also where it becomes a standard investment in homes, just as say a garage or WIFI is.

Thoughts on Cloud Peak Energy (CLD) and Coal

I’ve followed Cloud Peak Energy (CLD) since 2011. While at M*, I learnt that CLD was one of the few companies which are worth a moat rating, in this case a Narrow moat. CLD was spun off from Rio Tinto with 50% in 2009 and and the remaining in 2010. It’s mines are all in the Powder River Basin (PRB) where extraction costs are the lowest. The PRB has thick and uniform coal beds which allow miners to use massive trucks and draglines, making PRB operations low cost and efficient. The downside to the PRB is that it is far from where coal is used, whether in the domestic USA or for export purposes. A very approximate estimate of CLD’s cost per ton of coal is USD10/ton ($9.14 based on the Q315 earnings call). In fact, CLD is the lowest cost producer of coal in the lowest cost coal-producing region of the USA. CLD regularly sells its production with forward contracts, which allow visiblity on its projected earnings. CLD has low leverage and has spent most of its free cash flow paying down debt.

With this information, I have in the past bought CLD stock at the $15-$17.5 range and then selling it above $20. I felt that CLD was an opportunity since its stock price was being dragged down by the broader weakness in coal stocks. This proved correct and CLD was basically rangebound in ithe levels that I bought and sold.

In mid 2013, I had already exited my position in CLD and felt that coal was becoming a really messy industry to be invested in. I also feared that coal was losing out to natural gas in power generation. However, in end 2013 and early 2014, coal stocks boomed due to a really cold winter in the USA, causing energy demand to spike. At this point, I started thinking that coal stocks need not be in a continuous downtrend since they could spike every winter. How wrong I proved to be! In mid 2014, I started accumulating CLD stock again after its price had dropped back to normalized levels. Unfortunately, that was in fact the start of a downtrend and CLD stock has gone all the way down to the $2-$3 range, losing easily more than 70% of its price.

Fearing catching a falling knife, I’ve basically not averaged down for the past 6 months. However, coal could be turning a corner. Details of uncertain EPA regulation on coal-fired power plants in the USA has been released. Of the 5 major US-focused thermal coal players, Alpha Natura Resources and Walter Energy have declared bankruptcy and Arch Coal is on the verge of bankruptcy. Peabody Energy (BTU) has very high debt levels but CLD’s stock price has fallen by just about the same as BTU’s. This makes me feel that CLD has been unfairly punished. After releasing stellar Q315 earnings, I’m starting to think that CLD could be turning a corner.

By any valuation ratio, CLD stock is undervalued. It is also rated 5 stars by Morningstar. The key though is always timing. Since I already have a large position in CLD at relatively high prices, I believe it could be prudent to start averaging down again.

Walmart (WMT)

Walmart (WMT) needs little introduction to most investors.

2015 has been a depressing year for WMT, The stock had fallen by about 20% from the start of the year to mid-August. After WMT’s investor day in mid-October, the stock plunged 10% as the company warned that they expect profits to drop as much as 12% in 2016 and flat revenue growth. The stock is on pace for its worst year since 1973.

Walmart is a company with a wide economic moat coming from its efficient scale and low cost advantage It’s size allows it to negotiate lower prices with suppliers, which then allows it to offer lower prices to customers. Of course, this moat is under threat from the rise of internet shopping. However, I don’t  think Walmart is going to go away anytime soon.

Many of the reasons cited by the company for it’s lower expected numbers for next year are justified or even necessary. For example, raising the minimum wage for workers should reduce the high employee turnover rate and also motivate the staff.  WMT plans to spend almost $2 billion over the next two years to improve it’s e-commerce operations, hopefully stemming the loss of business to Amazon, and maybe even winning some customers back.

Morningstar gives WMT a 5-star rating at below $60, with a low uncertainty rating. I sold puts on the name, giving me a ~8% return on the investment if the puts expire worthless. I’m happy to be put the stock at an effective buy price of $53, giving me a position in a low risk company with a wide economic moat.