Tag Archives: investing ideas

Technically Speaking: The Real Value Of Cash

With the ” inmates running the asylum ” during a holiday-shortened trading week, the upward bias to the market is set to continue. However, as I addressed last week: ” As we progress through the last two months of the year, historical tendencies suggest a bias to the upside . This is particularly the case given the weakness this past summer which has left many mutual and hedge funds trailing their benchmarks. The need to play ‘catch-up’ will likely create a push into larger capitalization stocks as portfolios are ‘window dressed’ for year end reporting . This traditional ‘Santa Claus’ rally, however, does not guarantee the resumption of the ongoing ‘bull market’ into 2016. The chart below lays out my expectation for the market through the end of the year. ” (click to enlarge) ” With the markets currently oversold on a very short-term basis, the current probability is a rally into the ‘Thanksgiving’ holiday next week and potentially into the first week of December . As opposed to my rudimentary projections, the push higher will likely be a ‘choppy’ advance rather than a straight line. ” So far, the analysis over the last several weeks has continued to play out as expected. However, and this is crucially important, a near-term expectation of a bullish advance due to the recent correction and seasonal tendencies is not the same as long-term bullish outlook . As stated above, while seasonality likely holds the cards through the end of this year, projecting much beyond that window is foolishness. The Real Value Of Cash This brings to mind a call I had on the radio show recently discussing his advisor’s reluctance to hold cash . The argument against holding cash goes this way: ” If you hold cash, you lose value over time to inflation .” This is a true statement if you hold cash for an EXTREMELY long period. However, holding cash as a ” hedge ” against market volatility during periods of elevated uncertainty is a different matter entirely. As I discussed previously: ” I have written previously that historically it is relatively unimportant the markets are making new highs. The reality is that new highs represent about 5% of the markets action while the other 95% of the advance was making up previous losses. ‘ Getting back to even’ is not a long-term investing strategy . ” (click to enlarge) In a market environment that is extremely overvalued, the projection of long-term forward returns is exceedingly low. This, of course, does not mean that markets just trade sideways, but in rather large swings between exhilarating rises and spirit-crushing declines. This is an extremely important concept in understanding the “real value of cash.” (click to enlarge) The chart below shows the inflation-adjusted return of $100 invested in the S&P 500 ( using data provided by Dr. Robert Shiller ). The chart also shows Dr. Shiller’s CAPE ratio. However, I have capped the CAPE ratio at 23x earnings which has historically been the peak of secular bull markets in the past. Lastly, I calculated a simple cash/stock switching model which buys stocks at a CAPE ratio of 6x or less and moves back to cash at a ratio of 23x . I have adjusted the value of holding cash for the annual inflation rate which is why during the sharp rise in inflation in the 1970s, there is a downward slope in the value of cash . However, while the value of cash is adjusted for purchasing power in terms of acquiring goods or services in the future, the impact of inflation on cash as an asset with respect to reinvestment may be different since asset prices are negatively impacted by spiking inflation. In such an event, cash gains purchasing power parity in the future if assets prices fall more than inflation rises. (click to enlarge) While no individual could effectively manage money this way, the importance of “cash” as an asset class is revealed. While cash did lose relative purchasing power, due to inflation, the benefits of having capital to invest at lower valuations produced substantial outperformance over waiting for previously destroyed investment capital to recover. While we can debate over methodologies, allocations, etc., the point here is that ” time frames ” are crucial in the discussion of cash as an asset class. If an individual is “literally” burying cash in their backyard, then the discussion of the loss of purchasing power is appropriate. However, if cash is a “tactical” holding to avoid short-term destruction of capital, then the protection afforded outweighs the loss of purchasing power in the distant future. Much of the mainstream media will quickly disagree with the concept of holding cash and tout long-term returns as the reason to just remain invested in both good times and bad. The problem is that it is YOUR money at risk. Furthermore, most individuals lack the ” time ” necessary to truly capture 30- to 60-year return averages. For individuals, trying to save for their retirement, there are several important considerations with respect to cash as an asset class: Cash is an effective hedge against market loss. Cash provides an opportunity to take advantage of market declines. Cash provides stability during times of uncertainty (reduces emotional mistakes) Importantly, I am not talking about being 100% in cash. I am suggesting that holding higher levels of cash during periods of uncertainty provides both stability and opportunity. With the fundamental and economic backdrop becoming much more hostile toward investors in the intermediate term, understanding the value of cash as a ” hedge ” against loss becomes much more important. As John Hussman recently noted: ” The overall economic and financial landscape, then, is one where obscene valuations imply zero or negative S&P 500 total returns for more than a decade – an outcome that is largely baked-in-the-cake regardless of shorter term economic or speculative factors. Presently, market internals remain unfavorable as well. Coming off of recent overvalued, overbought, overbullish extremes, this has historically opened a clear vulnerability of the market to air-pockets, free-falls and crashes. ” As stated above, near zero returns do not imply that each year will have a zero rate of return. However, as a quick review of the past 15 years shows, markets can trade in very wide ranges leaving those who ” rode it out ” little to show for their emotional wear. Given the length of the current market advance, deteriorating internals, high valuations and weak economic backdrop; reviewing cash as an asset class in your allocation may make some sense. Chasing yield at any cost has typically not ended well for most. Of course, since Wall Street does not make fees on investors holding cash, maybe there is another reason they are so adamant that you remain invested all the time. Just something to think about.

TransCanada – It’s Not The End Of The World, Rather A Buying Opportunity

The president has finally rejected TransCanada’s Keystone XL pipeline. The decision seems more political than economical, but it is bad for TransCanada which has already spent $2.4 billion on the project. Although the market has been focusing on the future of Keystone XL, TransCanada has other projects in its pipeline that could fuel its growth in the coming years. Energy East could be the biggest growth driver in the long term, but the management has laid emphasis on a number of small projects. Earlier this month, the Obama administration finally rejected TransCanada Corp. (NYSE: TRP )’s Keystone XL pipeline on the grounds that the project was not in U.S. national interest and could reflect poorly on the country’s global leadership in protecting the environment. The decision, which was widely anticipated, finally concludes TransCanada’s seven-year efforts in getting an approval for the 830,000 barrels a day pipeline from the current administration. The decision seems more political than economical. It is difficult to imagine how a 1,179-mile pipeline spread over six states which would have mostly carried crude from Canada’s oil sands, but also up to 100,000 barrels a day of North Dakota oil, to Gulf Coast refineries would not lead towards meaningful economic benefits for the U.S. and Canada. Besides, the State Department’s environmental review , released in Jan. 2014, had already stated that the construction of the pipeline will not have any substantial negative impact on the climate. On the contrary, the rejection could increase the Canadian oil sands producers’ reliance on rail for delivering the crude to the U.S., which is far more carbon-intensive than the pipeline. Nonetheless, the decision is bad for TransCanada which has already spent C$2.4 billion on the project. A significant chunk of the expenditure could be written off as non-cash pretax charges in the coming quarters. The investment which related to the physical pipeline and equipment, however, can be utilized on other projects. As I have discussed previously , TransCanada has several options on its table following the rejection. The company can seek remedies under the energy chapter of the North American Free Trade Agreement, construct a rail loop that would connect U.S. and Canadian pipelines, or simply wait until a new U.S. president arrives in 2017 and then file another application. However, it is also important to note that the rejection is not the end of the world for TransCanada. Although the company’s stock declined 5.2% on the day of the rejection and has failed to completely recover completely since, I believe this could be an interesting buying opportunity. Although Mr. Market has been largely focusing on the future of Keystone XL, TransCanada has several other projects in its pipeline that could fuel earnings and cash flow growth in the coming years. This includes the giant Energy East pipeline which is bigger than Keystone XL in terms of investment, capacity and impact on the bottom line. Energy East, which comes with a price tag of more than C$12 billion as opposed to Keystone XL’s C$8 billion, will be able to ship up to 1.1 million barrels of crude per day from Alberta to Eastern Canada. Once Energy East becomes fully operational by 2020, it can lift TransCanada’s annual earnings (EBITDA) by C$1.8 billion. Keystone XL, on the other hand, was supposed to generate annual earnings of C$1 billion. Overall, excluding Energy East and Keystone XL, TransCanada has a backlog of C$15 billion of commercially secured major projects that can lift its annual earnings by more than C$1 billion in the long-term, according to my rough estimate. Energy East pipeline What’s even more interesting is that during the recently held investor day (Nov. 17), TransCanada emphasized that in addition to the major projects, it also has a C$13 billion backlog of eleven smaller projects, none of which require investment of more than C$1.4 billion, which will drive its growth over the next two years. Some of these projects, such as the Houston lateral and terminal, Topolobampo, Mazatlan and Canadian Mainline, will begin to contribute to earnings in 2016 while some of the bigger ones with capital cost of at least C$1 billion each, such as the liquids pipelines Grand Rapids and Northern Courier, will fuel earnings growth beyond 2016. Overall, the small and large projects are forecasted to drive 8% to 14% increase in annual earnings through the end of the decade. This will lead towards an average of 8% to 10% increase in dividends in each year through 2020. That’s higher than the CAGR of around 7% witnessed over the last fifteen years. Thanks to the recent drop following Keystone XL’s rejection, the stock is already offering an attractive yield of around 5%, which is higher than the industry’s average of 3.2%, according to data from Thomson Reuters. I believe the recent weakness could be an opportunity to buy this pipeline stock and earn strong returns in the long-run.

Karoon Gas – Give Me $1.00, I’ll Give You $1.20 And 2 Significant Oil Discoveries

Summary Karoon is a depressed stock trading 20% below cash backing due to a low oil price, and several major shareholders exiting the stock. A major selloff has resulted in Karoon being significantly undervalued. Provides fantastic long term exposure to a rising oil price with 85 mmbbls of 2C reserves from 2 recent oil discoveries. Karoon Gas is currently in the process of buying back up to 10% of stock on issue. Overview Karoon Gas (ASX: KAR, OTCPK:KRNGF , OTC:KRNGY ) is an Australia-headquartered oil and gas company with exploration opportunities focused in North-West Australia, Peru, and Brazil. With a set of great oil prospects, and no major gas prospects, they should consider changing their name to Karoon Oil. Of all the sell-offs in the oil and gas sector, this one has intrigued me the most. On a market cap of AU$450 (US$319) Million at the current share price, they sit on cash of AU$550 (US$390) Million. This cash came from their recent sale of their Browse Basin permits to Origin for the following: An upfront payment of US$600 Million (Received) A deferred cash payment of US$75 Million payable on FID A deferred cash payment of US$75 Million payable on first production A deferred cash payment of US$5 Million for every 100 BCFe of independently certified 2P reserves exceeding 3.25 TCFe Reimbursement of the costs associated with drilling its 40% held Pharos-1 well. (Received) So why are they trading so low? Apart from the oil price, I think it is primarily due to these 3 factors: Several major investors have exited the stock over the last year. IOOF Holdings, Future Fund Board of Guardians, and Paradise Investment Management all ceased to be substantial holders, selling out a major portion of the stock. The company has some corporate governance issues. There are concerns that family members of the chairman Bob Hosking are appointed on key positions at the company, as pointed out by the activist hedge fund manager Pegasus. The majority of shareholders may or may not agree with this, and I myself have questions regarding it, but none of the three candidates that Pegasus put up for election were voted in. A lot of Australian companies have corporate governance issues, and activist investment is much lower than in the US. Like any market risk, this is a risk that must be weighed against the benefits. Speculators pushed the price up to obscene levels, and then pushed the price back down in fear Despite these issues, Karoon has a great track record of increasing the long-term value of shareholders when you normalize for the boom and bust cycle. Past speculation during the boom had driven the share price as high as $12.10 – it currently sits at $1.81 at the time of writing. Karoon is, at present, up over 950% from 2004 and has managed to unlock plenty of cash for the exploration and appraisal of their major Brazil operation in the Santos Basin. (click to enlarge) ( Google Finance ) Offshore Brazil (Two Significant Oil Discoveries) The map below shows the Kangaroo and Echidna resource as well as the Bilby oil discovery dating back to 2014. (click to enlarge) ( Source – Karoon Annual Report 2015) Kangaroo went through further appraisal in 2014, production testing at rates that signaled a single vertical well could flow 6,000-8,000 bopd from a net pay of 135 meters ( Source ). It needs to be noted that Kangaroo 2 also had two side tracks as part of the appraisal that indicate that this may be a complex reservoir which would enhance the cost and difficulty of production. Despite the complexity, it remains a significant find that has a great chance of commerciality. Echidna followed up the Kangaroo discovery with a 103 meter net oil column and a facility constrained flow test 4650 bopd, further enhancing the chance of a commercial discovery for the region. (click to enlarge) ( Source ) From an operational perspective , Karoon is looking at a variety of options for producing the Echidna and Kangaroo discoveries that are less than 50km apart. The lowest capital cost method includes a Floating Production Storage and Offloading Vessel (FPSO) producing roughly 20,000 barrels of oil per day (bopd), then expanding that to 50,000 – 70,000 bopd once the field has been proven. Discussions for the development of Kangaroo have also involved Petrobras for an integrated oil hub in the region, which could be economic as low as $43/bbl according to Citigroup ( Source ). The same article also denotes the drop in costs which could make the project economic at even lower prices “Because it’s a distressed market now worldwide, we are looking at redeployed assets, for example, a redeployed FPSO [floating production storage and offloading vessel]. The labor market is getting cheaper, the labor is getting cheaper; we see there’s a lot of cost savings for us.” One of the primary reasons for investing in Karoon is that there is almost no value attributed to the Kangaroo and Echidna discoveries. After writing off Karoon’s AU$105 (US$76) million tax liability against its cash reserves, the 2C reserves equate to a value of AU$0.41 (US$0.29) /bbl. However, investors must keep in mind that production isn’t likely oncoming until 2018 at the earliest while Karoon moves through engineering and approvals, and this may hold the share price back for the medium term. Offshore Peru and Offshore Australia After all this, Karoon still has more to offer. A possibility of more major discoveries exists offshore Peru and Australia. Nearly 27000 square kilometers of permits sit on the acreage outside of Brazil, with significant long-term potential for Karoon. They have a habit of bringing in joint venture partners to free carry them through the initial drilling stages to minimize the capital outlay from Karoon. These are likely to sit for several years during the current supply glut, however, they provide some great upside for an oil recovery. (click to enlarge) (Karoon Annual Report 2015) Share Buyback One of my favorite things to see a company do is an all-cash share buyback – specifically when their share price is trading at an all-time low. Karoon has bought back 9.4 million shares at $3.27 over the last 12 months as well as announcing plans to buy back a further 25 million shares. That comprises up to 10% of the company’s ordinary shares on issue and will further expose investors to the upside of an oil price recovery in 2-3 years. On top of all that, Karoon has a significant amount of built up exploration expense of $AU485 Million that can be written off against future cash flows. Risks and Uncertainties Karoon is in the early stages of several significant oil discoveries. There are plenty of issues that need to be sorted out, and a significant amount of cash that needs to be spent to bring these oil fields into production. Production is not likely to begin for several years, and the oil price currently sits at levels that would make these projects uneconomic. Most investors would agree that the current supply glut will not extend out to 2018, however, it is possible and poses a significant risk as Karoon spends more on the appraisal process. Karoon also has no source of cash flow, and Origins deferred payments are unlikely in the current environment. Conclusion Having several major investors exit the stock over the last 18 months has left the share price in the doldrums. While Citigroup has calculated a combined development for Kangaroo and Echidna would be economic as low as $43, I would not expect the project to go ahead unless oil moved well into the 60’s – unless the resource is found to be much larger than current estimates. There is plenty of unrealized value in this stock with hardly any value attributed to the Kangaroo and Echidna discoveries, and no value to the significant amount of exploration expense that Karoon can write off against future cash flow. Karoon’s cash reserves can be used to develop these discoveries and increase shareholder value at the same time the share buyback is increasing investors oil exposure per share. As for the remaining Australian/Peruvian blocks, Karoon will likely delay drilling as much as possible to preserve cash for the Kangaroo and Echidna discoveries. Overall, there is a significant amount of risk around Karoon going forward. They are in the early stages of appraising these reservoirs while the oil price has crashed. However, a crashed oil price means cheaper drilling, completions, procurement, and construction. Karoon would not be likely to produce oil until 2018 at the earliest, and there is plenty of time for the oil price to recover in that time period. As the Financial Review quoted from an RBC Capital Markets report “Whilst high risk, this is a freebie and success would open a significant new oil play.” I love Karoon as an asymmetric bet on an oil recovery, and I can confidently see an upside of well over 100% in the next 3-5 years in the event that the oil price recovers. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.