Tag Archives: united-states

NorthWestern Corporation – A Year After The Near $1 Billion Transaction

Summary Cash flow generation outpaced dilution from the acquisition. The debt level is acceptable. The stock isn’t cheap, but you are paying a fair price in exchange for stability. NorthWestern Corporation (NYSE: NWE ) is a utility company that operates in Montana, South Dakota, and Nebraska. The company is both a generator and a distributor of electricity and a distributor of natural gas. In November 2014, the company completed a significant transaction, buying up hydroelectric generating facilities for $904 million. The idea is that this will decrease the company’s overall risk profile, since this transaction would decrease the company’s reliance on purchasing agreements. This is similar to how Questar Corporation sources natural gas from its own subsidiary instead of just being a typical distributor. Thus far, investors have been indifferent, as the stock hasn’t gone anywhere in a year. Is there anything wrong? To complete the transaction, the company issued 7.77 million shares at $51.50/share and $450 million of debt at 4.2%. The debt seems cheap, but the share issuance increased total share count by 20%, so there was significant dilution. However, this doesn’t seem to be a problem, as the company has significantly increased its cash flow generation. Year to date, the company generated $304 million of operating cash flow versus $205 million from last year. This represents an increase of 48%, well above the dilution. If we ignore the working capital changes, the improvement is more subdued (+15% from $207 million to $238 million), but is still impressive nevertheless. From an earnings perspective, the company seems to have gotten into a bit of trouble in Q3, as EPS dropped 33% from $0.77 to $0.51. As we’ve discussed earlier, the company was quite healthy from a cash flow perspective, so what caused this discrepancy? The answer lies in the income tax expense. In Q3 2014, the company benefited from the release of some unrecognized tax benefit. This was not repeated in 2015. For that reason I think the company’s performance is better judged by its earnings before tax, which mirrored the cash flow growth, rising from $12 million to $30 million. Looking at the balance sheet, I don’t see any reason for investors to worry either. Although there is $2 billion of debt, there is no major redemption until 2019, when $250 million would be due. Considering the company’s high cash flow, I believe that the company should not have any problem paying it off or rolling it over. From a coverage perspective, the company currently has an EBIT/interest expense ratio of 2.8x in 2015. For companies in other industries, I would be very cautious, but since the company is in the utility industry, investors do not have to worry about wild swings that could jeopardize the company’s current capitalization. From a valuation perspective, the company’s P/E ratio has steadily climbed to 18x given the multi-year long bull market. While the stock is no longer cheap on an absolute basis, I believe if you are looking safety, NorthWestern Corporation will still fit the bill. In other words, you are paying a fair price in exchange for the company’s stability. Keep in mind that the stability I’m referring to is the company’s ability to generate a profit, not revenue. Due to swings in the commodity market, revenue will not experience steady growth, but as a utility company, the company should continue to generate steady profits. (See below) Takeaway The company has continued to deliver good results in 2015. I believe that the relative muted response from the market can be attributed to the overall pessimism in 2015. As we head towards year-end, it has become apparent that a multi-year long bull market is finally coming to an end. As we step into a more uncertain future, I believe that defensive investors should be very confident about holding on to a company like NorthWestern Corporation.

Why These Funds Are Happy When Energy Players Are Sad

If you believe that breaking a record is always a good thing, you’re actually wrong. For instance, the price of crude has been on a record-breaking mode since mid-June last year. However, every record has been for the worse as oil prices could set only new lows. Last Wednesday, U.S. crude prices fell below the psychologically-resistant level of $40 for the first time since late August. The downward pressure intensified when last Friday the Organization of the Petroleum Exporting Countries (OPEC) – the international cartel of oil producers – decided not to cut oil production especially in the already over-supplied crude market. Obviously, this has spelled doom for investors who chose to hold on to their energy funds or stocks. For example Zacks Mutual Fund Rank #5 (Strong Sell) energy funds such as BlackRock Energy & Resources Inv A (MUTF: SSGRX ) and RS Global Natural Resources A (MUTF: RSNRX ) have nosedived 30.1% and 41.4% over the last one year, respectively. The agony is such that none of the energy funds under our coverage has a positive year-to-date or 1-year return. The least loss has come from Fidelity Select Energy Portfolio (MUTF: FSENX ), which is down 13.4% year to date and 17.7% over the last one year. However, we don’t want to sound too pessimistic as you gear up for your year-end celebrations. Losses in the energy sector can actually translate into gains for some other sectors. While auto and transportation are the direct beneficiaries, sectors such as retail, consumer discretionary and consumer staples also gain from low oil prices. So, investing in and profiting from favourably ranked mutual funds that focus on these sectors will make December merrier. The Recent Headwinds for Oil Last Wednesday, the U.S. government data revealed a 10th straight weekly increase in U.S. oil supplies. The federal government’s Energy Information Administration (EIA) report revealed that crude inventories increased by 1.2 million barrels for the week ending Nov. 27, 2015. U.S. crude inventories are now at the highest level witnessed around this time of the year for the first time in 80 years. As a result, U.S. crude oil prices settled below $40 for the first time since August, while Brent crude oil plummeted to an almost 7-year low. A curb in production from the OPEC was most wanted to lift the already-low crude price. However before the meeting, OPEC decided to raise the ceiling of daily production from the prior level of 30 million barrels to 31.5 million barrels. The cartel was considering an output cut during the 7-hour meeting last Friday, but found that lowering of output only by the OPEC members will not be enough to lift oil prices. Crude plunged to settle below the $40 per barrel mark post meeting. WTI crude slipped nearly 3% to $39.97 per barrel. Oil Price to Move Further South? The slide in the price of crude has been quite dramatic given that it was hovering above $100 around a year ago. Several factors suggest that the end of the slump is nowhere near to be seen. Oversupply has distressed the industry for a long time now. This is due to two factors – the U.S. shale boom and OPEC’s decision to keep output unchanged despite the slump in prices. Lower consumption across the world is the reason for lower demand. Europe and Japan continue to struggle even as they make vigorous efforts to boost their flagging economies. But the biggest worry on this front is China. The world’s second largest economy may never again experience the pace of growth it witnessed until recently, leading to falling demand even in the long term. Funds to Enjoy Crude’s Loss Auto & Transportation: Fuel cost accounts for a considerable portion of expenses of the trucking companies. The U.S. trucking industry is currently poised to benefit in two ways. Lower oil prices will reduce their operating expenditure, thereby boosting the bottom line. On the other hand, capacity constraint in the form of driver shortage and new government regulations will drive top-line growth. A decline in oil prices is probably even more crucial for airlines. Lower jet fuel prices have been a boon for the airline industry given the inversely proportional relation between crude prices and the value of aviation stocks. Fidelity Select Automotive Portfolio (MUTF: FSAVX ) invests a majority of its assets in companies that manufacture, market and sell automobiles, trucks, specialty vehicles, parts, tires, and related services. The non-diversified fund invests in both US and non-US companies, primarily in common stocks. This Fidelity fund currently carries a Zacks Mutual Fund Rank #2 (Buy). Year-to-date, FSAVX has gained just 1.8%, but it is showing an increasing trend since late September. The 3- and 5-year annualized returns are 18.9% and 8.2%, respectively. Consumer Funds: Another class of stocks gaining from this phenomenon is consumer staples. The Federal Reserve has expressed satisfaction over an improvement in the labor market situation. However, its inflation target of 2% still seems some way off. This is again a result of lower oil prices. Lower inflation has led to a considerable fall in input costs. This again would cushion the bottom line. Fidelity Select Consumer Discretionary Portfolio (MUTF: FSCPX ) invests a lion’s share of its assets in securities of companies mostly involved in the consumer discretionary sector. FSCPX primarily invests in common stocks of companies all over the globe. Factors including financial strength and economic condition are considered before investing in a company. FSCPX currently carries a Zacks Mutual Fund Rank #1 (Strong Buy). FSCPX has gained 7.7% and 9.3% over year-to-date and 1-year period, respectively. The 3- and 5-year annualized returns are 18.6% and 14.7%, respectively. Putnam Global Consumer A (MUTF: PGCOX ) invests in mid-to-large companies that are involved in the manufacture, sale or distribution of consumer staples and consumer discretionary products and services. PGCOX uses the “blend” strategy to invest in common stocks of companies. PGCOX currently carries a Zacks Mutual Fund Rank #1. PGCOX has gained respectively 6.3% and 5.3% in the year-to-date and 1-year period. The 3- and 5-year annualized returns are 13.9% and 11%, respectively. Original Post

Employment Triggers A Green Light For A Fed Rate Hike, But…

By Jack Rivkin It’s still a slow-growth environment. Inflation is low. Investors can expect continued performance dispersion. Employment is off the table for the Fed As mentioned in our earlier video blog , the November employment gain of 211,000 combined with the upward revisions totaling 35,000 for September and October certainly took the employment issue off the table as a showstopper for a Fed Funds target rate hike this month. There are very few categories where the actual unemployment rate is above the 5.0% rate for the overall workforce: teenagers at 15.7%, blacks at 9.4%, Hispanics at 6.4%, those with less than a high school diploma at 6.9%, those with only a high school diploma at 5.4%, and I would highlight mining at 8.5% (versus 2.8% a year ago). I would posit that these levels are not the responsibility of the Federal Reserve to deal with. And, what is going on in the mining sector, which includes oil and gas extraction, may have added to the employment roles in other categories as lower energy prices increased both consumption and most companies’ (ex-energy’s) profit margins. The November beige book and the latest JOLTS report point to a tighter labor market with increased difficulty filling jobs and quit rates high, which point toward an increase in wage rates. The Fed does have to look at a tight labor market and make some judgments regarding this ultimate impact on inflation and the pace at which its 2% target is achieved. So what about inflation? The Fed’s preferred measure of inflation is the core personal consumption expenditure (PCE) index. That index is up only 1.3% year-over-year and was actually flat month-over-month in October. The general belief is that the US inflation rate may stay lower longer given the expected slow pace of global economic growth, the strong dollar and continued technological innovation. One cannot ignore the tragic events in Paris and San Bernardino as having an impact – on the margin, of patterns of consumer spending and, possibly, levels. This is likely to keep the Fed on a very slow path of target rate increases extending the runway for slow but steady real and nominal growth. I think this path will be followed until inflation actually picks up. I have some views on the timing of this, which I have been saving for this year’s Perspectives piece “What to Expect in 2016 (and Beyond),” but will provide a preview in a separate blog as a wild card to watch for. And what about the markets? In turn, these economic and financial results will likely produce slow growth – matching nominal GDP – in the US stock market if valuations stay close to current levels. The fixed income markets, on the surface, could also appear somewhat benign with a moderate increase in overall rates. No doubt, the slower pace of growth will produce specific credit issues – certainly in energy, but likely some other entities – but credit overall, may hold up reasonably well. The credit markets, at the moment, would appear to be pricing a broader disaster, particularly in the high yield markets. I think we will see some specific disasters – credit issues, but decent credit analysis can eliminate or reduce the impact. An actively-managed portfolio in high yield could be a logical allocation to a portfolio. Odds are some of the longer term trends in currency, commodities, and relative market performance will continue for a while with some bumps along the way when markets misread central bank actions or statements (à la Draghi) or geopolitical events cause temporary disruptions. So, how should one invest? In the table below, which looks at performance of the S&P 500 over the last several years, an interesting pattern emerges: When the market has been up or down double digits, all one really had to do was either own or sell the whole market. However, when we have experienced single-digit performance for the overall market, much as we are seeing this year, there has been significantly greater dispersion among stocks. This is an environment we expect to continue for some time-slow nominal growth in the economy and the equity markets, leading to dispersion of performance tied to active company management and active investment management. Why do we expect slow nominal growth to persist for several years making active management more important? There are at least four reasons (and I am sure some others): As Eric Peters of One River Asset Management recently reminded us, when the Fed takes action, which is typically designed to reduce the magnitude of an economic decline or surge, it has an effect on future patterns of growth. Easing pulls growth forward, while tightening pushes growth out, reducing the depth of the valleys and the height of the peaks and the distortions in employment and inflation those produce. We have been through an extraordinary pulling forward of future growth and it will take time for us to return to normal. The debt burden incurred by sovereign nations has been and continues to be enormous. If nothing else this will affect fiscal policy as the tool it could be to add to growth opportunities. China’s transition from a global engine for industrial production and consumption to a more internally-focused services economy, combined with the reversal of its own extraordinary steps to offset the impact of the western world recession – just look at the production and pricing of hard commodities beginning in 2009 – will be a damper on global growth for the foreseeable future. This bears watching to see how closely the yuan continues to track the dollar, or if it’s inclusion by the IMF as a reserve currency leads to a tracking of a basket of currencies and a different interest rate regime. Without putting too much weight on it, the “Buffett Rule” – future equity growth is problematic for a number of years when the total market value of equities exceeds the value of GDP – is operative. I discussed this anecdotally in a recent post . In a slower growth environment the likely dispersion of equity returns would push one away from index-hugging strategies toward active managers both long only and long/short managers. We have been suggesting this for a while. We would include private equity allocations in the active long only category if immediate liquidity is less of a need and the attractiveness of a potential illiquidity premium in a lower growth environment is magnified. We have these more active managers in our stable of funds, but others do as well. The key message is to adjust allocations to include more of these active strategies in the portfolio as one looks at the environment ahead. In the fixed income space, while there is risk of rate volatility affecting all debt classes, as big a risk would appear to be more specific credit issues. Does that mean one should be moving up the credit curve? I think the answer is in part, “yes.” But, the preferred way to do that would be similar to the approach on equities: Look for active managers – not benchmark huggers – who are analyzing specific credits and taking advantage of the homogenization of yields that comes from index buying and selling. The high yield index is offering a fairly significant yield spread over treasuries – very tempting as a category. But, just remember that around 18% of that index is in energy and hard commodity bonds. As shown below, the rest of the index, while at lower yields, is at spreads we haven’t seen for almost three and a half years. Historically, in a different energy regime, the rest of the index used to trade at higher spreads than oil and metals. At this stage, I would rather have someone looking at individual securities making up a diversified portfolio where the detailed analyses show relatively lower credit risks in the environment we foresee. Who knows? There may even be some energy credits that are worth holding but have been tarred by association. We see that in our own portfolios. There are certainly some credits in both high yield and investment grade where the credit default swaps don’t fully reflect the degree of risk at this stage. I want managers who are running portfolios where they can tell me the precise nature of the balance sheets of their individual holdings and the risks associated with the businesses. This is different from what has been required previously. One should not ignore the uncorrelated strategies, particularly systematic trend following. There are some long-term trends in place. While there are likely to be occasional reversals – some of which could turn into more permanent moves, I would rather use these managers to recognize the patterns and determine which foreign exchange, commodity, equity and fixed income indices should be included, negatively or positively, in the portfolio at any given moment in time given the environment we are facing. Allocations need to change It is hard to determine in isolation what the allocations in a specific portfolio should be. That requires a discussion. I know the allocations to active strategies should be higher. As I have been saying, past performance may not be the best guide for the future as opposed to a realization of a different pattern of future returns and an understanding of the volatilities and risks that exist in the environment we foresee. It is a less easy environment, with lower overall returns, but possibly a broader set of opportunities to meet one’s specific goals.