Year end performance report on my public portfolio at Covestor

Fed started year 2014 with tapering long term bond purchasing. Bond market has adjusted since last year with increase in long term rates and declining bond prices. As long term interest rates start going up, funds invested abroad will start coming back home. As fed stated, if short term interest rate or real interest rate starts going up that will put upward pressure on dollar relative to other currencies. This has many consequences including decline commodity prices including gold, silver and oil. On other side increase in interest rates bring funds invested abroad back to US, that has already evident in currency value drop at developing countries like Argentina, Brazil, India, Indonesia, Turkey and Venezuela.

We don’t know how much third part of the quantitative easing helped US economy but certainly did hurt the banking industry. It kept yield curve less steep; banks had no incentive to lend their deposits. By the time Fed completes bond purchase program long term rates will go up again to historical normal yield levels which are much higher than current rates; yield curve will further steepen which is generally considered boon to banking sector.

2013 was one of the outstanding years for the stock market returns; our long term value portfolio returned 39.7% net of fee and most of the returns in the portfolio were unrealized and long term which is taxed at much lower rate. As far as 2014, we can predict economy is going to be healthier but we don’t know what general market is going to do next year, most probably higher than last year.

Many leading economic indicators are exhibiting very positive trends. Average weekly hours on private non-farm payroll are stable, unemployment insurance claims are lower, the trend in new orders for durable goods, non-defense capital goods are up trending. New residential construction is picking up, money supply is increasing and yield curve is steep, bottom line is all leading economic indicators are in upward trend. Will markets in 2014 follow the economic trend? We believe chances are high. We don’t know what year end S&P 50o is going to be but can certainly comment on couple of strong trends.

Year 2014 is going to be very remarkable for oil industry. This year, domestic production of oil and natural gas is going to be at remarkable level. Probably first time in long term our energy exports are going to be more than imports. That will add up big time into GDP growth. Glut of oil coming from Canadian Oil sands, Bakken shale and Marcellus shale is choking transport lanes. Crude Oil stock levels are at highest level at Cushing, Oklahoma keeping wide price margin between domestic West Texas intermediate (WTI) and Brent crude from Northern Sea. As we calculated average price gap in the fourth quarter of 2013 was $11.87, probably the trend will continue in the near future. We see the biggest beneficiaries are oil refineries in the Midwest such as Holly Frontier and lesser extent domestic refiners at gulf shore. Next year we see there will be either consolidation in refining industry or these refiners command higher valuations as their profit margins go up.

Another trend in 2014 is going to be higher travel costs as airline industry went through consolidation. Six major airlines became three big carriers created oligopoly market in domestic and international routes. Only competition to these big three is South west airlines in domestic front and Jet Blue at certain segments;whereas international market is vulnerable for high prices. Only option for price conscious travelers is South West Airlines and Jet Blue but they serve only selected cities. Recently South West airlines announced it is going to get into International markets, and the repeal of Wright amendment gives South West airlines right to fly direct routes from Dallas Love field to any other city. Despite huge run in last year South West may still have bright outlook next year.

Disclosure: Long on HFC and LUV.
References: http://www.sreenimeka.com/econ.php

Second Quarter letter to Covestor

Markets never go up straight or go down straight either. If you are a long term investor market jitters should not scare you. It is even better if you had purchased some of your watch list stocks when market went down recently.  Our overall economy trending up, fundamentals are good, housing market showing strength, unemployment, manufacturing numbers are getting better. As more people getting employed there will be more consumer spending. I see clear skies ahead. Occasional markets down turns are good; sometimes they will hand good stocks at great prices.

As I discussed in my earlier letters gold has started trending down. All these days gold traders were able to sell snake oil by scaring the masses with war premium, unexpected inflation and dollar depreciation.  So far none of them were materialized. Inflation is still at or below one percent for the long time. In fact dollar is going to appreciate as real interest rate is going to go up.  It takes longtime to form market bubbles but it takes one little pop to start the melt down. That is what happening in the gold market. Chinese and Indians can’t buy all the global gold output in the world.  Gold is neither consumable nor perishable good and there is no intrinsic value for it. It does not yield anything; the true value of the gold is whatever other person willing to pay for it.  As of now Hedge funds are dumping gold; sooner or later central banks around the world will start selling gold reserves while prices are still high.  That is what happened during recent internet bubble and housing meltdowns. Mark Twain once famously said “History does not repeat itself, but it does rhyme”.

In this letter we would like discuss one of an undervalued stock in our portfolio, Holly frontier. Holly frontier is an independent oil refiner, refines approximately 450,000 barrels of crude at its five refineries. Holly refinery products include gasoline, diesel, and jet fuel. One of its subsidiaries owns 39 percent including 2 percent general partnership in Holly energy partners a pipeline company. Holly’s refineries at El Dorado and Tulsa are very next to Cushing, Oklahoma a storage hub for mid-western oil and where it purchases crude oil cheaper than competition.

Refineries make profit from crack spread that is the price difference between crude oil input and refined products such as gasoline, jet fuel and diesel. Crack spread is generally priced on Brent crude (Global crude oil) prices. However Holly frontier acquires all of crude domestically known as West Texas Intermediate (WTI). West Texas Intermediate trades lower relative to Brent due to rapidly growing domestic oil production from Bakkan shale fracking technology. At some point the spread between WTI and Brent was twenty dollars and recently at six dollars. So Holly margins come from two fronts, one from crack spread in addition to spread between Brent and WTI oil. Due to its unique proximity Holly generally pays WTI price compared to its competitors at gulf shores pay Brent price. This spread may continue for couple more years until Seaway pipe line completes which transports oil from Cushing to Texas Gulf.  During first decade of the century, WTI traded on average $1 more than Brent, but Holly’s ROIC during that period was at average of 22 percent.

Whatever market perception may be, Holly Frontier is trading relatively cheaper to its peers and to its intrinsic value.  As of July 1st the PE ratio of Holly is 4.6 and trading 1.3 times the book value. Holly’s average five year return on equity is at 29 percent and return on investments is 20 percent.

As of now Holly has 204 million shares outstanding, and last year operating cash was $1.6 billion and spent $335 million on capital spending, that lest $1.3 Billion of free cash. In other words the free cash per share is $6.5.  Assuming there is absolutely no growth and industry stays same, at $42 per share, you will get your investment back within six and half years.  Holly balance sheet has $2.5 Billion of cash and minimum debt and last year it paid $2.50 special dividend and $0.60 on regular dividend, which is equivalent to 7.4 percent dividend.  Market seems to ignoring screaming value stock, but we think Holly is one of the stocks trading well below its intrinsic value and should trade lot higher than current price.

First Quarter Covestor Letter

http://investing.covestor.com/2013/04/the-feds-liquidity-party-wont-last-forever

 

The Fed’s liquidity party won’t last forever

 

The first quarter of 2013 was a positive one for stocks. The S&P 500 Index(SPX) returned little over ten percent in the first quarter. We believe part of that can be attributed to relative calm atmosphere in Washington and part of it to modest global economic growth.

The unemployment rate declined and now stands at 7.6% from the peak rate of 10% in October 2008. The U.S. economy is showing strength year over year and GDP is moving up, but at slower pace.

Early baby boomers reached their retirement age during 2007 and the pace of their retirement is accelerating. We believe this demographic trend will have a significant impact on the economy. On the positive side, more jobs are available to young workers; but on the negative side there will be big vacuum of skilled labor also more entitlements need to be paid to these young retirees.

Short term interest rates have been at near-zero levels for quite a few months and long-term interest rates are at historically low. The U.S. Federal Reserve is  buying long term bonds and keeping long term rates artificially low. The housing sector is exhibiting pockets of strength due to low levels of inventory, lower mortgage rates and higher rental prices.

Long-term rates have moved down in tandem in the Western industrial nations, including the USA. Long term rates generally depend on short term rates, expected inflation and market participants’ demand and supply.

Currently the Fed’s accommodative monetary policy is keeping real interest rates low, but as employment numbers get better, We believe disposable income and discretionary spending will go up. In our opinion, that will put pressure on inflation and Fed should start raising interest rates.

Sooner or later, the Fed will stop buying long term bonds and long-term rates will start creeping up in our opinion. Biggest concern right now is that with bond investors looking for higher yields, they will buy lower quality junk bonds.

Probably the prudent  thing to do we believe at this point is to refinance mortgage loans and lower the duration of the bond investments; in other words, in our opinion investors should increase short-term bonds in the portfolios.

At the end of the first quarter, our portfolio trended up along with general market. Going forward, we believe the market should go up more from these current levels as more funds start moving from precious metals like gold and bonds into equities. As of now, we are fully invested in the market and may not make any significant changes to our portfolio.

 

 

My October Monthly letter to Covestor.com

The following letter to covestor wriiten on October 4th and published on October 27th.

Here is the publisher link http://investing.covestor.com/2012/10/we-bought-wal-mart-on-the-strength-of-its-global-push

 

We bought Wal-Mart on the strength of its global push

 by Sreeni Meka

 

Recently, the Fed announced a new monetary policy (QE3) in which the central bank will buy mortgage backed securities and start pumping money into economy. This aggressive monetary policy keeps long-term rates low and may spur activity in housing sector. But with sagging unemployment levels, I doubt how quickly housing sector can bounce back. Once bitten, twice shy.

With recent bad memories, bankruptcies and foreclosures, I suspect the public will respond very slowly to the housing sector even though there are hundreds of houses on the market at rock bottom prices. So will the banks, as they are still cleaning their balance sheets from a glut of unwanted properties. I would rather credit the foreclosed property investors for the recent uptick in the housing sales than the general public.

There is a wonderful book “The Wall Street Waltz” written by Ken Fisher (Forbes Columnist) on real estate cycles. In one of the chapters in his book he concludes from 150 years of data, that real estate prices go through cycles like any other economic cycles. According Fisher, from the peak of the real estate cycle to trough is around nine years and from trough to peak is nearly nine years. Let us assume if the real estate peak was in early 2007, then the bottom of the real estate market may not be until 2016.

If you think this time is different and the Fed is easing its monetary policy, there may still be few more years to go to reach the bottom of the real estate market.  There may be pockets of strength in real estate, but I won’t rush to invest in home builders and other real estate related companies. Caveat Emptor.

The biggest event in the fourth quarter is presidential elections. And by end of the year, the Bush tax cuts are going to expire. Long term capital gains tax rates are going to go up from 15% to 20%, and if your annual income is above $250,000 there will be 3.8% surcharge on capital gains. Dividends will be considered as ordinary income.

Market participants may not wait until the election results. Some of them may adjust their portfolios and realize capital gains this year rather than waiting until the last minute. Some companies may even declare one-time cash dividends before the end of the year.

In my opinion fiscal policies, including reduction of fiscal deficits, may do more to dictate future economic recovery than just changes in taxation or relying on monetary policy when interest rates are at zero percent. Oversupply of money into the market may benefit in short run, but will have painful consequences in the long run once inflation picks up speed.

For years Amazon.com (AMZN) has enjoyed a tax exemption on its online sales. From September 15th onwards the state of California joined Texas, New York and other five states in imposing sales taxes on Amazon online sales. The combined population from all these eight states is more than third of the national population. Next year New Jersey and few other states start collecting taxes from online sales. The well anticipated tax change can keep companies like Wal-Mart (WMT) is competitive edge with online retailers like Amazon, and may give second life to lone brick and mortar book companies like Barnes and Nobles and electronics retailers like Best Buy (BBY). But it certainly helps many big retailers like Wal-Mart. If the unfair tax advantage is eliminated people may tend to buy at brick and mortar retailers like Wal-Mart due to free shipping to nearest retail location for pickup and for convenience of sales returns.

Last month the Indian government eased restrictions on foreign retailers; Wal-Mart is now spreading its wings into the Indian market through joint ventures. Twenty nine percent of Wal-Mart’s revenue comes from international sales and revenues at international segment and are growing at a 15% rate, according to a recent earnings statement.

Wal-Mart has about 5,800 international retail stores; out of that Wal-Mart has only fifteen stores in India. The potential to serve more than billion customers in Indian market is tremendous.  Wal-Mart financials look impressive and can weather both tough and good times. Recently I included Wal-Mart into my portfolio.

I am a long term investor and most of my funds tied to assets are held for long term; however last quarter I have made few quick runs when short term opportunities with relatively less risk have arrived. Also I adjusted last few days of the September to protect the capital and to address my perceived volatility of the fourth quarter of this year.

Finally, as of October 4th, I have completed two years of managing the Long-Term Value (LTV) portfolio. In two years the cumulative portfolio return was 45.2% (net of advisory fees) versus 27.6% return of S&P 500 (excluding dividends), that is annualized returns of 20.4% (net of advisory fees) versus 12.8% on S&P 500 return. Year to date, LTV portfolio returns were 26% (net of advisory fees) versus 15% on S&P 500.

 

Recent Trades: Power One Inc (PWER)

 

 

Here is  my recent investment PWER (Power One); one of the old dogs from California. Power-One, Inc. engages in sale, and service of power supply products for the renewable energy (RE), servers, storage and networking, telecommunications, industrials, and network power systems industries worldwide. Predominantly focusing its energy into solar invertors . Invertors are used to store the power for future usage similar to batteries.

This stock is currently under performing due to decrease in sales growth and concerns about German and Italian government support to solar projects. Recently they have entered into emerging markets like India where Solar power projects picking up speed.

Apart from the market conditions, PWER balance sheet looks very attractive. PWER is trading at six times earnings and has $2.00 in cash with no debt priced at $4.60 (as of now) . The price to book ratio is 1.25, and has generated $148 million in free cash , that is equivalent to $1.21 per share ( Trading just four times free cash flow).

Market is treating this company as if there is no hope in the future, but based on the numbers it should trade lot higher ( 15 time free cash is nominal for US stocks). Bottom line, in my opinion it has little downside risk and can be bought over by its rival firms or private equity firms .

For more financial details , check Reuters web site, here at http://www.reuters.com/finance/stocks/financialHighlights?symbol=PWER.O

Disclosure: I purchased this stock for long term at my Covestor portfolio. Please do your due diligence prior to purchasing any of my trades I discuss here.

Groupon straddle looks appealing.

Straddle is a strategy you use it when you do not know the direction of the stock price. In straddle you buy a call and put at the same strike price. It’s a bi-directional trade. Here I am going to demonstrate how you can use straddle and make a trade of it using Groupon Options. On Friday October 5th Groupon (GRPN) closed up at $5.25. That is $0.45 or 9.37% price change in one day. The trading volume on Friday was 18 million versus daily average of 12 million.  Groupon quarterly earnings are coming on October 11th. I do not want to speculate what happens to the stock right after the quarterly results.

However there is lot of pressure on internet companies to show the profits and justify the valuations. Groupon has market cap of $3.4 Billion and has negative earnings of 12 cents per share in the last trailing twelve months. There is tremendous pressure on Groupon to show the great earnings numbers or else market is going to treat it really bad. If the earnings beat market expectations stock may go up really good or tank really bad if earnings numbers are bad.

Here let’s look at the option prices on Groupon to make a straddle .Generally, to create a straddle you buy both calls and puts at the money. Since Groupon is trading $5.25, we buy little out of money calls and puts. That is October 5.50 call and 5.00 put.

In this case both these calls and puts are trading at $0.25 each, so the straddle is going to cost $0.50. Or you can also interpret market participant are expecting at least ten percent of move after release of quarterly results.

In this straddle, there are two breakeven points, one at when stock is trading above $5.75 other at below $4.75. After earnings, If the stock does not move and stays at exactly at $5.25 both your call and put options loose value. Given the volatility and market expectations on Groupon the chances of staying at same price is relatively low.

Same time if stock goes to zero, your put price will be valued at $5.25 and your profit will be $4.75 which may not happen  or if stock goes really high your potential in call is unlimited. These are theoretical and exaggerated   case scenarios.  But given the market conditions and expectation on Groupon’ s earnings, there is greater chance that Groupon can move more than 10 percent in any direction and this straddle may end up in profit.

There is also another scenario, volatility can play bigger role in straddle.  Since earnings are few more days away, there may be last minute rush.  Many more market participants and speculators may enter into the trade to buy calls or puts that makes implied volatility to go up prior to earnings day. That is good news if you buy straddle on this stock. Volatility increases both call and put prices, you can even exit the straddle by selling your overvalued calls and puts right before earnings and can make quick profit.

Remember, straddle strategy is speculative bidirectional trade and you must be experienced in trading options and understand the risks associated with. I already own straddle on Groupon.

Wal-Mart: Great stock to own in rough times

Wal-Mart: Great stock to own in rough times

All these days Amazon.com enjoyed tax exemption on its online sales. From September 15th onwards state of California joined Texas, New York and other five states in imposing sales taxes on Amazon online sales. The combined population from all these eight states is more than third of the national population. Next year New Jersey and few other states start collect taxes from online sales. The well anticipated tax change keep companies like Wal-Mart on competitive edge with online retailers like Amazon, and may give second life to lone brick and mortar book companies like Barnes and Nobles and electronics retailers like Best Buy. But it certainly helps many big retailers like Wal-Mart.  If the unfair tax advantage is eliminated people tend to buy at brick and mortar retailers like Wal-Mart due to free shipping to nearest retail location for pickup and for convenience of sales returns.

Last month Indian government eased restrictions on foreign retailers; Wal-Mart is now spreading its wings into Indian market through joint ventures. Twenty nine percent of Wal-Mart’s revenue comes from international sales and revenues at international segment are growing at 15% rate. Wal-Mart has 5600 international retail stores; out of that Wal-Mart has only fifteen stores in India. The potential to serve more than billion customers in Indian market is tremendous.  Wal-Mart financials look impressive and can weather both tough and good times. Recently I included Wal-Mart into my portfolios including Covestor.

 

 

Disclaimer: These are my opinions, not a recommendation to buy or sell equities or derivatives. As always do your due diligence .