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


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.



Wal-Mart: Great stock to own in rough times

Wal-Mart: Great stock to own in rough times

All these days 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 .