Monday, January 31, 2022

Copper Prices at 5-Week Lows. Is this a Bad Sign for the Global Economy?

Aluminum and copper prices are a study in contrast. Aluminum is trading near all-time highs (See Exhibit 1: Aluminum Trading Near All-time High Price) while copper's rally is beginning to fade. Copper is trading at 5-week lows.  

Exhibit 1: Aluminum Trading Near All-time High Price

According to Trading Economics, low inventory levels, the power crisis in Europe, and Ukraine-Russia tensions are all to blame for this incredible rally in aluminum.

Meanwhile, copper prices are at five-week lows due to the strong dollar and increased production. Trading Economics reports that Chilean authorities are projecting that copper production will increase by 4.1% during 2022, returning to pre-pandemic levels. Even at its current price of $4.32/lb, copper is trading at all-time highs (See Exhibit 2: Copper Prices at 5-Week Lows). I am watching copper see if it falls below $4/lb. Falling below that price level may be a bearing sign not only for copper but for the world economy.

Exhibit 2: Copper Prices are at 5-Week Lows


If copper continues to fall, the stock prices for miners, such as Rio Tinto (RIO), might fall with it. The share price of Rio Tinto has tumbled about 9% from its peak of approximately $78.48 achieved in mid-January (See Exhibit 3: Rio Tinto's Share Price Takes a Hit in January).

Exhibit 3: Rio Tinto's Share Price Takes a Hit in January

(Source: Seeking Alpha)


Friday, January 28, 2022

Invest in an Equal-Weight ETF in these Turbulent Times.

The S&P 500 index is market-capitalization-weighted. The weighting by market cap means the companies with the largest market capitalization (Market capitalization = Number of shares outstanding x Share Price) get the highest weight. Last year, this method for calculating the index made the five largest companies by market cap account for 23% of the index. That is just 5 out of the 500 companies accounting for about a quarter of the market capitalization. These five companies were: Apple, Microsoft, Alphabet (Google), Amazon, and Facebook (Meta). When the share price of these companies starts underperforming, the market takes a huge tumble. We can see that happening now. The S&P 500 index (VOO) is down about 9.72% (pre-market on January 28), while the S&P 500 equal-weighted ETF (RSP) is down 7.48% (See Exhibit 1: Invesco Equal-Weight ETF Beats Vanguard S&P 500 Market-Cap Weighted ETF). That is a difference in the performance of 224 basis points. In essence, the equal-weight ETF outperformed the market-cap ETF. The dividend yield is about the same for both ETFs. The Invesco Equal-Weight ETF charges a higher expense ratio than the Vanguard S&P 500 ETF. Invesco charges 20 basis points (bps) or 0.2%, while the Vanguard S&P 500 ETF (VOO) charges three bps or 0.03%. Invesco charges 7x more than the Vanguard ETF. Even after deducting the extra expense of investing in the Invesco ETF, it comes ahead in performance by over 200 bps.  

The era of big-tech is coming to an end due to more regulation and their size inhibiting growth. At least for now, Apple seems to be bucking the trend after reporting blockbuster results yesterday. Interest rates are also rising, putting pressure on valuation because future earnings will be discounted at a higher interest rate. It may be good to have a position in the Invesco Equal-Weight ETF (RSP) during these times. 

     Exhibit 1: Invesco Equal-Weight ETF Beats Vanguard S&P 500 Market-Cap Weighted ETF
(Source: Seeking Alpha)
Also, there may be other equal-weight ETFs in the market. I am aware of Invesco's ETF, so I have invested in it. I am not endorsing the Invesco ETF. 

Monday, January 3, 2022

Few Things to Know About Our Current Energy Transition from Fossil Fuels to Renewables.

In a discussion hosted by Bridgewater Associates (the world's largest hedge fund), Daniel Yergin discussed the current energy transition, geopolitics, and government. Daniel Yergin emphasizes a few things about our energy transition:

  • Energy transition to oil from coal took nearly a hundred years. 
  • Instead of trying to control oil supplies, now we are trying to control materials used in batteries and solar panels. Increasing lithium and cobalt prices pose a challenge for electric vehicles. 
  • Electric vehicles may need subsidies to make them affordable. 

Governments can offer subsidies, but the loss of revenue due to the subsidies need to be compensated by higher taxes, lower social benefits, or higher deficits. The world is grappling with excessive debt levels and does not have the flexibility to take on more deficit spending. Take the example of Japan, where the outstanding government bonds have crossed one thousand trillion yen for the first time.    

You can watch the Daniel Yergin discussion on YouTube.  

Sunday, January 2, 2022

Energy Transition will be Messy and Expensive. Hold on to Your Barrel of Oil for Now.

Many people anticipate that electric vehicles will win the transportation race and replace the internal combustion engine. Many journalists and energy experts have been warning for a while that the transition from fossil fuels to renewables will be messy. Daniel Yergin says that we are in an energy-mix era

Lithium - one of the critical materials used in batteries - is in short supply, and its prices have increased by 5x. Electric vehicle battery costs are set to increase for the first time in a decade. 

Meanwhile, European Union is beginning to realize that they cannot simply abandon nuclear power and still keep the lights on. They plan to classify nuclear power and natural gas as "green" power sources. In my opinion, there is no such thing as fully green energy. For example, lithium mining and mining for other materials in producing an electric vehicle are damaging to the economy. The world needs good recycling technology to create a circular economy and minimize emissions and environmental damage.       

General Motors Ultium Battery and Global Vehicle Platform for Electric Vehicles.
(Source: General Motors)

The surge in oil prices in the past year, coupled with the reluctance of oil companies to invest in new oil discoveries, could lead to higher energy prices and even an energy shock. This lack of investment in new oil supplies could increase inflation.   

Covered Call on J. M. Smucker, Public Service Employee Pay in China, Indonesia's Foreign Relations Dilemma

I recently wrote about my investment thesis for J. M. Smucker (NYSE: SJM) on Seeking Alpha. I have also written in the comments section about how selling a covered call on $SJM at current prices can boost overall investment returns.  

J. M. Smucker's Has Timeless Brands, but the stock has run up a lot. 
(Source: J. M. Smucker)

Nikkei Asia has published a fascinating article on how China cut public employees' paychecks. Many Chinese citizens are probably amazed and shocked to learn that some public employees make 200,000 yuan a year. Their paychecks are getting cut by about 25%. Cities in China were collecting revenue from land sales, but there are not many land sales with the indebted real estate market anymore. 

Indonesia is grappling with more meddling from China in the South China Sea. China is trying to assert itself in Asia.  

Note: Please pay for good journalism. When you support good journalism, you are keeping your freedom. Also, each day you will go to bed brighter. I read a lot of articles on Seeking Alpha every day. I subscribe to The Economist, The Financial Times, Barron's, Nikkei Asia, Bloomberg BusinessWeek, and The Wall Street Journal. I have a subscription to Seeking Alpha because I am a contributor on that site. 

Fun Fact: Nikkei - a Japanese company - owns The Financial Times.      

Monday, December 27, 2021

Comparing Inflation Using Producer Price Index (PPI)

The Bureau of Labor Statistics does a world-class job of compiling the producer price index (PPI) across multiple industries and product groups. I wanted to better understand inflation from one category - Fruit and Vegetable Canning. 

We know 2020 was a year like no other in world history. Demand slumped initially when the pandemic shut down the economy. But, the stimulus that was unleashed in the U.S. and across the world helped stimulate demand for products. The work-from-home trend added to the need for furniture and laptops. Comparing the producer price index between 2020 and 2021 may not accurately picture inflation. So, I have compared the change in the index between 2019 and 2021 for the fruit and vegetable canning industry. That shows a sharp increase in inflation (See Exhibit: Increase in Producer Price Index Between 2019 and 2021). The graph also shows the trend line and the equation. The slope for the change in PPI between 2019 and 2021 is 0.0037. The data used is for January to November for each year.   

Exhibit: Increase in Producer Price Index Between 2019 and 2021 (%)   

(Source: BLS, Author Calculations)

We compare this producer price index year-over-year change with change in PPI for the fruit and vegetable canning industry between 2007 and 2009 (See Exhibit: Increase in Producer Price Index Between 2007 and 2009 (%)). The year 2009 was when the world was coming out of the deep recession caused by the U.S. subprime mortgage crisis. Inflation for the fruit and vegetable canning category saw a year-over-year increase of 14% between 2007 and 2009. The slope was -0.0021 showing that the inflationary pressure tailed off by the end of the year in 2009. In 2021, the price index is still increasing.   

Exhibit: Increase in Producer Price Index Between 2007 and 2009 (%)  
(Source: BLS, Author Calculations)

In the first half of 2022, the stimulus-driven demand should be fading. That should lead to moderation in the growth of the producer price index.  
      

 

Sunday, December 12, 2021

Oracle: Excelling in Financial Engineering.

Oracle (ORCL) faced its first real challenge to its business model from Amazon AWS (AMZN). For a long time, Oracle's relational database has been the standard for many companies in the Global 2000. Oracle's database is still so entrenched in many corporations across the globe that they pay millions of dollars in Oracle license and support fees each year to keep the right to use their software. But, companies formed in the last 10-15 years have shunned the Oracle database. Instead, they have relied on myriad open-source database options and cheaper databases from other companies. The advent of AWS made it easy for any company to manage databases in the cloud. 


Oracle has lagged behind the prominent three cloud vendors in offering infrastructure-as-a-service (IaaS). The company has a reasonably significant market share position in SaaS software, where it competes against the likes of Salesforce (CRM), Workday (WDAY), and SAP (SAP). But, Oracle is still heavily dependent on revenue from its database software. Since Oracle cannot attract new customers to its database, it has resorted to using its existing database install base as an annuity business. In essence, the Oracle database software generates much rental income from its remaining customers.  


In the face of Oracle management's inability to innovate and compete, they have resorted to financial engineering to prop up their share price. A company innovating and competing well in the marketplace is most likely growing revenues. At the very least, revenue growth needs to keep up with GDP growth. Unfortunately, there is no revenue growth at Oracle. In the fiscal year ending May 31, 2011, Oracle had total sales of $35.622 billion. In the fiscal year ending May 31, 2021, Oracle had total sales of $40.479 billion. That equates to a 13.6% growth in revenue over 11 years. The 13.6% rate amounts to a compound annual growth rate (CAGR) of 1.16%

Exhibit: Oracle Annual Sales Revenue from Fiscal Year Ending on May 31, 2011

(Source: SEC.GOV)

How does a company show earnings per share (EPS) growth when revenue growth is nonexistent? Investors react positively to a growing EPS number. One way to show an ever-increasing EPS number is to repurchase the company shares and retire them. The repurchase transaction reduces the outstanding shares, and thus when stagnant net income is divided by outstanding shares, the resulting EPS number looks as if it is growing. 

The company has spent billions of dollars each year repurchasing its stock. The company has spent $137.65 billion in repurchasing its shares in 11 years. Initially, the share repurchases did not do much to the stock price. So, in recent years, the company has gotten even more brazen in buying back its stocks (See Exhibit: Annual Amount in Billions Spent by Oracle on Share Repurchase).  

Exhibit: Annual Amount in Billions Spent by Oracle on Share Repurchase 

(Source: SEC.GOV)
One way to analyze how much the company has spent on its repurchase is to compare its operating cash flow to the repurchase amount. The company had $155.212 billion in operating cash flow in 11 years and it spend 88.6% of that in buying back its own shares.
 
Exhibit: Oracle's Annual Operating Cash Flow

(Source: SEC.GOV)
In the end, Oracle's management led by Safra and the company's largest shareholder - Larry Ellison - benefit the most from these buybacks. Larry is now on the list of the top-10 wealthiest people in the world solely due to these buybacks. Due to these buybacks, the stock has risen a lot, and ordinary investors should prudently book profits. You do not want to be in this stock when the music stops.  





        

 

   

Saturday, December 11, 2021

Why ViacomCBS's Preferred Shares (VIACP) are a Great Buy Currently Offering 10.68% Dividend Yield?

In January 2021, during the start of the meme stock bubble, ViacomCBS (VIAC) stock started climbing from about $36. The stock kept on climbing until March 22, 2021, when it traded briefly above $100. Other than a few Wall Street banks, nobody knew why it was rising. Even the Wall Street banks did not have a complete picture. It was also around the Super Bowl, so CNBC host Jim Cramer speculated that it might have had something to do with all the Paramount+ ads that aired during the Super Bowl. Paramount+ is ViacomCBS's streaming brand. 

But, Bob Bakish, the CEO of ViacomCBS, did not care about why the stock was rising. He needed all the money he could get to feed his company's push into the streaming business, and with the stock trading at an all-time high, he decided to make use of the opportunity. So, the company sold 10 million preferred shares at $100 with a 5.75% yield and issued a further 20 million of class B common stock. The class B common stock causes immediate dilution of existing shareholders.

Exhibit: The Spike in the Price of ViacomCBS During the Archegos Scandal 

(Source: Seeking Alpha)

The dividend on the preferred works out to a quarterly dividend of $1.435. The preferred shares have a mandatory conversion clause that would take effect in April 2024. The preferred shares will convert between 1.0013 and 1.1765 into ViacomCBS common shares. Since the preferred stock is currently trading below the offer price of $100, each preferred share would be converted to a maximum of 1.1765 shares of the ViacomCBS common shares.  

Once Bob made this announcement about the issuance of the common and preferred shares, the stock promptly tanked. Soon it became clear that ViacomCBS and Discovery (DISCA), Inc (home of HGTV, Food Network, and other channels, were both caught up in the Archegos Capital Management scandal that nearly brought down Credit Suisse. Other Wall Street banks booked millions of dollars in losses when they allowed Bill Hwang (owner of Archegos Capital Management) to speculate on the stocks of ViacomCBS and Discovery. Credit Suisse booked over $5 billion in losses due to the scandal.

Exhibit: Spike in Discovery Shares During the Archegos Scandal

(Source: Seeking Alpha)

The stock has flat-lined lately due to increased competition in the streaming business and the increased cost of customer acquisition. Did you notice the deal that Discovery was offering during the 2021 Thanksgiving break? Discovery offered three months of subscription at $0.99 per month.     


ViacomCBS is a solid company with good cashflows, and its content library is top-notch. The preferred stock now offers a 10.6% dividend yield, which you can get until 2024. In early 2024, we can decide to either stay invested in the preferred shares or exit before the mandatory conversion date in April.


The debt to EBITDA multiple is at 4x. So, debt is a concern, and I prefer to see companies at a debt to EBITDA multiple 2x. One caveat to remember is that Discovery is acquiring Warner Media from AT&T. Discovery will have a 5x debt to EBITDA after the acquisition.

Exhibit: Debt to EBITDA Ratio for ViacomCBS, Walt Disney Co., and Discovery 

(Source: Seeking Alpha)
The high level of debt may be negative, but the company has the cashflows to cover it. Its quick ratio is above 1 indicating that the company has the liquidity to cover the current liabilities.  

Exhibit: Quick Ratio for ViacomCBS, Walt Disney Co., and Discovery
(Seeking Alpha)
 
The company's return on equity is much higher than that of Walt Disney and Discovery and comes in at around 18%. 

Exhibit: Return on Equity for ViacomCBS, Walt Disney, and Discovery

(Source: Seeking Alpha)

Its return on invested capital is higher than that of Walt Disney and Discovery.  

Exhibit: Return on Invested Capital for ViacomCBS, Walt Disney, and Discovery

(Source: Seeking Alpha)
I own both ViacomCBS Class B (VIAC) and the preferred stock (VIACP).  I also own Discovery (DISCA), and Walt Disney (DIS). But, I am most bullish about ViacomCBS. They have already acquired over 43 million customers. They have a customer acquisition deal with T-mobile to offer their Paramount+ subscription as part of their plan. That should bring in millions more customers to ViacomCBS.  
Exhibit: Paramount+ Subscription Included in T-Mobile Cell Phone Service 
(Source: T Mobile)

Finally, the company is trading at an EV to EBITDA multiple of just 6x and Discovery is trading at just around 3x. Disney is trading at an EV to EBITDA multiple of 34x. Both ViacomCBS and Discovery are trading at steep discounts. Yes, the competition is intense and the customer acquisition cost is high, but the content is top-notch. All media companies need content more than ever. But ViacomCBS will thrive in the long term.  The ViacomCBS' dividend on the preferred and the common is too good to pass up.       

 


    

    

Wednesday, December 1, 2021

Can Salesforce (CRM) continue growing to justify its valuation?

Salesforce (CRM) grew at a breakneck speed over the past two decades. The is hoping that the growth will continue in this decade.

The company's free cash flow yield is very similar to that of Microsoft (MSFT) and Adobe (ADBE). Salesforce's free cash flow yield has been consistently around the 2% level over the past decade. Microsoft and Adobe have seen their market capitalization and earnings multiple expand over the years causing their free cash flow yield to drop. I might have to look into their number more closely. 

Exhibit: Free Cash Flow Yield
(Source: Seeking Alpha)

Salesforce is lagging behind Microsoft (MSFT) and Adobe (ADBE) on return on equity. Both those companies have more than 8x more return on equity than Salesforce.  

  Exhibit: Return on Equity

(Source: Seeking Alpha)

Microsoft and Adobe have 6x and 8x more return on invested capital (ROIC) compared to Salesforce. 

Exhibit: Return on Invested Capital 

(Source: Seeking Alpha)


Salesforce's EBITDA margin is much lower than that of Microsoft and Adobe.  

Exhibit: EBITDA Margin
(Source: Seeking Alpha)

Salesforce's EV to EBITDA multiple is higher than that of Microsoft and Adobe.  

                               Exhibit: EV to EBITDA Multiple for Salesforce, Microsoft, and Adobe.  

                                        
   (Source: Seeking Alpha)                                         

Salesforce's year-over-year quarterly revenue growth (See Exhibit: Year-over-Year Revenue Growth) has converged with Microsoft and Adobe.  

    Exhibit: Year-over-Year Revenue Growth

(Source: Seeking Alpha)

Salesforce's price to earnings growth ratio (See Exhibit: Salesforce, Microsoft, and Adobe PEG Ratio) was attractive during the past decade compared to Microsoft and Adobe. If the company's growth can continue, that would justify its higher valuation multiple compared to Microsoft and Adobe. Salesforce's revenue is already in the high $20 billion, so for it to grow at a 20% rate would take some work.  

                                        Exhibit: Salesforce, Microsoft, and Adobe PEG Ratio

(Source: Seeking Alpha)





Paccar: Peak Demand For Trucks

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