Stein´s law makes me 99 % certain that the oil price will bounce back in the mid- to long-term

Some weeks ago I made the case for a significantly higher oil price in the mid- to long-term (2016 - 2018) than the current price. Thus far the oil price development has been flat or slightly down since my prediction (brent currently trading at 45 and WTI 42 USD/ bbl.). I am quite sure that I mentioned something about how it is impossible to predict the oil price in the short-term (if I did not I am mentioning it now).

Currently it is quite simple to make the case for a lower oil price in the short-term and Goldman Sachs has stated that there is a high probability for the oil price to plunge to 20 USD/ bbl in the coming months.

The case for a lower oil price in the short-term:

• A mild upcoming winter has been predicted
• It costs more to store oil as cheap storage already has been filled
• Even stronger dollar due to expected higher interest rates in the US
• Increased supply from Iran

Currently oil is trading at a mid to long-term disequilibrium as the marginal cost of replacing the oil we are currently consuming is significantly greater than the current price (70 - 80 USD/ bbl.). Furthermore demand is growing.

Stein´s law simply states that "if something cannot go on forever, it will stop". As for the oil price we can restate the simple but brilliant quote to: "since the oil price cannot trade below its marginal replacement cost forever, it will stop". For you that don not know, Herbert Stein is the former Chief Economist to Richard Nixon.

We do not know when the oil price will bounce back, however we know it will. My best guess is at some point during 2016 - 2018 (due to the case I made some weeks ago). As a long only value investor with a long-term horizon I am heavily invested in dirt cheap oil companies. At some point I am quite sure it will make me a lot of money... in the meantime the hedge fund shorts will laugh their shorts of making money hand over fist.

If the oil price plunges even lower in the short-term I will buy even more oil stocks.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. 

Bayerische Motoren Werke AG (BMW) - Brilliant company that was dragged down by VW

As a value investor looking for themes the german car industry was a solid opportunity post the Volkswagen driven "dieselgate" scandal. VW dragged down the stock price of BMW, without BMW having anything to do with the scandal. The financial press reported fake stories regarding the company´s involvement in the scandal assisting in the stock´s bearish development.

I bought a significant position in the company 2nd October and have thus far had a 28 % return on my investment. At the time of the purchase BMW was trading at a trailing P/E of 8.6x. The stock is currently trading at a trailing P/E of 10.7x, still significantly below most comparable companies. I will exit my position when the company is trading in the 12 - 13x trailing P/E range (inline with the rest of the industry). The company´s justified trailing P/E is 12.5x if one assumes a 5 % growth in dividends, 8 % required rate of return and a 34 % payout ratio. It is not too late to get in on the action.

Peer analysis:

                               Source: Financial Times

Besides still being priced cheaply compared to many of its peers BMW is one of the most valuable brands in the world and a solid company that has proven steady growth. According to Forbes BMW is the 16th most valuable brand in the world, and the second most valuable automobile brand. The brand´s focus on solid, quick and sporty cars have been a successful receipt for decades.

Automobile brand value:      

                                Source: Forbes

Consensus expected earnings growth BMW:

                               Source: Financial Times

My BMW M4 (I may hold on to this stock out of loyalty):

Disclosure: I am long Bayerische Motoren Werke AG

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Audi AG - High-end brand on discount - not doing much - structural nightmare

At the same time as I invested in Volkswagen I also picket up some Audi shares (and BMW which will be discussed on a later date) as they had been dragged down alongside Volkswagen on the tail of the "dieselgate" scandal. At that point there were no public news regarding Audi's involvement in the scandal. My point of view was that I now could buy the premium brand Audi at a significant discount.

Since I bought the shares Volkswagen's share price has made a significant comeback, while Audi has done nothing. The share just sits there, looking somewhat illiquid and confused regarding its own existence.

Audi has tended to trade at a discount to its peers BMW and Daimler historically due to structural issues. Frankly, I am not sure why the share floats at all considering that 99.5 % is owned by Volkswagen and only 0.5 % is free-floating. I am also confused regarding the disappointing annual dividend payment (0,5 % dividend yield) where outside shareholders receive the amount that is paid as a dividend on one Volkswagen ordinary share each fiscal year. I have no idea how that makes sense.

On a more positive note the share trades at a significant discount to its historical Price/ Book and P/E. Furthermore the company is experiencing above industry growth and has proven resilient and solid profit margins.

Audi delivery growth:

                                Source: Audi AG

In essence Audi is a solid company and brand with a stock currently trading at a steep discount to historic trading while being confused regarding its own existence. I will sell the stock as soon as its pricing multiples normalizes as I don't know if and how the structural discount will ever cease to exist (and yes, I do know VW could at some point float more shares, or take over the floating shares at fair market value. VW could even sell the whole company in a trade sale, however the current situation has not changed in decades).

Audi Price/ Book development

   Source: YCharts

Disclosure: I am long Audi AG

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Volkswagen preferred shares up 17 % the last eight days

Early last week the Volkswagen preferred shares were trading at a 18 % discount to the common shares. As I have mentioned previously I expect the discount to tighten as the current situation normalizes (NOX diesel scandal). As we speak the discount has tightened to approximately 10 %. The preferred shares are up by 17 % the last eight days (and ~4.5 % thus far today) mainly due to news that 90 % of the cars in question can be fixed in a cheap and swift manner. Most of the cars can be fixed through a software update.

Preferred should trade at the same or slightly higher level than the common shares:

• Both share classes have the right to the same assets
• Preferred shares pay a slightly fuller dividend than the common shares
• Preferred shares have historically traded at a premium to the common shares

Why the preferred should trade at a lower level than the common shares:

• Preferred shares have no voting rights

Preferred (blue) vs. common shares (pink):

                              Source: SaxoBank

If you want in there is still 10 % free upside left if you buy the preferred shares!

As for me I got lucky and bought the common shares (pure luck) close to the trough (turning point) and held on to the shares until I had a 15 % return. I than turned around and sold the common shares and bought the preferred shares when I realized that there was an obvious arbitrage between the share classes.

Disclosure: I am long Volkswagen AG

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Time to buy Hong Kong listed Chinese banks? High risk, high return (or loss)

Large Hong Kong listed Chinese banks are at their cheapest ever according to P/B, trailing P/E and dividend yield measures. In fact they are the cheapest large banks in the world. The large Chinese banks are priced as if China is moving in the direction of a financial crisis. Is this true, or have their pricing been killed by negative sentiment?

For example the largest of the lot Industrial and Commercial Bank of China (ICBC) is currently priced at 0.87x book value vs. approximately 1.35x for large banks globally. When it was listed in 2006 the bank was valued at 2.6x book. 

There is no doubt in my mind that, 1) Large Chinese banks are dirt cheap considering current pricing and potential growth, 2) there are significant risks involved. In my perception a bet on Chinese banks may be a good one, however I would not stack up my portfolio too much with this stuff either. 

Some major risks:

• Some believe China is moving into recession: Junheng Li (founder of Chinese focused research firm Warren Capital) stated that "China is headed into a recession, and the nation wasted USD 200 billion on its stock market stabilization efforts". He further believes that the coming Chinese crisis will drag the rest of the world down with it
• Chinese banks experience somewhat of a margin squeeze from lower interest rates
• Increase in none performing loans and illegal fundraising and frauds spreading to the banking system

Large Hong Kong listed Chinese Banks:

Source: Financial Times

Large US and UK banks: 

Source: Financial Times

Disclosure: I hold no positions in any of the above discussed companies.

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Following HitecVision's lead - part 2

As mentioned in my previous post HitecVision picket up a approx. 10 % stake in the oil service company Kvaerner ASA. The Kvaerner controlling shareholder, Aker ASA stated that they have no plans to alternate the company´s strategy after the Private Equity player made its move. Furthermore HitecVision went on record stating that the purchase of the Kvaerner shares was purely a financial play. Hitec representative Frode Sigurd Berg stated in a short interview with the Norwegian newspaper Dagens Næringsliv that Hitec will attempt to get board representation.

As far as I know the Kvaerner investment was Hitec´s first ever pure financial play public stock purchase (as they usually want a controlling stake in the companies they target). So, if this is one of, if not the best energy Buyout group´s first ever public financial play, it is probably a good risk/ reward.

About Kvaerner: Norway based EPC company (engineering, procurement, construction). Delivers products and services to oil and gas facilities/ structures both offshore and onshore. They have both a upstream and a downstream business.

Kvaerner value drivers:

• No financial leverage. This may be perceived as a positive for a oil service company these days
• A lot of cash in the bank. Kvaerner currently holds more than a billion NOK of cash on hand, this versus a market cap of 2.1 billion NOK. Half the market cap value is cash
• Although the company´s top-line has been hurting alongside the rest of the industry, it´s EBITDA figures are holding up quite well
• The company´s order backlog looks decent, and a lot stronger than what I have seen for many other oil service companies these days
• Solid growth platform and strong management. At some point the oil price will make a comeback, and the service companies with the best platforms will make a lot of money
• Price/ book of approximately 0.9x. Not to shabby taking into account the fact that half the market cap value is cash

Kvaerner order intake and backlog:

                                 Source: Kvaerner ASA

Disclosure: I am long Kvaerner ASA.

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

HitecVision is picking up public stocks as financial plays

For you that do not know, HitecVision may be the most successful Buyout (Private Equity) player within the energy space the last 20 years. They may have the best track record in the business and are famous for their solid buy and build cases. From memory I am quite sure that their 2002 vintage fund ended up with a net money multiple (TVPI) of approximately 4.5x the initial investment, and their 2006 vintage fund ended with a approximate net money multiple of 3x (three times invested capital to the investors/ Limited Partners).

Traditionally HitecVision has invested in medium sized businesses within the energy sector. Complete target control has usually been important as they act as an active investor. Furthermore the target companies have usually been privately held.

The last couple of weeks HitecVision bought stakes in two publicly traded companies as pure none controlling financial plays (I can not recall Hitec doing this before). In my perception, knowing HitecVision´s track and organization, I believe it is a good call to follow whatever they are up to in the public markets. Not surprisingly my focus today was to make space in my portfolio for the HitecVision investments (by rebalancing all my energy stocks to a lower base).

Hitec has bought 10 % of Prosafe and 10 % of Kvearner, where I find Prosafe to be the most obvious candidate for a 20 % or more annual return over the next five years (it is my perception that a buyout player like Hitec would never invest in anything that they do not expect would yield at least 20 % annually).

About Prosafe: The company owns and operates semi-submersible accommodation and service rigs to support oil production (11 of them). They also own a jack-up to use for additional needs. The rigs support both living quarters, offices, storage, desk cranes and so on. Most of its operations are related to activities on oil fields already in production...

Prosafe value proposition: The company mitigates its financial risk (approx. 70 % leverage), with relatively low operational risk, where the company focuses on mid- to long-term charters with operators while operating on oil fields already in production. The accommodation market may not have been hit as hard by the low oil price as the conventional drilling rig market, although Prosafe feels the pain as all other oil and gas related companies. The company currently trades at 0.9x book value, not very cheap compared to the drilling rig companies and at a 4.72x trailing P/E which is cheap considering the visibility of the company`s earnings. The dividend yield is currently 4.34 % and they are expected to pay dividend going forward (probably lower levels than during the boom times).

In my opinion investing in Prosafe as part of a diversified energy exposure is a good oil price bet!

Contract status rigs:

Source: Prosafe ASA

Disclosure: I am long Prosafe ASA.

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Eurasia Drilling Co ---> some crazy stuff is going on...

I have a positive long-term view on the oil price and therefore beaten down oil stocks (my current oil stock allocation is international and weighted 1/3 asset heavy companies, 1/3 service companies and 1/3 E&P companies). One of the beaten down oil stocks in my portfolio is Eurasia Drilling Co. which i bought at USD 11.30 per share last month.

Eurasia Drilling Co. is a onshore and offshore drilling and well service company. They own and operate a large fleet of land drilling and worker units (one of the largest in the world). They also own jack-ups stationed in the Caspian Sea. As you may figure from the name it is a Russian company.

I bought the stock due to:

• My positive view on the oil price
• The company was dirt cheap (trailing P/E = 5.3x, P/CF = 2.9x, P/B = 0.8x, dividend yield = 8.8 %)
• It seems like Russian companies are punished more than what they deserve due to temporary political situation
• Core investors had an agreement to buy out minority shareholders at USD 22 a share, more than twice the current stock price. The core investors would than turn around and resell the shares to Schlumberger, which would be given an option to buy the whole company within three years

The Schlumberger deal fell through in September due to regulatory issues, however it definitely gave me as an investor some visibility in terms of potential value. Today the share was delisted.

The company made a statement that it has been taken private and that a merger is going to be conducted between the company and a consortium of majority shareholders and top management. The shares are being bought from minority shareholders at USD 11.75 per share (smells kind of fishy at the given pricing point?). According to Financial Times minority shareholders are planning to sue and challenge the deal due to the low price offered (slightly above last closing price). The transaction has been recommended by the board, however we will see if the minority shareholders will let this one slide.

As for me I am happy with my short but sweet return if the deal goes through, however I am rooting for my fellow minority shareholders suing the company. 

Stock price development pre delisting:

                               Source: SaxoBank

Disclosure: I am long Eurasia Drilling Co.

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

How I invest in emerging markets...

As discussed in my previous post emerging markets are currently priced attractively and I currently have a 40 % diversified exposure to the space in my public stock portfolio and a 20 % overall exposure after entering a couple of months ago (the MSCI emerging markets index is currently priced at a P/E, Shiller P/E and P/B of approximately 12.5x, 10x and 1.3x respectively).

75 % of my exposure to the market is held through an ETF as, 1. I wanted a diversified exposure, 2. the only emerging market component I know reasonable well is the Hang Seng. I just don´t know the marketplace well enough to pick individual stocks and I don´t feel confident that I have a shot at beating the overall market. As you probably know approximately 60 % of individual stocks underperform the overall market.

An ETF or Exchange Traded Fund is a fund that tracks an individual index such as the MSCI Emerging Market Index or the S&P 500. When you buy ETF shares you buy a portfolio which tracks the performance of its native index. ETFs don´t attempt to outperform the index, but replicate the index performance as cheaply as possible.

My criteria when choosing my emerging market ETF:

• Tracks the MSCI Emerging Market Index as closely as possible. I want exposure to all regions and company sizes
• Low cost
• Provided by a reputable ETF provider
• Tight spread between NAV (Net Asset Value) and trading price
• Solid liquidity
• Availability of performance measures

After conducting some due diligence I landed on iShares Emerging Markets UCITS ETF (acc) as the ETF was the best fit to my criteria. As illustrated below the fund tracks the index quite well, and the expense ratio is only 0.68 %. The ETF´s portfolio manager is the reputable manager Blackrock and the ETF is trading close to NAV which is a sign of solid liquidity. The availability of performance measures is decent and the ETF trades at various larger exchanges   (http://www.morningstar.co.uk/uk/etf/snapshot/snapshot.aspx?id=0P0000I5AI&tab=3).

MSCI Emerging Markets UC/TS ETF (ACC) performance:

                                Source: IShares

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

The time to buy emerging markets may be now

Emerging market stocks have had a stand still in upward price movement since 2006 if measured in USD and gone nowhere since 2010, while US and European stocks have gone through the roof.

Emerging markets performance in USD:

                                 Source: Franzlischa.blogspot.com

The MSCI emerging markets index is currently priced at a forward P/E, Shiller P/E and P/B of approximately 12.5x, 10x and 1.3x respectively, versus 17.0x, 25.5x and 2.8x for the S&P 500. According to the the valuation measures you can currently buy emerging markets stocks at half the price of US stocks. When one takes into consideration the high growth expectations for emerging markets vs. developed markets, emerging markets stocks seem to be priced attractively. To be frank, when you can buy high growth at half the price of low growth, you should choose high growth. 

And yes, China is not growing at a 15 % annual pace anymore, however 6 or 7 % is not too shabby either considering the current size of the Chinese economy.

Economic growth emerging markets vs. the "developed world":

                              Source: Market Realist

As we´re discussing a large part of the global stock market (some would define emerging markets stocks as its own asset class), it is helpful to look at the less volatile Price/ Book ratio in order to discuss investor sentiment. 

The Pirce/ Book ratio of emerging markets is currently at a lower level than during the trough of the financial crisis in 2008. The ratio has only been at current low levels 3 % of the time since 1989 and only lower during the emerging market crisis of 1997 - 98. Although growth is not as great as expected, the shape of emerging markets is not close to as bad as in 1997 - 98. It seems like emerging market stocks currently are significantly out of favor and unpopular, in other words, it is time for a value investor to get a move on and buy. 

MSCI Emerging markets Price/ Book development:

                                             Source: Financial Times

So, what should your horizon be as an emerging market investor? In my opinion long (5 - 10 years) as emerging markets are very volatile. It is impossible to tell if emerging markets will develop positively or negatively within the next year, however what we do know is that emerging market stocks currently are cheaply priced compared to historic pricing and other markets.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Does value investing outperform?

As you know a value investing strategy is implemented when the investor buys shares in companies which he or she believes are undervalued compared to intrinsic value. Intrinsic value meaning what a company´s equity is actually worth, based on the value of discounted future cash-flows to the equity holders. People looking for undervalued stocks tend to use valuation measures such as Price/ Earnings, Price/ Book value, EV/ EBITDA, P/CF..... such measures are utilized to tell the investor something about the current price of the stock versus intrinsic value, and therefore something about future returns. A stock currently priced below it´s intrinsic value should in theory yield a greater return than its peers in the future as its stock price at some point moves upwards in the direction of its intrinsic value.

Yes value stock investing does outperform the broader market systematically according to empirical research based on historical data. This does not necessarily mean that the outperformance will last forever (as this implies that a value investor following a value investment strategy should be able to take over the world at some point, as he eventually would own all outstanding shares in the world due to the everlasting outperformance). Although outperformance has been observed both on a total return basis and a risk adjusted basis (sharpe ratio), some argue that the outperformance is due to a systematic risk factor not picket up by neither standard deviation of returns or the beta risk measure. They argue that the outperformance of value stocks is due to such stocks horrible performance during economic shocks (such as the 2008 financial crisis or the 30s economic crisis), and that this is a systematic factor that should be taken into consideration (i personally keep my self to good old beta for stocks, as the systematic distribution of returns don´t concern me to much as a long-only investor with a time horizon lasting into eternity).

Below I have borrowed a table from the article "Analyzing Valuation measures: A Performance Horse Race over the Past 40 Years" from The Journal of Portfolio Management (Wesley R. Gray and Jack Vogel as main authors). Their results are impressive and strong, proving the significant outperformance of value stocks over growth stocks the last 40 years or so, and that with a healthy alpha too. Although all value measures have their significant merits as shown below, the best overall performer is the EV/ EBITDA measure (or EBITDA/TEV as they call it in the article). A portfolio rebalanced once a year based on finding the 1/5 lowest EV/EBITDA stocks in the market have returned an annual return of 17.66 % over a 40 year period. That´s just plain impressive (not as impressive as Warren Buffet, but close).

Source: The Journal of Portfolio Management

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

There is value to be found in oil stocks

As discussed in my previous post the low Shiller P/E of the energy sector should trigger an appetite for oil stocks for the patient investor (at least a five year horizon). The reason for this is simple, the oil price will once again bounce, and earnings will once again soar for the oil companies and the oil service companies. Make sure you make this a diversified bet, and that you do not tilt your portfolio too much in the direction of the highly leveraged drilling, OSV or seismic companies.

I am not an expert, however this is my take on the oil price:

• Price elasticity of the oil price is immense. All we know about the future is that we don't know, and disruptions to supply may happen anywhere in the world. Currently the oversupply is 1.5 million b/d, out of a supply of 96. To me that just doesn't sound like a lot in the big scheme of things.
• Demand is growing significantly, especially in emerging markets. I am a strong believer in the growth of the emerging market transportation sector. Guys in emerging markets want a Porsche just as much as the next guy.

                             Source: Energy Information Administration

• The marginal cost of replacing the oil the world is consuming today is significantly greater than the current oil price of 45 USD a barrel. And, all my friends on the west-coast of Norway know that we are currently not working hard on replacing the oil we´re currently consuming.  

                              Source: Energy Information Administration

• Saudi Arabia and the other OPEC countries budget deficits. Decreases in government spending in order to pay for the over supply of oil may not be tolerated by the populations of these countries. At some point sooner than later OPEC will have to end the ongoing fight for marketshare in order to balance national budgets.

                                  Source: Bloomberg

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Value in oil stocks? Yes according to Schiller P/E, however you need to be a believer

According to the infamous Shiller P/E matrix, the only sector worth investing in these days (at least in the US) is the energy sector. The Shiller P/E for the sector is currently 11.9x vs. 26.3 for the S&P 500 as a whole. What a significant discount or what?

There is only one problem with the Shiller P/E, it will only work as a buy signal if the depressed earnings of the energy companies make a comeback, and this will only happen if the oil price moves back to previously seen levels within a reasonable time-frame. Stating that energy stocks are cheap due to a low Shiller P/E is the same as making the statement that the oil price will make a comeback.

Shiller P/E by sector:

                                  Source: Gurufocus

Oil prices and energy stocks track each other like no other, and you have to be a believer that oil demand will outstrip oil supply at some point during the near future in order to trust energy stocks as a value play. From the looks of it, oil stocks have not strayed away from their normal close tracking of the oil price during the current downturn. 

Oil price vs. energy stocks:

                               Source: Gurufocus

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Volkswagen preferred vs. common shares arbitrage

As we speak the preferred shares of Volkswagen is trading at a 20 % discount to the common shares. The shares have a equal claim to the company assets as the common shares and have tended to trade at a slight premium to the common shares. Is this the most obvious equity arbitrage out there, or am I missing something? Is the voting rights of the common shares worth a higher price during turbulent times?

In any case the shares are trading at a normalized trailing PE multiple of approximately 4.5x. The company still makes some of the best cars out there, and the brands will in my perception survive. I currently have a overweight position in my portfolio and expect the stock price to bounce back at some point. My exit point is when the preferred shares are priced equally to the common shares once again.

Disclosure: I am long Volkswagen AG

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.