Search Results for: Deerfield

Buying Cheap and Holding My Nose

Buying Cheap and Holding My Nose

Posted on by David Merkel

How comfortable would you be buying National Atlantic Holdings?

Or Deerfield Triarc?


Or YRC Worldwide?

I could go on, after all, recently I bought some Redwood Trust, and a number of smaller cap value names that don’t seem to be getting much respect right now. Value as a strategy is lagging now, and I am feeling that in my performance. Financials that deal with mortgages are out of favor also.
So why mortgage REITs now? Take a look at this chart of the 10-year Treasury yield less that on mortgage REITs:

Mortgage REIT yield spread
Yields are pretty high relative to “safe” Treasuries, comparable with 1990 and mid-2002 spreads. Only the bad old days of 1974 surpass the yield spreads of this era by a significant amount. As I recall, REITs had a really bad name in the late 1970s after the mid-decade shellacking. I remember technical terms like “fraud,” but then, I was an impressionable teenager with an active imagination. 🙂

Now consider this chart of the 10-year Treasury yield less that on equity REITs:

Equity REIT Yield Spread

The result is closer to fair value. I certainly would not call equity REITs as a group cheap; future returns rely on property price appreciation, which doesn’t seem likely to me at present.
Now, I’m not endorsing all mortgage REITs. Review funding structures and excess liquidity; you want excess cash flow and conservatism at this point. Heroics offer more downside than upside here.

As for YRC Worldwide, trucking is needed in our economy, and even with some slowdown, YRC should still make money, just not as much. On National Atlantic, I would only say that it seems that there is a forced seller in the name now, and when he is exhausted, the stock will lift. It is difficult to destroy a personal lines insurer with a conservative balance sheet. At 60% of a conservative book value, I can live with adverse outcomes.

Remember, do you own due diligence here. Just because it looks cheap does not mean it can’t get cheaper.

Full disclosure: long RWT NAHC DFR YRCW

Eight Notes on a Distinctive Day

Eight Notes on a Distinctive Day

Posted on by David Merkel
  1. My broad market portfolio trailed the market a little today. I’ve been a little out of favor over the past three months; I’m not worried, because this happens every now and then. That said, we are coming up on another portfolio rebalancing, where I will swap out 2-3 stocks, and swap in 2-3 others. Watch for that in the next few weeks.
  2. Every group in the S&P 1500 was up today. I can’t remember when I have seen breadth like that before. Financials and Energy led the pace. Names like Deerfield Triarc flew on the Fed cut. They will benefit from cheaper repo rates, and the excess liquidity injected the system should eventually ease repo collateral terms.
  3. If the US dollar LIBOR fix at 6AM (Eastern) tomorrow follows the move in the US futures markets today, then we should see LIBOR drop by 27 basis points or so. Given the smaller move down in T-bill yields, 14 basis points, that would leave the TED spread at 132 basis points, which is still quite high, and higher than the 10-year swap spread. (LIBOR would still be higher than the 10 year swap yield.) This indicates that there is still a lack of confidence among banks to lend to each other on an unsecured basis. Things are better than they were two weeks ago, but still not good.
  4. The short term crunch from the rollover of CP, especially ABCP is largely over. The good programs have refinanced, the bad programs have found new ways to finance their assets, or have sold them, or used backup guarantors, etc.
  5. Watch the slope of the yield curve. It is my contention that the slope of the yield curve changes relatively consistently through loosening and tightening cycles. In the last tightening cycle, the curve flattened dramatically through the cycle, making the word “conundrum” popular. This is only one day, but the yield curve slope, measured by the difference in yields between 10-year and 2-year Treasuries, widened 10 basis points today. (The curve pivoted around the 7-year today.) If I were managing bonds at present, I would be giving up yield at present by selling my speculative long bond positions that served me well over the past few months in my model portfolio. I would be upping my yen and Swiss Franc positions.
  6. We learned some new things about the FOMC today: a) They don’t talk their book publicly, so don’t take their public comments too seriously. b) They are willing to risk more inflation for the sake of the non-bank financial system (which is under threat), or economic growth (which may not be under threat). c) They are flagging the Fed funds rate changes any more by letting rates drift nearer the new target in the days before the meeting. d) Beyond that, we really can’t say yet whether this is a “one and done” or not yet. We just don’t have enough data. e) The FOMC really isn’t interested in transparency.
  7. It would be historically unusual for this to be a “one and done.” Fed loosenings are like potato chips. It’s hard to stop at one. Just as there is a delay in the body saying, “that’s enough,” with the potato chips, the in the economy in reacting to monetary policy is slow as well, often leading policy to overshoot, as the FOMC reacts to political complaints to do more because things aren’t immediately getting better. It’s hard to sit in front of the short-term oriented Congress, or listen to the manic media, and say, “But the FOMC has done enough for the economy. It doesn’t look good now, but in 18 months, our policy will take effect and things will be better. Just trust us and wait.” That will not fly rhetorically; it will take a strong-headed man to not overshoot policy. On that Bernanke is an unknown.
  8. To me, it’s a fair assumption then that this cut will not be the last. Investment implications: in fixed income stay in the short to intermediate range, and remain high quality. Buy some TIPS, and have some foreign bonds as well. I like the Yen, Canadian Dollar, and the Swiss Franc. In equities, think of high quality sectors that can use cheap short-term credit, and sectors that benefit from inflation and a weaker dollar. So, what do I like? High quality insurers, mortgage REITs that have survived, (maybe trust banks?), basic materials, energy, goods transportation, staples, some areas in healthcare and (yes) information technology (if I can find any more cheap names there that I like).

Full disclosure: long DFR

Triage, Part 3 (Final)

Triage, Part 3 (Final)

Posted on by David Merkel

Here are parts one and two of this series.? Rather than give a detailed list of what is right with my portfolio, I left the companies that were least likely to have problems for last.? The entire portfolio is over at Stockpickr.? What I will go through here are the potential trouble spots.

The Dead

Deerfield Triarc

Bad Shape?

  • Jones Apparel
  • YRC Worldwide

Questionable

  • Deutsche Bank
  • Royal Bank of Scotland
  • Sara Lee
  • Gruma
  • Tsakos Energy Navigation
  • Cemex

Barclays plc has already been sold, as have the two auto dealers.? Deerfield is too cheap to sell, and I expect that they will not be able to complete their merger, which doesn’t harm Deerfield much, or help them much.? Conditions in the
bank debt markets aren’t too cooperative now, and I would expect that there won’t be too many CDOs done in the next two years.

Bad shape: As for Jones Apparel, a lot depends on what they do with the cash from the sale of Barney’s.? Personally, I would use it to reduce debt; if they use it to buy back stock, I will be one of the people selling the stock to them.? YRC Worldwide is a cyclical company with more debt than I would like; trucking stocks have been weak so I might sell into a rally, or do a swap for a less levered company.

Questionable: None of these balance sheets are in great shape, but aside from the banks, their underlying businesses are likely stable enough to bear the strain.? As for the banks, do they really have enough capital to survive through a real crisis?? Probably, if only because they are “too big to fail.”? Governments will take action to protect their existence, though not necessarily the interests of the current equityholders.? That said, I am a little encouraged by Deutsche Bank’s relatively good positioning in this crisis so far, and the CEO’s willingness to encourage transparency.

So, for now, on rallies, I may be lightening some of the above names.? I am in no rush at present, and will take my time in adjusting the portfolio.

Full disclosure: long DB RBSPF SLE GMK TNP CX YRCW JNY DFR

Additional tickers mentioned: BCS

Triage, Part 2

Triage, Part 2

Posted on by David Merkel

In the first round of triage I went through the first third of my portfolio. Now is the time for the second third; definitely a more positive experience, together with my changes on the first third, after further reflection.
The Dead ? Companies with bad balance sheets, but have been whacked so bad that it is still worth playing

  • Jones Apparel
  • Deerfield Capital

If they rally a lot more, I am out.

Walking Wounded ? Companies with okay balance sheets that we feed more cash to

  • Lafarge
  • Industrias Bachoco
  • YRC Worldwide [moved from The Dead]

Seemingly healthy that might have financing problems ? Sold

  • Lithia Automotive
  • Group 1 Automotive

Uncertain as of yet

Sara Lee

Don’t know what to do here. Balance sheet has issues but profitability is improving as the turnaround progresses.

Healthy companies that we leave alone

  • Barclays plc (Moved from Uncertain as of yet — Capital levels are seemingly adequate.)
  • Deutsche Bank
  • Mylan Labs
  • Cimarex Energy
  • Nam Tai
  • Arkansas Best
  • Bronco Drilling
  • Vishay Intertechnology
  • Aspen Holdings
  • Safety Insurance
  • Lincoln National
  • Assurant

Safe New Names Bought

  • PartnerRe
  • National Atlantic [Did not get a full position on, was too stubborn about levels… not buying here.]

So, there’s the triage with one third to go — I have not done the companies with my largest gains, which I presume to be in better shape. At this point, I’m relatively happy with what I have.

PS — As to my methods, the main parts are reviews of the balance sheets and cash flow statements. It’s basic bond analysis, asking how likely it is that future cash flows will be able to cover the debts in question. At present, I am looking to hold companies that can survive a crisis. With the reservations noted above, most of this portfolio can do so.
Full Disclosure: Long JNY DFR LR IBA YRCW SLE BCS DB MYL XEC NTE ABFS BRNC VSH AHL AIZ LNC SAFT PRE NAHC

Triage

Triage

Posted on by David Merkel

I’m still working through my portfolio, but I have categorized some stocks:

The Dead — Companies with bad balance sheets, but have been whacked so bad that it is still worth playing

  • Jones Apparel
  • Deerfield Capital
  • YRC Worldwide

Walking Wounded — Companies with okay balance sheets that we feed more cash to

  • Lafarge
  • Industrias Bachoco

Seemingly healthy that might have financing problems — Sold

  • Lithia Automotive
  • Group 1 Automotive

Uncertain as of yet

Barclays plc

Safe New Names Bought

  • PartnerRe
  • Microcap yet to be named when I have my full position on.

More tomorrow. As you can tell, I am positioning my broad market fund more conservatively. I am not optimistic on how we work through the amalgam of debts that might not get paid.

Full disclosure: long PRE IBA DFR JNY YRCW BCS LR

The Value of Having a Deposit Franchise (or a Printing Press)

The Value of Having a Deposit Franchise (or a Printing Press)

Posted on by David Merkel

I’m worried.? That doesn’t happen often.? Over the years, I have trained myself to avoid both worry and euphoria.? That has been tested on a number of occasions, most recently 2002, when I ran a lot of corporate bonds.? Ordinary risk control disciplines will solve most problems eventually, absent war on your home soil, rampant socialism, and depression.? I like my methods, and so I like my stocks that come from my methods, even when the short term performance is bad.? Could this be the first year in seven that I don’t beat the S&P 500?? Sure could, though I am still ahead by a few percentage points.

Let’s start with the central banks.? I don’t shift my views often, so my change on the Fed is meaningful.? But how much impact have the temporary injections of liquidity had?? Precious little so far.? Yes, last I looked, Fed funds were trading below 5%; banks can get liquidity if they need it, but credit conditions are deteriorating outside of that.? (more to come.)? I don’t believe in the all-encompassing view of central banking espoused by this paper (I’d rather have a gold standard, at least it is neutral), but how much will full employment suffer if most non-bank lenders go away?

Why am I concerned? Short-term lending on relatively high quality collateral is getting gummed up.? You can start with the summary from Liz Rappaport at RealMoney, and this summary at the Wall Street Journal’s blog.? The problems are threefold.? You have Sentinel Management Group, a company that manages short term cash for entities that trade futures saying their assets are illiquid enough that they can’t meet client demands for liquidity.? Why?? The repurchase (repo) market has dried up.? The repurchase market is a part of the financial plumbing that you don’t typically think about, because it always operates, silently and quietly.? Well, from what I have heard, the amount of capital to participate in the repo market for agency securities, and prime AAA whole loan MBS has doubled.? 1.5% -> 3%, and 5% -> 10%, respectively.? Half of the levered buying power goes away.? No surprise that the market has been whacked.

Second, away from A1/P1 non-asset-backed commercial paper, conditions on the short end have deteriorated.? As? I have said before, complexity is being punished and simplicity rewarded.? High-quality companies borrowing to meet short-term needs are fine, for now.? But not lower-rated borrowers, and asset-backed borrowers.? Third, our friends in Canada have their own problems with asset-backed CP.? Interesting how Deutsche Bank did not comply with the demand for backup funding.? Could that be a harbinger of things to come in the US?

On to Mortgage REITs.? Thornburg gets whacked.? Analyst downgrades.? Ratings agency downgrades.? Book value declines.? Dividends postponed.? It all boils down to the increase in margin and decrease in demand for mortgage securities (forced asset sales?).

It’s a mess.? I’ve done the math for my holdings of Deerfield Capital, and they seem to have enough capital to meet the increased margin requirements.? But who can tell?? Truth is, a mortgage REIT is a lot less stable than a depositary institution.? Repo funding is not as stable as depositary funding.? There will come a point in the market where it will rationalize when companies with balance sheets find the mortgage securities so compelling, that the market clears. After that, the total mortgage market will rationalize, in order of increasing risk.? Fannie and Freddie will help here.? They support the agency repo market, but the AAA whole loan stuff is another matter.? Everyone in the mortgage business except the agencies is cutting back their risk here.

By now, you’ve probably heard of mark-to-model, versus mark-to market.? The problem is that mark-to-model is inescapable for illiquid securities.? They trade by appointment at best, and so someone has to estimate value via a model of some sort.? The alternative is that since there are no bids, you mark them at zero, but that will cause equity problems for those buying and selling hedge fund shares.? This is a problem with no solution, unless you want to ban illiquid securities from hedge funds.? (Then where do they go?)

There’s always a bull market somewhere, a friend of mine would say (perhaps it is in cash? that is, vanilla cash), but parties dealing with volatility are doing increasing volumes of business, which is straining the poor underpaid folks in the back office.

Why am I underperforming now?? Value temporarily is doing badly because stocks with low price-to-cash-flow are getting whacked, because the private equity bid has dried up.? That’s the stuff I traffic in, so, yeah, I’m guilty.? That doesn’t dissuade me from the value of my methods in the long run.

Might there be further liquidity troubles in asset classes favored by hedge funds?? Investors tend to be trend followers, so? yes, as redemptions pile up at hedge funds, risky assets will get liquidated.? Equilibrium will return when investors with balance sheets tuck the depreciated assets away.

Finally, to end on a positive note.? Someone has to be doing well here, right?? Yes, the Chinese.? Given the inflation happening there, and the general boom that they are experiencing, perhaps it is not so much of a surprise.

With that, that’s all for the evening.? I have more to say, but I am still not feeling well, and am a little depressed over the performance of my portfolio, and a few other things.? I hope that things are going better for you; may God bless you.

Full disclosure: long DB DFR

I Like My Stocks

I Like My Stocks

Posted on by David Merkel

It was not a great week for my portfolio, but I still like my stocks. Is global growth slackening? I don’t think so. Are the financials that I own under threat? With the possible exception of Deerfield [DFR], no, not at all. Four quality US insurers, three quality European banks, and DFR. Hey, Deutsche Bank actually profited from the crisis. And Safety Insurance, unlike Commerce Group which missed estimates, beat estimates by a dime after the close. Bright management team there, and it trades at 97% of book, 5.7x 2007 earnings, and 6.8x 2008 earnings. (Did I mention that the reserves look conservative?)

 

Today’s action makes me think that there is some mindless “sell financials” program out there, and not caring about what is inside the financials. I will be adding to my names that were the worst hit recently, and perhaps, giving a higher weight to some of the insurers that I recently purchased. Assurant at 8.7x 2008 earnings, and Lincoln National at 9.2x 2008 earnings? It doesn’t make sense; these are two high quality companies with excellent growth prospects.

I am a value investor. Scanning my portfolio, I see a median 2008 P/E between 9-10x, and a median P/B in the 1.1x area. My portfolio will find support, even if the market falls further.

Full disclosure: long DFR DB AIZ LNC SAFT

Portfolio Reshaping Mid-Year 2007, Part 3

Portfolio Reshaping Mid-Year 2007, Part 3

Posted on by David Merkel

Time for my most recent portfolio changes. The reshaping is complete, here is the data file and here are the qualitative details:

 

Buys

 

  1. Arkansas Best [ABFS] — Inexpensive, and trucking is out of favor. Trucking should pick up with the economy in the second half of 2007, and as the dollar cheapens, trucking is needed to get the exports to the ports.
  2. Deutsche Bank [DB] — Cheap major European bank. I’m light on financials (though if I lost my restrictions you would see a lot of insurance in my portfolio). 9-10x earnings for the next two years seems too cheap for me. Can they have that much exposure to the same problems faced by Bear Stearns? Maybe, but the valuation compensates for that.
  3. Gruma SA [GMK] — Inexpensive, and a play on the growing middle class in Mexico. Also a play on the growing popularity of Mexican food in the world. I don’t have a lot in consumer staples, so this helps.
  4. Mylan Labs [MYL] — returning to a name I last owned in 1988. Inexpensive generic drugmaker. I have nothing in healthcare, so this diversifies me a little. Generics are unlikely to fare badly as the branded pharmaceuticals should the Democrats win in 2008.

 

Sales

 

  1. Sold Komag [KOMG] because of the merger, and the arb premium (amount of incremental gains from holding on until deal consummation) was less than what I could earn in cash.
  2. Sold St. Joe [JOE], and I wish I had sold when one of my colleagues explained their likely troubles to me one month ago. St. Joe is going to have it tough for a while because they don’t have a lot of ways to generate cash, without selling property, and the land market is not as good as it was two years ago.
  3. Sold Sappi [SPP]. The glossy paper market, like other fiber markets faces their share of challenges. Demand is sluggish, and likely to stay that way for a while.
  4. Sold a little of Lafarge [LR]. Still have a position there. It’s had a nice run, so I rebalanced down to my normal target weight.

 

With these moves, I am back to 35 positions, up from 34. I am running with 16% cash, which is high for me. At the beginning of the year, I reinvested and brought cash down to 5% of the portfolio, but good investment results, combined with rebalancing has brought the cash back, and then some. If the cash hits 20%, I will raise my normal portfolio position size, and move cash to 10% or so. Maybe we get a pullback?

 

What I did not sell

 

  1. SPX Corp — the turnaround continues. For now, honor the momentum.
  2. Noble Corp — Hey, I just bought this last during the reshaping; I am not kicking it out so soon, no matter how well it has done.
  3. Sara Lee — the turnaround continues. No momentum here; maybe management will succeed. A few of their ideas seem to be on target.

 

What I did not buy

 

Many more entries here. As I worked down my list, I kept saying, “Cheap for a reason… cheap for a reason…”

 

  1. Too small: Charles and Colvard, PAM Transportation
  2. Don’t care for the industry: Chipmos Technologies, Finish Line, Foot Locker, Encore Wire, First Consulting, Freightcar America, Korea Electric, and Metrogas
  3. Already own something that I like better in its industry, and don’t want to increase exposure: Crystal River and MVC Capital (both interesting, though I like Deerfield better)
  4. Irregular operating history: Optimal Group and Northgate Minerals
  5. Tyco International is not as cheap as the data would indicate because of the recent spinoffs.

 

After I finish this, I will adjust the portfolio over at Stockpickr.com.
Full Disclosure: Long SPW NE SLE LR GMK DB ABFS MYL

My Stray Mortgage REIT

My Stray Mortgage REIT

Posted on by David Merkel

A personal note before I start; I’ve been gone the last two days because I am part of the leadership of my denomination, and we had a regional meeting for the better management of our congregations. The hotel that I stayed at promised internet service, but did not deliver on that promise; that’s why I didn’t post yesterday. My intention with this blog is to put up one or two good posts every day, excluding Sundays.

I don’t trade that often, so being away is not a problem Sometimes when I get home, there is a surprise waiting for me.? This time the surprise was a positive one, where Nelson Peltz does some house cleaning, and gives his shareholders a gift in the process. He has simplified his life by selling his stake in Deerfield Capital Management to the mortgage REIT that they manage, Deerfield Triarc Capital [DFR]. Also, he reduces his stake in DFR down to a 10% level. He gets to focus on the restaurants that he owns through Triarc [TRY].

I would encourage interested readers to look through the presentation that they did for this acquisition, and this presentation that they did to describe their management style. At my previous employer, I suggested that we start a REIT like DFR. Good as that firm was, they did not take my advice.

The price as a ratio of EBITDA for purchasing Deerfield Capital Management was around 7.5x. Pretty good acquisition price, considering that capital is not a constraint for the growth of the combined enterprise. I think the stock goes higher from here. My main concern is this: once they get to full deployment of alternative assets, this company will be very profitable, but also risky. You will likely see me sell my shares once the company reaches maximum portfolio risk. At that point, I might miss some upside, but with Meyer Rothschild, I will have sold too soon.

Full Disclosure: Long DFR

A Good Quarter

A Good Quarter

Posted on by David Merkel

I’m still looking for a way to document my performance to readers, but let me simply say that the broad market portfolio beat the S&P by a few percent. What worked?

  • Fresh Del Monte
  • Grupo Casa Saba
  • Valero Energy
  • Helmerich & Payne
  • ABN Amro (sold too soon) 😉
  • Dorel Industries (wish they hadn’t delisted)
  • Lyondell Chemicals
  • Dow Chemicals, and
  • SPX Corp

You see any commonalities there? Energy, especially refining. Chemicals. Aside from that, I don’t see anything really correlated.

What didn’t work?

  • St. Joe
  • Barclays plc
  • Japan Smaller Capitalization Fund
  • Nam Tai Electronics
  • Cemex
  • Lithia Motors
  • Conoco Phillips
  • Magna International
  • Jones Apparel
  • Deerfield Triarc, and
  • Allstate (ouch)

Commonalities? Autos, maybe? Away from that, it seems eclectic to me.

In my balanced mandates, my foreign bonds and floating rate securities worked. High quality paid off as volatility rose. Really didn’t have any problems with my bonds.

Now I just have to do as well next quarter. 🙂

Full disclosure: long? FDP SAB VLO HP ABN DIIB LYO DOW SPW JOE BCS NTE CX LAD COP MGA JNY DFR ALL

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