Friday, 28 February 2014

Shrink to survive or shrink to grow . . .

This blog doesn't follow the retail sector, nor for that matter does it follow pharmaceuticals. The rational for this is because of the deafening noise that extraneous factors bring to the process. In retail I spent many years trying to come to grips with a moribund retail environment while trading Japanese equities. During those years there always seemed to be a reason for failure to deliver. Perhaps the most frustrating reason was weather.Leaving that aside I do occasionally get an interest in the space when things get to extremes. Let's take J C Penny for example.

I remember walking into a J C Penny store in Chicago in 1993 and coming away with the feeling that they had what I wanted, but I just couldn't find it. It never occurred to me to ask anyone for help as staff seemed fairly conspicuous by their absence. Anyhow flash forward to yesterday when Penny's released their results. Now the only thing I knew about them was the Hedge Fund Pershing Square owned about 18% of the shares and had spent the last few years agitating for a turnaround of some king. Bill Ackman, the boss at Pershing Square has been on the board of JCP since 2011. The results yesterday must have brought a smile to his face after a seemingly fruitless campaign. In the new world of stock analysis it must have been somewhat galling to those betting on a total collapse of this retailing stalwart that the company actually produced a profit for 4Q13 by increasing margins and a decline in sales. This is the crux of things. JCP had become an undisciplined giant giving away margin for the sake of sales, always trying to out-discount competitors. The realisation that this game is a fruitless race to the bottom seemed to allude many, especially today when internet companies spend most of their time on conference calls talking only about the top line and avoiding questions about how they'll actually make money. This blog only 2 weeks ago pointed out the problems with this business plan in respect of Amazon (Margins 0.6%). JCP has provided an example today why in order to stabilise a business you have to shrink to grow returns. They are not out of the woods yet, but investors interested in the end game for companies trumpeting top line growth would do well to follow this one and its' board over the next 4 quarters.

Of course if the JCP board is showing retailers a new face you might expect that here in Australia someone at Qantas might be watching what can be done when you realise your limitations. QAN yesterday produced another big loss (AUD 250m) and decided they needed to sack 5,000 staff. The problem is that the way the airlines current management set things up very few observers believe that they can deliver. This blog also is in that camp. The current CEO Alan Joyce drew a line in the sand and was determined to defend a 60% market share of the domestic market in the face of a better financed, newer operation (Virgin Australia). This effectively meant that every time Virgin added a 100 seats to a route QAN added 200. And because QAN has a higher cost base due to old union agreements they either had to swallow the margin or introduce a new low cost entity Jetstar to a route. This of course also had the knock-on effect of educating the public away from premium price levels and played into the hands of Virgin. I mean the travelling public once it had been weened off QAN saw no reason not to at least try Virgin or move to Jetstar. In other words the confusion became similar to what I'd experienced at that JCP store in Chicago and just like me people walked away and looked for something more simply presented and therefore easier to deal with. The end game with QAN will be a severe shrinkage and this blog is of the view that QAN will end up as a domestic player with 50% of the market. Investors should heed Warren Buffetts words from an interview in London's Daily Telegraph in 2002:

“If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You’ve got huge fixed costs, you’ve got strong labor unions and you’ve got commodity pricing. That is not a great recipe for success. I have an 800 (free call) number now that I call if I get the urge to buy an airline stock. I call at two in the morning and I say: ‘My name is Warren and I’m an aeroholic.’ And then they talk me down.”

Its not so different being on a bicycle. After all the growth rate in cycling is starting to imply very different metrics when it comes to valuations of bicycling related stocks. The trouble of course comes when growth starts too plateau. Look at Shimano . . . it's very similar to something like Apple because theres a cap at which the market can expand. At that level you start to see valuation dew back and RoE pick-up. Clearly there's only so many times you can release a new group set. The next high earnings will be when disk brakes are legalised by the UCI  . . . . until then you better hope for natural growth through population up-take . . .

I switched back to tubulars this week on the Cannondale because I'm sensing a problem with my Mavic Cosmic Carbones SLRs. I felt a shuddering through the front fork of my bike late last week which at first seemed likely to be a loose headset. When I checked I found no discernible movement in the headset so tried switching front wheels. Immediately the sound was gone. I checked the skewer and cleaned and greased it which helped a bit, but I checked with Mavic and they suggested it was probably that the bearings were starting to go. Interesting? I'm not sure, but will take the wheels down to Cheeky Monkey next week as they are a Mavic authorised dealer. Im off to Orange; north west of Sydney (3 - 4hrs) and need clinchers to ride on. The team I'm going wit are from Tattersalls Club in Sydney and there's no way I want to hold up fellow 40+ year old men on a weekend away from wives and loved ones. Patching and pasting with super glue and tubulars is boring. Imagine if you will taking a pre-glued tubular and carrying it on a ride. Then a puncture . . . stripping off the old one, adding rim tape and stretching the new one on , , , if you're a 50 year old man you're not going to want to wait around . . . you get the idea . . . .


Thursday, 20 February 2014

Composites . . .

Composite materials are taking over the world. In 2007 while working as a hedge fund manager in Singapore I spent hours listening to stockbrokers describing the magic that was within reach of Japanese carbon fibre wonder company Toray Industries.

Toray at the time was one of the prime contractors to Boeing for the soon to be king of air travel the 787 Dreamliner. For a long time it outperformed the N225 and was a good bet for those of us happy to be long technology and short the rusting carcass of Japan's hopelessly moribund industries caught in a race to zero margin nirvana. Problems arose when engineers at Boeing couldn't master the bonding of the wing frame box to the aircraft's main fuselage. If you were part of this clogged supply chain you were toast and Toray Industries shares quickly returned to a marginal out performer. As with a lot of Japanese companies investors will almost always be frustrated by the conglomerate nature of these companies. Often you'll want to buy into a company because of some amazing new technology, but what you'll probably get is a management likely to be timid in exploiting the new segment and almost always end up giving you 20% of what you want. Of course if you were in another country you probably would have floated of the carbon fibre business to allow it to achieve it's full potential both in entrepreneurial terms and in terms of company valuation. 

Technology companies need to be single minded in their passions to an almost pig-headed degree. I want to see companies with either unique technologies (such as Toray's high end fibre business) or be in position to use technology in a new way that plays against the consensus (think Apple under Jobs or todays big news WhatsApp). If you can get both then you're really in an investor friendly zone.

While skiing recently I was struck by just how ridiculously heavy the gear you have to carry around is. As I said to a banker in Zurich, how come my entire bike weighs about 6kgs, while my skis weigh at least 7kgs and boots must be close to 10kgs. Think about it . . . imagine strapping an extra 15kgs on your bike and trying to ride up a hill. In fact imagine the same scenario downhill and what that means to your breaking. Why then haven't we seen more composites in skiing? Well there are companies out there experimenting with this type of thing. Dodge Boots in the US or the team on this report from Bloomberg:

What I liked about Zai skis was their purported desire to damn the costs and just try to produce the best skis they can. As these cost from CHF 6 - 10k I haven't raced out and bought a pair, so maybe they're not very good? I don't know whether the company will achieve what they set out to do, but if they stick to their business plan they'll probably be OK. My point is that investors need to think outside of the consensus to achieve returns greater than normal.

There is a war going on between currency and other markets at the moment. If you're long equities you want to believe the Fed is not going to continue "add" to the taper anytime soon. That is a problem because minutes of the January policy meeting released yesterday showed several members f the board were in “the absence of an appreciable change in the economic outlook, there should be a clear presumption in favor” of continuing to trim asset purchases by $10 billion at each meeting. If that happens yield plays will have to devaluated. The currency market believes it with the Bloomberg Dollar Spot Index reaching its' highest level since Feb. 13 yesterday.

Equity world is clinging on to 'bad' data from the Phili Fed, Empire State manufacturing and Chinese PMI (amongst others). Broad market equity bulls think all this data will see the Fed pause. This blog thinks that the bad US weather has distorted the US data (NY has got 40+ inches more snow this year than average).

The bond market has other problems. Emerging market anxiety is centred on China. The HSBC and Markit Economics Index of Chinese manufacturing fell to 48.3 from January’s final figure of 49.5. GDP growth is forecast to fall to a 24-year low of 7.4% in 2014. The worry for investors in bonds is that we start to get a surge in credit rating downgrades of China-centric companies. This blog has seen what happened in 1997-8 in Asia when growth hit a debt wall. That was a time when Samsung Electronics was within a month of not being able to pay there workforce and Malaysia shut its' currency market down. Given this investors should re-evaluate their current exposure to emerging market bonds a and instead look for euro-centric issuers to express their preference for any carry advantage they might wish to take.

It's Friday in Sydney as I write this and the weather has turned for the better. Being unemployed has it's advantages as I'll be getting on my bike to stretch out again. I've managed to get nearly 150km's under my belt so far this week. I'm riding on the north side of Sydeny on Sunday morning with a big group of middle aged men and the odd lady. My cold / lung problems have nearly disappeared and I'm noting that I have a bit more zip in my pedal stroke. Yesterday I hit the park after 2 hours in the dentist chair and happily racked up the km's. Amazingly cycling seems to be growing daily in Sydney. It's very encouraging that even in the face of poor infrastructure, driver ignorance and a hilly geography that people are increasingly putting in time on their bikes. I'm not sure what the end game is for this city, but I tend to think that numbers alone, like in London, will dictate more cycling infrastructure. Good days are ahead . . .


Monday, 17 February 2014

Consensus cycling . . .

The consensus is now firmly of the the view that not only did Ben Bernanke do a good job stimulating the US (and to a degree) the global economy, but in fact he should have gone further. I was listening to my favourite left of centre political podcast over the weekend (Slate's Political Gabfest) and found it strange that the debate on this was so reverential of the Fed establishment.

What happened to a bit of barricade burning by angry revolutionaries? That's why I listen to views opposite to mine. To me the left in the US has coalesced with the very people that they most ardently wanted to expose only a few years ago. If you want a truly old school left wing view of the world you need to go to someone like Robert Scheer and read his book 'The Great American Stickup: How Reagan Republicans and Clinton Democrats Enriched Wall Street While Mugging Main Street'.

This blogs view is that the consensus where economics and markets are concerned almost always spells danger.  One only has to remember the tame questioning of latter day guru Alan Greenspan in the years leading up to 2007 to have an example of a dangerous consensus. Is it therefore too much now to question the new doctrinal orthodoxy post the crisis? Paul Krugman is St Paul to Bernanke's St Peter, one establishing a church and the other forming the doctrinal basis for bringing various cells together. Krugman's columns and blog reminds me more and more of Paul's various letters to disparate groups (Corinthians, Thessalonians, etc . . .). Perhaps a reformation is needed? I always cringed when Paul's letters were the reading of the week in my school's chapel as somehow the tone always offended my own sense of logic. It was made worse by the Catholic clergy of my school who never wanted to debate Paul's position in the hierarchy of the Christian church. Therefore given the current consensus surrounding the global economy it's hard to believe that anyone in economics currently is willing or able to nail their argument to the cathedral doors and get a fair hearing. If you try you'll end up like me . . . in detention writing an essay . . . "Why I need to have faith".

Volatility is always close to the heart of this blogs thought process when it comes to accessing markets. Recently I penned a piece suggesting to sell some of the recommended VIX Index exposure and buy back into equities or various types. This has been a winning strategy and can clearly be seen in the charts below:

The established pattern is that every time we get a policy shift volatility escalates as market participants re-weight into more appropriate asset classes. Just as rhythmic has been the central banks pronouncements that have calmed the markets. In the case of the Fed it's the usual hints by various Fed Governors that they remain committed to stimulus over a longer period, or from the BoE which never tires of telling the media that they see no reason to scale back QE operations. 

Sterling is an interesting case study in markets hearing one thing and behaving differently. The BoE under it's Canadian head Mark Carney has indeed been consistent in spruiking deflation, but the markets have not been willing to listen. Here's the GBP over the last year:

Sterling has outperformed all the major currencies not because the BoE has tapered, but rather because they haven't. This blog is of the view that the UK is likely to have to raise rates more steeply in 2015 than other countries because the BoE has ignored inflation being above it's target for many months now. Having said that here's an interesting debate that gives both sides of the argument:

Somewhat predictably this blog takes the view that the UK has built in another cycle of boom and bust. Up until now the view of this blog has been to be long GBP assets. Now is the time to move away from the UK aside from inflation sensitive plays. Investors will be best placed moving deeper into southern European geographies.

I'm currently dogged by a chest infection I picked up while skiing, as such my cycling hours have been somewhat restricted. I managed to get out on Saturday for a short ride before it started to rain in Sydney. My home city has been dry of late and therefore at the first sign of rain all the oily dirt comes to the surface of the roads and makes conditions quite slippery. Needless to say you have to slow down or get off the road. I chose to curtail things in favour of safety.

I changed tires after many months being back on Mavic rubber. I picked up some new Vittoria Open Corsa CX's before Xmas and decided it was time when the number of deep cuts in the Mavics started to become noticeable. The Vittoria's provide a fantastic ride, but downside is the longevity is not ideal for city training. Perhaps I should have gone with their Robino Pro's as they have a tougher all Nylon case which is more resistant to the road debris that big cities throw at you.

My policy is never to skimp on rubber, whether on my car or my bike. In Europe the Avis hire car I was driving had extremely poor winter tires which caused me some grief when trying to dig the black Renault out of the parking area in Austria where I'd basically seen it disappear over a week. I know from my time in Geneva that good winter tires will in the vast majority of cases get you out of most situations without having to go through the whole snow chain dance. I still have some mountain bike tires that I never got around to putting on my commuter bike in Switzerland. They're quite nifty; you get a box of studs with the tires and they have pre-drilled holes into which you screw the studs. Luckily the Swiss are ever efficient at clearing main roads, thus precluding the necessity to try them out. In Sydney they remain an oddity in my workshop as snow is unlikely to ever be a problem here and I left the mountain bike in Geneva. Maybe I'll send them to a friend of mine in Switzerland as a birthday gift?


Monday, 10 February 2014

Just minding my own business . . .

I finally made it back to Australia on Friday after a brief stop in Zurich. Things seemed to be going pretty well for the inhabitants of private banking central. The recent up-surge in market volatility outwardly was having little impact on my favourite small city of Europe. I wonder what it might take to change the mood?

Before I got to Zurich I had been thinking about commodities and and more specifically Oil. One of the bankers I met handed me a 2014 outlook booklet and I coincidentally flicked it open to the commodities page and found that I was not the only one thinking about oil. I'm a great believer in the petro-dollar, but I also understand that there's a reasonable amount of hot air in the price because of Iran, Syria and Egypt . . not to mention the lesser instability in places such as Iraq. The flip side has been the shale gas boom in the US and the subsequent change from energy importer to newly minted exporter. My ex-partner was a firm believer in the metrics that Oil would remain fundementally in a tight market as the BRICs economies continued to take up slack that the US economy was now generating in the energy markets. While in the long term I think he is right, I'm a short term (12 months or so) bear. This blog's position is that the US dollar will strengthen further in 2014 and therefore concludes that there will be some downward pressure on the oil price in USD's. This one is not for the faint hearted and therefore it would be best to develop a cautious short overall, best manifested from cheap out-of-the-money type options of various strikes and maturities.

Given the above I suggest equity investors remain underweight various contractors in the sector as any downward price spiral will inevitably lead to the closure or delay in slated projects, as has been the case in other commodities such as coal and various metals.

I was asked about the final stop of my skiing expedition in Cervinia . . . Not sure what I think of this resort. The snow never stopped falling during my 6 days there and as such getting a clear view of the terrain was somewhat difficult. By the time we left the slopes were recording about 4 metres of powder, mostly dry and very skiable. As is my usual practice when arriving at new ski resorts I always hire a guide/instructor for day one so as to limit the amount of time you would normally spend squinting at one of those huge piste maps located on the sides of most lift stations. Anyway with the snow falling I spent 3 hrs or so being shuffled around he Italian side of the mountain. The idea of being in Cervinia is that you get to ski over to Zermatt, thus creating a huge high altitude mega resort. Cervinia itself is already at 2000m and the top stations are closer to 3600, so when the weather is bad the mountain closes off access to Switzerland to avoid people being stuck. You can't just grab a taxi back from Zermatt as you have to go the long way around, about CHF500.

Cervinia doesn't advertise itself as a restaurant paradise, so our expectations were quite low. In reality there's a number of good restaurants both on and off the mountain, but few make it into the conventional guidebooks. We managed to spark up a conversation with an English girl working the lunchtime shift in a hidden gem of a bar. She gave us a list of suggestions which proved to be all good. Readers can contact me directly for the list.

During one lunch there I met a young Canadian guy and his wife. He was working for a multi-family wealth management office that had 1.5bn to play with. The usual complaints flowed pretty quickly regarding the ability to execute deals with any urgency. This is familiar territory to me. If you're fresh out of university or a graduate position at an investment bank it no doubt seems very attractive to be given the keys to the "financial Ferrari" and told to go out and look for opportunities. Unfortunately unlike in a large institution the ability to act is much more limited as these offices firstly seek to protect family wealth and secondly enhance it. It's therefore very unlikely that (say) a family who built their wealth in packaging is going to let a 28 year old lead them down the path into coal mining assets in Mongolia. Having said that, so long as you're willing to play the long game and build up a portfolio of actionable ideas you just may after a lot of due diligence get the chance to get out on the "deal highways" and see what that V12 can do. Patience is your friend.

My Canadian friend and I didn't get to talking ideas, which was a pity because I'd like to have heard what he thought about the current situation. A lot of the Gen Y's I meet were still at business school during the crisis and have come to see the current central bank activism as being quite the normal thing within the financial system. That may or may not be a good thing and I somehow think that the Fed taper may leave more than a few MBAs splattered like financial road kill by the side of the road. The problem is the only example of this type of thing we have is the Japanese and their flirting with ultra-lose monetary policy ever since the collapse of the real estate boom in the late 80's through early 90's. I know a couple of readers of this blog would tell me that the US version has had far more conviction behind it and therefore will ultimately prove successful. I'm not as a confident if stage one of the taper and the markets reaction to it is anything to go by. The overall correlation between markets has been so high for so long that it's hard to believe that the carry trade gang can extricate themselves from the developing world without some unforeseen systemic risk. Investors will just have to put up with the volatility. 

Finally I managed to get back on my bike yesterday and thanks to jet lag made it out early on to Sydney's roads. I can report that all systems were in working order. My legs were a bit heavy and I've definitely put on a pound or two thanks to a constant diet of rich european food. As is my custom I try not to ride on Mondays because of the early week "aggro" most drivers in Sydney show, therefore today I'm restricting myself to clothes washing, blog writing and bill paying.