2020: Third Quarter Update

Portfolio Update
- Uranium:  Our Man continued to materially increase the Uranium position, as the positive signs continued.

- Blockchain/Crypto:  Our Man added to the Bitcoin (GBTC) position near quarter-end.

Performance and Review
OM’s portfolio hasn’t yet been invited to the market fun, rising just +2.2% during the third quarter.  This pales in comparison to the S&P 500 Total Return (+8.9%) and the MSCI World (Total Return, Net Dividends; +7.9%).  For the year, this leaves the portfolio down -28.3% while the market indices have recovered their early year losses (S& P 500: +5.6%, MSCI World: +1.7%).

Third Quarter Attribution
 

The third quarter was surprisingly quiet for OM’s portfolio, with broad-based gains being partially offset by losses in Shipping/Tankers (-103bps) and the Texas Pacific Land Trust (TPL, -82bps) position in the Idiosyncratic book.   Both positions  indirectly impacted by oil, especially fears about second COVID waves and a slow recovery in oil demand.  In the case of tankers, the market expects exceptionally weak rates through 2021 with the companies receiving little credit for the extraordinary earnings of the last 12mos that have radically improved their balance sheets.

The two other positions that fit into the broad “supply is constrained” theme – Uranium (+55bps) and Blockchain/Crypto (+60bps) were good contributors.  The news flow on Uranium continues to be positive on the supply side, as well as the removal of some regulatory uncertainty that may encourage utility demand.  The Blockchain/Crypto book benefited as bitcoin continued to see increasing acceptance as a store of value, with Microstrategy, a publicly listed company, moving part of its cash holdings into bitcoin.  OM believes that this institutional acceptance is likely to continue, but that the role GBTC may play in consuming the supply of bitcoin (similar to GLD's impact on gold during the 2000s) is under-rated.   Given the commodity-bias (Uranium & Tankers) at the top of OM’s portfolio, the Blockchain/Crypto exposure is OM’s hedge in case we get a full on bubble in software/growth.  Bitcoin is digitization and "software taking over the world" taken towards its logical extreme.

The rest of the portfolio showed reasonable gains led by the exposure to the 4th Industrial Revolution, especially Software-as-a-Service (SaaS) stocks.  While SaaS is a great business model and technological progress has been pulled forward by COVID, the valuations are exceptionally high.  The median public SaaS company trades at 16.0x next-twelve month’s revenue estimates, a healthy jump from the already nosebleed 13.1x pre-COVID.  Caveat emptor; beware, they’re not ALL going to turn into the next FANG companies!

The thematic exposure to Vietnam (+38bps) and India (+49bps), both emerging markets countries with attractive demographics, finally started to participate in the market rally.  This broader participation also helped the Funds (+128bps), which recouped its losses for the year during the quarter.


Portfolio (as at 09/30/20 - all delta and leverage adjusted, as appropriate)
Dislocations: 41.5%
18.8% - Uranium (URNM, CCJ, NXE and URG)
17.8% - Shipping/Tankers (STNG, DSSI, EURN, TNK and DHT)
4.0% - Greece (GREK & ALBKY)

Thematic: 21.2%
7.1% - Tech: 4th Industrial Revolution (JD & WCLD)
5.8% - Blockchain/Crypto (GBTC)
4.2% - Vietnam (VNM)
3.6% - India (INDA)
0.5% - Brazil (EWZ)

Technical: 0.0%
0.0% - OEW Technical positions (DDM, SSO, and QLD)

Idiosyncratic: 18.8%
16.3% - Funds (ARTTX, CWS, GVAL, and CAPE)
2.5% - Equities (TPL)

Shorts/Hedges: 0.0%

Cash: 15.3%

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

Things from my Newsblur; 2020 Part 3

It’s been too long since OM’s last “Things from” so I’ll spare you much of an introduction.  The broad inspiration for this “Things from” is the FT interview with the world’s greatest short seller, where he called this “the golden age of fraud”.  While it’s rarely wise to disagree with Jim Chanos, perhaps the more charitable “the golden age of half-truths” is a better description.

The Vampire Ship
As you know, OM likes tankers and here’s a wild tale about one, the Noor One.  It’s a tale about heroin smuggling and Europe’s largest ever drugs bust, but that’s just the opening act.  The main course sees the gangsters involved trying to murder each other across the globe, together with witnesses and journalists dying in unexplained circumstances in Greece.  It ends with still-raging political corruption scandals in Turkey and the Middle East, as well as in Greece where the one of the country’s leading oligarchs has been enveloped.
(Alexander Clapp, The New Republic)

Beware What Sounds Insightful
With the proliferation of newsletters (and Medium posts) comes a fine warning; what sounds insightful and what is useful or true are often not the same thing!
(Cedric Chin, Commonplace)

Wirecard and me: Dan McCrum on exposing a criminal enterprise
Wirecard, a multi-billion dollar market cap German fintech company, which imploded earlier this year is the public market's poster child for the Golden Age of Fraud.   This article is just the cliff notes of the FT’s 5-year investigation of the firm, which included providing evidence that much of the business wasn’t real.  Yet all this led to was the stock rocketing upwards (and into Germany’s DAX index), Wirecard spying on the journalists and the BAFIN (German securities regulator) choosing to investigate McCrum & the FT rather than Wirecard.  In the end, a special audit by KPMG led the company to announce $2 billion was ‘missing’ in June 2020, and this turned out to be the tip of the iceberg.  Today, the stock is worthless, the CEO and various associates are in jail awaiting charges, and the COO is on the run.
(Dan McCrum, Financial Times)

An Arrest in Canada Casts a Shadow on a New York Times Star, and The Times
This story, about the unraveling of Rukmini Callimachi’s reporting on terrorism is one OM was sad to read.  It shows the difficulty for journalism as it seeks a profitable business model, but also – much like the markets – how bad incentives can lead to narrative driving everything, and facts being rearranged to suit them.
(Ben Smith, New York Times)

From Boom to Bloodbath
One of the things OM is currently researching is the opportunities arising as a result of the collapse of Shale – I see your natural gas producers, and (eventually) offshore oil services cos!   With the collapse in oil prices bringing the Shale revolution to a screeching halt, Justin Miller looks at what it means for Texas and whether the state can transition to become a renewable energy powerhouse.
(Justin Miller, Texas Observer)

This Overlooked Variable is the Key to the Pandemic
Spoiler alert, it’s not R!  Another fantastic piece by Zeynep Tufekci – the West has been slow to understand and adapt to the evidence that ‘the corona’ (to quote OM’s kids) doesn’t spread like the flu but more like 2003’s SARS.  Super-spreader events are far more important than the average captured by R, and recognition of this leads to VERY different policy choices.  See Japan for more information.  (Zeynep Tufekci, The Atlantic).

The Students Left Behind by Remote Learning
“The desire to protect children may put their long-term well-being at stake” sub-heading is another reminder of the touch choices COVID-19 has forced upon us, and how we struggle when the benefits and costs are unequal and when measured on different time horizons.  
(Alec MacGillis, New Yorker)

Uranium - COVID-19 Brings the Supply Deficit to a Head.

It’s been a while since OM last talked about Uranium in depth – over 2.5 years(!) – and with it closing in on becoming the largest position in the portfolio, what better time for an update!

    
Demand
The demand for uranium comes from one source – nuclear power plants, which generate ~10% of the world’s electricity, and show consistent and steadily increasing demand.  
 
Since the Fukushima tsunami in 2011, the trend in the US & Europe had been towards closing nuclear power plants leading to a belief (and lots of press articles!) that nuclear was being phased out.  Since OM started investing in uranium this has changed, with existing plants seeing extensions and projects being planned.   The change has been driven by a recent focus on ‘clean energy’ (vs. ‘green’ energy) that values nuclear’s carbon-free, safe(!) and low cost provision of base power,  coupled with the beginning of the development of small and advanced modular nuclear reactors.
 
While the Western world and press was focused on the decline of nuclear, the same was not true in Asia where countries, led by India and China, continued to plan and construct nuclear power plants.  

Source: Visual Capitalist - Mapped: Visualizing the World's Nuclear Reactor Landscape

Finally, nuclear utilities typically purchase uranium through primarily through  long-term contacts and the cost of uranium is a small % of their total costs.  The chart below shows the long-term contracting boom of the last cycle, with the recontracting phase expected to be begin in the next 18 months.

Supply Side
While demand for uranium has been a nice gentle incline, the attractiveness of the opportunity reflects that supply is constrained!   Almost 2.5 years ago, OM discussed how the 2 largest miners – Cameco (through its Mcarthur River/Key Lake mine) and Kazataprom – both cut supply by a combined 20% in an economically rational attempt to help bring the market back towards balance.  
 
The magnitude of these supply cuts has seen the Uranium market shift from being oversupplied to a supply deficit of ~20mn lbs (or 15% of global production) before COVID-19!  COVID-19 had a major impact on uranium mining with  Cameco closing its remaining flagship Cigar Lake mine (12% of primary uranium supply!), and Kazataprom having to reduce both its production targets (by 10mn lbs, or 8% of annual primary supply) and its 2020 wellfield development (which will reduce its 2021 production capacity).  This led to fears of a potential supply shortfall of ~40mn lbs in 2020!  The cutbacks also led to both Cameco (especially in Q2) and Kazatprom (beginning in late Q2) entering the spot market to fulfil existing contracts.

This short video from Purepoint Uranium shows the impact of the cuts.

 

Eagle-eyed readers will have noted (i) the importance of Kazataprom and Cameco (Cigar Lake & McArthur River) due to both their size and as the lowest cost producers and (ii) that almost half of the existing & idled production is uneconomic at today’s prices!
 
While Cigar Lake will start coming back online in September 2020, the market is expected to remain in significant deficit, which is exacerbated by major mines (Ranger in Australia & COMINAK in Niger, which are a combined >5% of primary supply) permanently closing at the start of 2021 and Kazataprom confirming low 2022 production levels (i.e. no attempt at trying to recover from 2020/21 production losses).
 
Why Now?
Earlier this year, before the impacts of COVID were fully felt, the World Nuclear Association published its biennial "Nuclear Fuel Report", and for the first time made the Expanded Summary available publicly.  For those who don't follow the space, charts such as the below helped codify the supply gap.

Source: World Nuclear Association - The Nuclear Fuel Report Expanded Summary

However, even the WNA report was overshadowed by the impacts of COVID-19 - demand for nuclear power remained largely unchanged, while the impact on supply pulled everything forwards.   The Uranium spot price jumped ~50% after Cameco started purchasing in the open market, and both Cameco & Kazataprom will be doing so in the second half.  OM suspects Cameco is re-opening Cigar Lake, both due to the costs of keeping it in care & maintenance but also for security of supply (to meeting existing contracts) given the limited inventory in spot markets, and Kazataprom needing to buy.   

This combination has made clear that after the decade long bear market Uranium trades below its cost of supply limiting the incentive for new mines to be built.  COVID-19 has exacerbated and highlighted the supply deficit.  For utilities (and the primary consultant that advises them) security of supply is a vital factor, and the upcoming contracting cycle will being the problem to a head and OM believes to materially higher prices to encourage new uranium mining development.  Our Man hopes to capture the vast majority of this move in the Dislocation book over the next couple of years!

 

 

Major Risks

 - It’s long been claimed the secondary supply, or spot market traders, will make up the difference.  With both Cameco & Kazataprom in the spot market during H2-20, we will find out.

- Idled supply will rush back into production though this is largely Cameco and Kazataprom.  It reflects a belief that Kazataprom will return to its 2014-era behavior of maximizing supply, despite the firm's changes (no longer selling in spot market, IPO, etc) and statement/behavior (supply cuts and statement re. supply through 2022).

- Less uranium being required (i.e. following the WNA’s lower scenario for reactor requirements) due to fewer nuclear reactors being built or greater efficiency.

- Another Fukushima!

2020: Second Quarter Update

Portfolio Update
Please see the recent Portfolio Update piece, for some thoughts on the current portfolio and its structure. 

During the quarter OM made the following changes:
New Position:  Blockchain/Crypto (Thematic)
Added to: Shipping/Tankers (Dislocation), and Uranium (Dislocation)
Reduced: Greece (Dislocation), Brazil (Thematic), and Fourth Industrial Revolution (Thematic)
Exited: None.

Performance and Review
Following the dismal first quarter, equity markets surged during the second quarter with the S&P 500 posting its best performance since the fourth quarter of 1998!  OM’s portfolio sadly failed to join the Q2 party, rising a measly +0.7% and significantly underperforming both the S&P 500 Total Return (+20.5%) and the MSCI World (Total Return, Net Dividends; +19.4%).  For the year, this leaves the portfolio down -29.9% while the market indices are down mid-single digits (S& P 500: -3.1%, MSCI World: -5.8%).

Second Quarter Attribution

Our Man’s Q2 can largely be summed up as a significant negative contribution from Shipping/Tankers, a good contribution from the 4th Industrial Revolution theme and reasonable contributions elsewhere.

Shipping/Tankers (-853bps) were a significant drag on performance during the quarter, and for the first half of 2020.  While tanker rates are shaping up to have a stellar year and companies have performed exceptionally strongly, the stock price performance has been abysmal with most trading at or below the lows of March 2020!  

The bear case for tankers is centered on expectations of a prolonged period of rates at or below break-even stretching into early 2022.  These low rates will be driven by (i) demand for oil coming back slowly, (ii) floating storage - where oil was stored on tankers at sea - unwinding over a prolonged period now there is no contango, and (iii) ship owners will order more vessels.    Let’s be clear, these are not unreasonable or crazy fears especially for an industry that’s been in a 10-year bear market.   Certainly, it’s hard to argue that post-COVID demand is uncertain and that unwinding of floating storage will likely increase pressure on rates as more ships become available for transportation.  However, as noted in the recent portfolio update, OM believes that “if demand remains weak then pricing will not be as bad as investors fear”.  Why?  Firstly, supply is constrained; it’s one of the oldest fleets, with one of the smallest order books of the 2000s.  Secondly, the strong rates over the last 9 months coupled with the operational and financial leverage have created options for tanker companies to weather periods of low rates and reward shareholders.  This is best shown through a couple of examples.  

Teekay Tankers (TNK) came into Q4-2019 over-levered and with significant debt payments due within 12-24mos.   The exceptional rates of the last 9mos have allowed the company to (i) refinance 31 vessels pushing its debt maturities out 4 years, (ii) earn ~$7.50-8.00/share in 9 months (or almost two-thirds of its Q2-end market cap), which it wisely used to (iii) reduce its net debt by over 35%, and finally (iv) it leased some of its ships out for 6-24mos at strong rates, thereby reducing the break-even of its vessels in the spot-market to ~$10K per day.  The end result is a company vastly better poised to handle a period of lower rates, through both its financial position and its reduced sensitivity to those rates (due to the ships out on those 6-24month time charters).  OM rather hopes this starts to get reflected in stock prices, especially if/when tanker rates prove to be “not as bad” as investors fear.

On the other hand, Euronav (EURN) is the least levered and best managed of OM’s tanker names.  In 2020, it has so far returned 10% of its market cap in dividends and is happily purchasing its shares in the open market while they trade at a discount.

Given the rise in the markets, it’s not surprising that most of the portfolio were at least positive contributors.  The Idiosyncratic book led the way, aided by solid performance from the Funds (+238bps) which all rose 15-21% leaving 3 of the 4 broadly in line with the S&P 500.  GVAL, which systematically focuses on the most undervalued stocks in the most undervalued markets is lagging.   The position in Texas Pacific Land Trust (TPL, +130bps) rallied strongly, as oil prices rebounded and the company edged closer to converting to a corporation (from a land trust).

The Thematic book’s performance was driven by its 4th Industrial Revolution (+270bps) holdings, and especially the positions in Software-as-a-Service/Cloud software (WCLD).   With many of us working from home during the government lockdowns, these companies saw significant demand for the technological solutions.  Unfortunately, the median SaaS company now trades at 12x revenue, with many of the leaders trading at 20x revenue.  Though the group may continue to trade higher, OM isn’t comfortable adding at these valuations.   The rest of the thematic group performed reasonably win both India (+49bps) and Vietnam (+80bps) outpacing global markets during the quarter, though both lag meaningfully year-to-date.   Unfortunately, OM trimmed back the position in Brazil (+16bps) just before it rallied strongly.  The Blockchain/Crypto (-68bps) position was added late in the quarter.

Portfolio (as at 06/30/20 - all delta and leverage adjusted, as appropriate)

Dislocations: 38.5%
19.6% - Shipping/Tankers (STNG, DSSI, EURN, TNK and DHT)
14.5% - Uranium (URNM, CCJ and NXE)
4.3% - Greece (GREK & ALBKY)

Thematic: 18.1%
6.4% - Tech: 4th Industrial Revolution (JD & WCLD)
4.1% - Blockchain/Crypto (GBTC)
3.9% - Vietnam (VNM)
3.1% - India (INDA)
0.5% - Brazil (EWZ)

Technical: 0.0%
0.0% - OEW Technical positions (DDM, SSO, and QLD)

Idiosyncratic: 16.0%
15.4% - Funds (ARTTX, CWS, GVAL, and CAPE)
3.4% - Equities (TPL)

Shorts/Hedges: 0.0%

Cash: 24.6%

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

Portfolio Update – Mid-2020

For those who follow markets, I’m sure you’ve seen numerous pieces trying to look at the dichotomy between the rallying stock market and the improving but still uncertain economy.  For those who don’t follow the markets closely, don’t worry this is not going to be one of those pieces!  Frankly, OM is more sanguine than most and there are reasonable arguments on both sides.  As a natural cynic, OM currently struggles to be too bullish but there are some broad themes that he’s comfortable with – thus this portfolio update will break the book down differently from normal.  As you might quickly surmise from the depth of the write-ups, OM is more inclined to add to those themes listed first over those listed later on.
 

Supply is Constrained (38.3% of the ptf)

This is the largest part of the portfolio, and it will likely be for some time.  In essence, OM has no great conviction in what demand will look like and so has instead concentrated much of the portfolio in areas where supply is constrained.  In the not-going-to-happen ideal world, if demand is good then the constrained supply will manifest itself in higher prices, and if demand remains weak then pricing will not be as bad as investors fear.  Supply has been constrained in these areas predominantly as they have been terrible, horrible, no good, very bad sectors (or are otherwise controversial) for a long time.  Clearly, OM thinks they are at an inflection point BUT until this is proven over time the good news will be discounted, the bad will be extrapolated and the stocks will be VERY volatile.  That unfortunately is the cost of investing here and so the ability to see the forest from the trees, the conviction to stomach that volatility, and the honesty to walk away if/when things change are what is going to matter.  Our Man added to all three positions during the quarter.

- Uranium (URNM, CCJ & NXE): 14.5% position
Our Man added significantly to his Uranium position multiple times during the quarter.  While there is a longer piece coming on Uranium, most of the key factors have been discussed before – the difference is that after numerous false starts, and aided by COVID-19, the time is finally right.  Today, there are clear tailwinds on both demand and supply sides.  Notably, there are changing attitudes in the West that will impact demand; even AOC has gone ‘no nuclear’ in the Green New Deal to ‘leaving the door open for nuclear’ in 18-months, and in a subtle shift 'green energy' has become 'clean energy' that includes nuclear.  On the supply-side, COVID-19’s impact means the two largest producers have largely shut-down their production creating a major short-term supply-demand imbalance and further highlighting the longer-term supply deficit.
 
- Shipping/Tankers (EURN, DSSI, STNG, DHT & TNK): 19.6% position
The tanker thesis can be summarized as the lowest ship order book in a decade+ combined with the oldest fleet in history: supply is constrained!  It is why things like the COSCO sanctions and the oil contango drove significant increases in shipping rates.  Unfortunately, while rates for 2020 are amongst the best in history, the stocks’ performance is not!  Investors expect rates to be fallow, falling beneath operating break-even, in the coming quarters as the floating storage unwinds and oil demand comes back slowly.  Unsurprisingly, OM doesn’t think that rates will be as bad…
 
- Blockchain/Cryptocurrency (GBTC): 4.1% position
OM will spare you a debate on bitcoin merits (or not), though as many of you know he owns cryptocurrency directly and has thus eschewed owning the less efficient ways of owning it in this portfolio.  Well that changed in Q2, as he held his nose and overlooked GBTC’s inefficient structure to start a position in Bitcoin.  Why?  Two reasons;
(i) COVID-19 launched a perfect storm of unprecedented fiscal stimulus and monetary easing coinciding with Bitcoin’s halving date (when supply became more constrained!).  Even the most ardent bitcoin believers couldn’t have dreamt of this!  It’s not a coincidence OM refreshed you on Plan B’s stock-to-flow model in the last Things from My Newsblur.
(ii) OM is old enough to remember when UK Chancellor Gordon Brown selling half the UK’s gold for $275 in 1999-2002 (it’s ~$18,000 today!) and the launch of the GLD ETF a couple of years later, which helped the gold price rise through consuming a large part of new gold supply during the 2000s.   After the collapse from the late-2017 highs reversed in late 2019, OM will be watching GBTC’s purchases of bitcoin to see if history rhymes.
 

 

Long-term looks good, short term questions (7.6% of the ptf)
OM’s positions in Vietnam, India and Brazil fall into this category.  The long-term thesis was covered last year; all three countries have a large millennial cohort that’s entering the workforce as the countries are economically liberalizing.   That’s historically been a great sign for a country’s economic growth and stock market performance.  The short-term questions all stem from COVID-19, the respective country’s handling of it and its broader impact.  While developed world nations have provided massive fiscal and monetary stimulus, those avenues are not as open in emerging markets.  The positions in India and especially Brazil were reduced, as it became clear that the two countries were struggling to deal with COVID-19.  Vietnam showed them how it should have been done.
 
- Vietnam (VNM): 3.9% position
- India (INDA): 3.1% position
- Brazil (EWZ): 0.5% position

 

The Department of the Near Future (6.4% of the ptf)
This has been the best performing part of the portfolio in 2020, with both the Software-as-a-Service (“SaaS”) exposure and JD.com up 50%+ through mid-year.  The thesis for SaaS is largely unchanged from when OM wrote it last year (part 1  and part 2) though the pandemic has likely hastened the transition to cloud services.  Unfortunately, this is largely priced in with the median SaaS company trading at ~12 x revenue, which is bubble territory!!
 
- SaaS (WCLD): 4.6% position
- JD.com (JD): 1.7% position

 

Permanent/Semi-Permanent Exposure (15.4% of the ptf)
An important part of investing is knowing yourself: OM tends to be cynical, which leads to him being underinvested.  The Funds book and the Technical book are two ways in which he tries to limit this investment flaw.  The Funds book is permanent exposure; it’s made up for 4 Funds, where OM either likes the thesis (if quantitatively driven) or the approach/manager (if qualitatively driven).  The positions aren’t traded and so provide consistent global market exposure.   The Technical book is based on OEW and is either invested or not, depending on the longer-term technical signals.
 
- Funds (ARTTX, CWS, CAPE, and GVAL): 15.4% position
- Technical: 0.0% position

 

Other/None of the Above (7.8% of the ptf)
Two positions don’t fit easily into any of the themes above. 
- Greece (GREK, and ALBKY): 4.3% position
The opposition New Democracy party swept to victory in Greece last year, in what OM was hoping would be the event that crystallized the dislocation in Greece.  Unfortunately, despite a strong economic plan and fruitful discussions with Europe, COVID-19 dealt the Mitsotakis government a poor hand. Greece has managed the crisis the best of any European country, with the Mitsotakis government showing the pragmatic approach OM had hoped for.  However, the lockdown has impacted economic progress, which has once more made Greece reliant on others and reduced investor interest.  As such, the Greece position is vastly smaller until there’s some clarity on the various European recovery mechanisms (which Greece will have to tap) and an increased sense of investor interst.
 
- Texas Pacific Land Trust (TPL): 3.4% position
Texas Pacific Land Trust is publicly traded land trust, with land in the Permian basin that benefits primarily from oil & gas royalties with a smaller (but growing) water business.  The trust was historically self-liquidating, using its excess cash to buy back shares, but has recently decided to convert itself to a C corporation

 

Cash (24.8% of the ptf)

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

Things from my Newsblur; 2020 Part 2

I hope you’re all safe and not going too stir crazy!   A broad Things from my Newsblur covering everything from Lord of the Flies, to Ewoks, to gambling on horse racing, before the finance and COVID-19 stuff!

The real Lord of the Flies: what happened when six boys were shipwrecked for 15 months 

William Golding’s book focuses on a stranded group of boys and their disastrous and brutal attempts to govern themselves.  The real-life version proved to be rather different from that best-selling book!

(Rutger Bregman, the Guardian)

The Great Buenos Aires Bank Heist

It’s not quite Ocean’s 11, but sometimes art imitates life – an all-star crew pull-off a simple but audacious plan and become folk heroes!

(Josh Dean, GQ)

Ewoks are the Most Tactically Advanced Fighting Force in Star Wars

It is a prerequisite that the bad guys in movies are incompetent.  Unfortunately, the same is often the case for the heroes – as demonstrated by the ineptness shown in the Battle of Winterfell. Now behold, far more on this subject.  As Star Wars fans must recognize, the Empire/First Order despite their overwhelming fire power lack basic co-ordination!  And the Rebels…well they have great spies, but their only plan is rely on “The Force” and regularly making low probability shots from one of their fighters!   Instead, as the article comprehensively shows…it is those cuddly Ewoks who’re the only ones that know what they’re doing!

(Angry Staff Officer, Wired)

The Gambler Who Cracked the Horse Racing Code

Horse racing was long considered the hardest sport to bet on due to the large number of variables and potential outcomes. This is the amazing story of Bill Benter, who wrote an algorithm that won at the track - and by won, we’re talking $1 billion!  For the finance folks, lots of similarities to the world of finance here! 

(Kit Chellel, Bloomberg)

The Birth of the NHS

While Aneurin Bevan was never Prime Minister, he is one of the most important British politicians of the 20th century.  Certainly the most important Labour one!  Some 75-years later, we can say that Bevan largely succeeded in his ambition to build a national health service based on four principles: it was to be free at the point of use, available to everyone who needed it, paid for out of general taxation, and used responsibly.  The irony, of course, was that the biggest opponent of the NHS at its inception – the British Medical Association – is now one of its biggest supporters.

(Andy McSmith, The Independent)

Modelling Bitcoin Value with Scarcity

With the Fed’s money printer going brrr coinciding with Bitcoin’s halving, it might be Bitcoin’s time to go mainstream.  For those of you of a financial persuasion, here’s Plan B’s important paper fusing a stock-to-flow to model Bitcoin’s value as one would precious metals.

(Plan B, Medium)

Coronavirus Will Bring Trade Wars and Rising Inequality. How to Fix it.

OM is a huge fan of Michael Pettis, whose posts and tweets on China are essential reading.  He’s just written a new book, together with Matthew Klein, espousing a different view on globalization, rising inequality, rising debt and the fragile economies they produce.   Matthew Klein previews it in this piece, noting “the danger is that a global conflict between economic classes within countries gets misinterpreted as a series of conflicts between countries with competing interests.”

(Matthew Klein, Barron’s)

Five Points about US Trade Over the Last Thirty Years

Speaking of trade, Brad Sester’s been through the data and pulled some interesting (and surprising) nuggets.  Unsurprisingly economic theory holds up less well in the real world, especially when IP can be off-shored to a tax haven!

(Brad Sester, Council of Foreign Relations)

The Real Reason To Wear a Mask

The ever changing ‘advice’ around masks – the CDC and WHO both went from no masks to wear masks – is one of the examples of institutional failure during this crisis.  Simple common sense and the maths of it should have led to early insistence on masks in public places! 

(Zeynep Tufekci, Jeremy Howard & Trisha Greenhalgh, The Atlantic)

COVID-19 Targets the Elderly.  Why Don’t Our Prevention Efforts?

As much of Europe and the US starts to exit lockdown and slowly open the economy back up the ‘debate’ over our choices has been largely non-existent, and largely limited to two groups insisting the other’s aims are to kill the economy or kill people.  Instead, we should be discussing if/how we can most effectively prevent COVID’s spread going forward.  On a related point, for New Yorkers - while Governor Cuomo has largely done a good job in handling COVID-19, it may well be the ill-advised executive order to send COVID-19 patients to nursing homes negates it all!

(David Wallace Wells, New York Magazine)

2020: First Quarter Update

Portfolio Update

The rationale behind most of Our Man’s main portfolio changes was discussed in the recent post, No Más!!

The subsequent addition to the Shipping – Tanker names was also discussed in Can You Spell: C-O-N-T-A-N-G-O.

Performance and Review

The first quarter saw the portfolio fall -30.4%, significantly underperforming both the S&P 500 Total Return (-19.6%) and the MSCI World (Total Return, Net Dividends; -21.0%).

First Quarter Attribution

The first quarter can pretty easily be summed up as OM doing too little too late! 

Frustratingly, this was especially the case with the portfolio’s Emerging Markets exposure, which accounted for approximately half the losses.   OM knows better; the low-level of local institutional ownership means EM always sees a shoot first and ask questions later approach during crises.  This has the inevitable double whammy for US dollar investors of hurting both the stocks and the currency.  Given the longer-term nature of OM’s theses the delay in reducing the positions was exceptionally poor portfolio management.  

The limited position sizes help curtail the losses in the thematic positions in Brazil (-240bps), India (-150bps) and Vietnam (-180bps) though none are now positive contributors over the last year+.  The biggest loss came from the large dislocation position in Greece (-1,040 bps), which also gave up slightly more than all of last year's gains.  Ironically, the new Greek government acted much more quickly and decisively than its European peers to combat the Covid-19 crisis.   It is now receiving plaudits for its efforts, which have helped limit both cases and deaths but OM vastly over-weighted this competence in his decision-making.   Unfortunately, given tourism represents ~20% of the economy and small businesses are the major employer there will still be significant economic consequences.  However, Greece’s prompt actions should help restart its economy more quickly than others, and hopefully the government can continue to show similar competency in rebuilding the economy.

The other Dislocation positions in Shipping/Tankers (-467bps) and Uranium (-139bps) were detractors during the quarter.  We’ve discussed Shipping/Tankers enough, but similar dynamics resulting from a tightly supplied market are finally starting to play out in the Uranium space.  Both positions were added to in early April.

The remaining Thematic position in Tech: 4th Industrial Revolution (-14bps) was a minimal detractor, with the position in online Chinese retailer JD.com (JD) benefiting from the lock down in China.

The Idiosyncratic book saw the position in Texas Pacific Land Trust (TPL, -160bps) fall in sympathy with the decline in the oil price, which overwhelmed the news that the Trust’s internal Committee recommended it convert to a C-Corp structure.   Finally, the Funds exposure (-270bps) and Technical book (-370bps) largely fell back in line with global markets.

Portfolio (as at 03/31/20 - all delta and leverage adjusted, as appropriate)

Dislocations: 39.4%

26.9% - Shipping (STNG, DSSI, EURN, TNK and DHT)

8.9% - Greece (GREK, ALBKY, and EGFEY)

3.5% - Uranium (CCJ and NXE)

Thematic: 14.0%

5.4% - Tech: 4th Industrial Revolution (JD & WCLD)

3.2% - Vietnam (VNM)

2.7% - India (INDA)

2.7% - Brazil (EWZ)

0.0% - Blockchain (no positions)

Technical: 0.0%

0.0% - OEW Technical positions (DDM, SSO, and QLD)

Idiosyncratic: 16.1%

13.7% - Funds (ARTTX, CWS, GVAL, and CAPE)

2.3% - Equities (TPL)

Shorts/Hedges: 0.0%

Cash: 30.6%

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

Shipping/Tankers: Can you spell C-O-N-T-A-N-G-O?

Yup, it’s yet another Tankers post!  If you think that all OM talks about is tankers, you’d be right and Mrs. OM and his colleagues can vouch for that! 

After the last update, OM kept buying tanker stocks until finally reaching the “stop buying” limit of 25% NAV on March 23rd.  This article helps explain why.

It was just over a year ago when OM first wrote about tankers, and November's update laid out the thesis' key points:

• Tanker Supply:  After years of oversupply, the tanker markets were finally tight with order books well below historical averages.  With the supply of vessels fixed in the short-run, small changes in demand can have a big impact on tanker rates.
• Operating (and Financial) Leverage:  The operational leverage of tankers, where most of the costs are fixed, means that a small change in rates has a massive impact on the P&L.
• Valuation:  The fall in the tanker stocks during January/February 2020 took valuations back to the early 2019 lows of 0.3-0.5x net asset value.
• Impact of IMO 2020: OM felt that IMO 2020 was going to be the catalyst that brought tanker stocks to the attention of others.  This was largely proving to be the case, though rates are very seasonal, January’s was the best January in a decade and February was heading in a similar direction.  It has since been usurped...

So what changed?

In the last three weeks there have been major changes to both the demand and supply for oil:

• Demand has collapsed.  In response to Covid-19 most of Europe, the US and India are on lockdown, while even the recovering parts of Asia (such as China) are only operating at 70-80% of historical levels.  Unsurprisingly, this has meant that the demand for oil and oil products has also collapsed, with some estimating it has fallen by 20 million barrels/day. 
• Supply has increased.  In the first half of March, OPEC+ couldn’t come to an agreement to reduce oil production after the Russians balked at further cuts.  Saudi Arabia responded by stating it would increase its own production by 2-3 million barrels/day and offering discounts to key customers.

These factors have led to the oil price plummeting.  It has also created two interesting things for tankers; the surplus of oil (10-20mn barrels/day) needs to be stored somewhere and there is a huge contango in the oil markets.

Oil can be stored on land in tanks, at refineries, at oil terminals and in countries’ strategic oil reserves.  However, there’s only ~1 billion barrels of storage available globally and the oil has to be shipped there on crude tankers that move really really slowly! 

Oil can also be stored at sea, in crude tankers, and the contango in the oil market is making this exceptionally attractive.   Contango is when the futures price of a commodity is higher than the current spot price.

This shows that magnitude of the contango, which is surpassing that of the Great Financial Crisis.  Today, someone buying oil and immediately hedging it six months out (by selling the future) can make ~$13.43 per barrel of oil profit, less the cost of storing it for 6 months.   Or put another way, you could make almost ~$27mn risk-free profit if you filled a VLCC tanker to store your oil.  How much to pay for that storage?  The answer has been a lot, the majority of your profit since the market for tankers is tight your profit is risk-free.  The impact of this is two-fold (i) its putting a floor on tanker rates, and (ii) every VLCC that’s used for floating storage is unavailable to transport crude (at a time when Saudi wants to increase production).  

What has this meant?

Well Q2 is typically the seasonal low for tankers as refineries go into maintenance and the deals signed today are for journeys in the second quarter.  Yet, as the chart below shows we’re seeing record rates – in fact rates haven’t been higher since the 1980s!!!

Source: Allied Shipbroking

The chart is for VLCCs, but you could substitute just about any crude or product tanker chart in there and it would look similar.

Will it last forever? 

Of course not but remember the operating leverage.  It means the sharp uptick in rates is dropping straight into the profits and free cash flow.  Combined with the low valuations, OMs tanker holdings are conservatively going to earn 25-50% of their entire market caps in just the first half of 2020.   Until last week, the market didn’t care and there’s a reason why this industry has seen companies and mgmt. aggressively buying shares!

It’s a perfect once in a generation positive storm; a tight tanker market, with massive excess supply and a huge contango incentivizing storage all at a time when cos are trading at low valuations.  

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in DHT, TNK, STNG, DSSSI and EURN - that’s a terrible reason for anyone else to invest in them.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.

Things from my Newsblur; 2020 Part 1

With COVID-19 having spread to the West, OM has repurposed this Things from my Newsblur into a COVID-19 special.   Hopefully, a non-COVID-19 mental health break Things from my Newsblur will soon be upcoming. 

Stay safe people and WASH YOUR HANDS!

It’s hard not to drown in the sea of information, and misinformation, out there on COVID-19.  For OM, the single best curator of all things COVID-19 has been Azeem Azhar (@azeem), who’s refocused his weekly newsletter towards the subject.  His Exponential View newsletter is always one of OM’s weekly must reads.  That is especially the case this week, so if you read nothing else find time for this one.

Exponential View Newsletter #262 (free)
Read this; great curation of all things COVID-19, from progress against the virus, to China after covid and what it may mean for business models.  (Azeem Azhar)

Can Handwashing Really Stop the Spread of COVID-19

In short, it won’t eliminate the risk of infection but there’s evidence that it’s a simple and powerful safety measure.  Importantly, it also allows people to feel that they have something they can control in this fight.  (Sara Rigby, Science Focus)

Coronavirus: Why You Must Act Now
Coronavirus: The Hammer & the Dance (follow-up to above article)

Tomas Pueyo’s original post used statistical analysis of the data available in early March to show why Western nations had to move far more aggressively on COVID-19.  It has been viewed 40 million times, and widely shared and quoted by numerous experts.   His follow-up article on what the next 18 months might look like offers a glimpse at the potential road ahead.  (Tomas Pueyo, published in Medium)

Why the Coronavirus Has Been So Successful

This clear and detailed report on the pandemic explains why we should all be taking social distancing and self-isolation seriously.  (The Atlantic, Ed Yong)

But it’s not all bad news; having most of the world’s best scientists focus on one disease, leads to jumps in progress.

There are over 250 clinical trials for COVID-19 currently underway.

There’s already new cheaper and quicker tests developed for testing for it and numerous groups are racing to develop antibody tests that can show if you’ve previously had COVID-19 (and thus potentially be immune to it).

We can learn best practices from some other countries’ success in stopping the virus affecting their healthcare workers. 

Portfolio Update: No Más!

Our Man followed through with the things on his docket last week, reducing the portfolio’s exposure about 8-10% above Thursday's market bottom.  Frankly, OM hopes it’s a decision that looks abysmal in the future, since that likely means that COVID-19 came and passed quickly with limited impact.

The primary rationale for it was a combination of material year-to-date losses, increasing evidence of the West’s questionable handling of the COVID-19 outbreak, and the increased uncertainty caused by COVID-19.  

• The losses began with Shipping’s sell-off in January and accelerated last week, as emerging market indices collapsed.
• It appears that most of the Western governments were caught off-guard by the spread of COVID-19, and reacting to events rather than having proactive plans.   Bizarrely, the UK is an exception; it has a very clear plan though it is highly controversial and has been at least partially misunderstood.   If you’re in the UK you must read Azeem Azhar’s newsletter post on it.  If you're not in the UK, you should read it anyway.
• The uncertainty around COVID-19’s impact is worth discussing as ideally one should be a buyer in weeks like last week when there is “blood in the streets”.  The argument for buying now is that this too shall pass, and numerous high quality stocks cheap on historical (or post-COVID-19) earnings.  Thus buying today is right, even if there’s another 10-20% downside, as these names will be markedly higher in 12-months’ time.  Normally, OM would nod in agreement.  However, with COVID-19’s spread to Europe and the Americas, the weak response and the potential multiple week lock-downs ahead OM believes the range of outcomes is exceptionally wide.  In the best case, it will look like nothing more than your typical economic or market slowdown and OM’s decision will be costly.  However, the impacts of a prolonged lock-down are non-linear; too many (both large and small) businesses have too thin margins, too many fixed costs, and too much debt to be able to survive with limited revenue for that long.  That starts to raise questions of the health of the economy we'll come back to post COVID-19.  OM suspects that in many scenarios, the solution is going to look a lot like MMT.

Portfolio Changes

The planned reductions to the portfolio were discussed in the previous post but were:

• Technical Book:  The Technical Book’s sell signal flashed in the final days of February, but OM waited for a meaningful bounce that never really came.  He exited it at the close (thankfully!) on Friday, but the delay (vs. the first trading day of March) cost a couple hundred bps!
• Greece:  OM cut this back materially.  It was the only particularly hard decision in the reduction of exposure.  The new government in Greece is largely doing very good job, including their fast response to COVID-19, but it doesn’t matter.  The economic rebound is going to be tested by COVID-19’s impact on tourism among other things, and Greek equities are going to get limited attention from investors.  The Greece ETF is trading below the levels when folks thought the country was run by a Crazy Leftist and about to leave the euro for the drachma.   This is why it’s still the 2nd largest position in the book.
• Brazil, India & Vietnam:  Both Brazil and India saw their first COVID-19 cases during the week, which led to OM to slightly increase his reduction in those positions.  Longer-term, Vietnam continues to a beneficiary of broadening supply chains but was also reduced.
• SaaS & Uranium:  The exposure to the older ETFs was cut back.  There are some more recently launched ETFs that better fit the theses, and OM will be adding these when the moment comes.  OM also trimmed back the JD.com position, which is up for the year.

OM also bought some more crude and oil product tankers!

In the week since OM’s last post on Shipping, Saudi Arabia and Russia started an all-out price water which saw oil prices tumble 30%+.  The combination of the attractiveness of storing crude & oil products and the Saudis hitting the bid on every VLCC tanker they could find saw tanker rates rise 4-8x last week!  This is the start of the low season, but instead rates are printing at all-time highs; there are ships that are literally making a year’s worth of income in a single 45-day voyage!!  OM added some Double Hull Tankers (DHT, crude tanker company with a fleet of VLCCs) but didn’t get filled in his attempt to buy Teekay Tankers (TNK).  If these rates continue and the stocks don't reflect it, expect OM to continue to keep buying more of his existing positions (and TNK) till he hits 25% NAV.    Given the cash flow that these companies are going to throw off in Q1 and Q2, OM is happy keeping this position at a much higher size though he’ll be selling lots of the rest of the portfolio to keep overall risk in check.  OM exited the existing position in Navigator Holdings (NVGS), which is focused on liquid natural gas not crude and oil products.

Portfolio (as at 03/13/20 - all delta and leverage adjusted, as appropriate)

Dislocations: 31.0%

17.9% - Shipping (STNG, DSSI, EURN, DHT and NVGS)

9.9% - Greece (GREK, ALBKY, and EGFEY)

3.2% - Uranium (CCJ and NXE)

Thematic: 15.1%

5.2% - Tech 4th Industrial Revolution (JD & WCLD)

3.4% - Vietnam (VNM)

3.3% - Brazil (EWZ)

3.2% - India (INDA)

0.0% - Blockchain/Crypto (no positions)

Technical: 0.0%

0.0% - OEW Technical positions (DDM, SSO, and QLD)

Idiosyncratic: 16.9%

14.2% - Funds (ARTTX, CWS, GVAL, and CAPE)

2.6% - Equities (TPL)

Shorts/Hedges: 0.0%

Cash: 37.1%

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

COVID-19 and Portfolio Thoughts

Well, that was a fun! *sarcasm alert*

Our Man isn’t a doctor and, unlike far too many in finance and politics, he doesn’t even want to play one on TV! It says far too much about today’s world that the most sensible thing about COVID-19 from a non-expert came from the manager of Liverpool FC!

Thus OM isn’t going to opine on the spread of COVID-19, how you should deal with it, and what the various estimates of the virus’s potential R0, incubation period and case fatality rate are or what they might mean.  If, like OM, you work at a smaller company he will point you in the direction of Elad Gil’s primer and if you want to start thinking about the broader economic effects of a pandemic then Professor Wren-Lewis has you covered.   The three things OM will note is that so far we’ve learned:

1. Strict containment works in limiting COVID-19’s spread (see Singapore)
2. Aggressive and broad testing helps identify early who to isolate in order to prevent the virus' spread (see South Korea).
3. Western countries have, so far, been slow to do both of these things.

Instead OM is going to talk about is the market and some forward looking thoughts, as well as what it might mean for the portfolio. 

While COVID-19 originated in China, it was largely ignored by Western markets until the end of February, which coincided with (was caused by?) a sharp rise in cases in the West. The subsequent correction has been swift, sharp and brutal.   The largest factor in COVID-19’s market impact is the uncertainty – how far will it spread, how bad or deadly is it, and how much impact will it have on the economy and life. In the absence of high quality data, and limited trust in leadership and institutions (WHO, Chinese Government, CDC, etc.), the range of outcomes is wide and it’s often the loudest, not the best placed, voice that holds court. After not affecting the markets for ~6 weeks, this uncertainty quickly became doubt and fear.  In such times, investors go where they feel safest and to what has worked previously – especially government bonds. In the US equity markets, that has been Software and especially Software-as-a-Service, which ended February +7% for the year.

Since COVID-19 started in China, OM will be watching to see the resumption of normality there first.  Like all systems, China’s is incentives based - watch what the government does not what it says. OM is doing that by stealing Bill Bishop of Sinocism’s playbook for signs of China declaring victory.   OM doesn’t expect to be a buyer of much until we at least start to see:

• Xi visit Wuhan
• The Two Sessions is re-arranged
• Kids are sent back to school

OM’s operating assumption is that the uncertainty is the West will linger until there is greater clarity on COVID-19’s spread and impact, and the stock market will reflect this.  The longer it lingers then the worse the economic impacts of COVID-19 will be.  Even at this stage, OM suspects we’re starting to approach the point where we need both fiscal and monetary stimulus and the much like in 2008, it’s not going to come (in enough size) immediately.  Finally, the UK with an emboldened Prime Minister, a new Chancellor and a new Governor of the Bank of England might even be the first country to go full MMT on us!

So what is OM doing with the portfolio?

Unfortunately, nothing so far. 

Here are the things on his docket for the coming days/weeks:

- Technical Book: It saw its sell signal near the end of February.  Real-life issues meant OM failed to exit it during last week’s bounce, he won’t be so remiss next time.

- Uranium:  Though it has largely held up pretty well, OM is looking to exit the Uranium ETF (URA) position that is about 50% of the uranium exposure.  This reflects the reconstitution of the ETF to provider broader uranium exposure, and not just to the miners.  OM’s thesis is focused on the miners and a new more appropriate ETF (URNM) launched at the tail-end 2019.  Expect the capital to end up there eventually.

- Emerging Markets exposure:  OM has a LOT of it – Greece, Vietnam, Brazil and India are ~40% of the portfolio.  Irrespective of the long-term outlook, in times of financial stress emerging markets are never the place to be and OM will be trimming this exposure back.  This was not an unknown risk, and he should have been more proactive much earlier in the year!

- Software-as-a-Service: is largely flat on the year, despite everything.  OM suspects that it goes one of two ways from here: 

(i) COVID-19 fears are quickly dispelled and Software becomes that mythical investment; it protected when there was huge uncertainty and is also growing rapidly.  If so, OM expects to hear justifications that surely such a business, which was valued at 10x Sales before the model proved itself in times of economic stress deserves a higher multiple still?  And so, a real bubble shall have its narrative (and crypto as the logical extreme of this concept will go crazy).

(ii)  Or perhaps SAAS stocks are just 2020’s version of commodity stocks in 2008 – bullet proof and up healthily in mid-2008, until they collapsed to end the year down ~80%.  If so, they’re probably an attractive buy with far far better valuations at that point!  

Either way, OM will be exiting his position in the broad Software ETF (IGV); originally, it was the best of the bad proxies for SaaS.  OM would rather add capital to the existing position in the WisdomTree Cloud Computing ETF (WCLD), a recently launched SaaS-specific ETF, when it becomes clearer which path software will take.

- Shipping:  Oh shipping, that beautiful delightful hot mess.  See the most recent post!

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

Shipping, wtf?

Almost 50% of Our Man’s losses in January and February came from the Shipping positions.  There's a broader post on OM's thoughts coming, but here’s a follow-up to the recent post on shipping.

COVID-19 was identified in January in China and there was a sharply bifurcated reaction in the market.  Initially, Western markets generally held-up well, but economically sensitive stocks exposed to China were dramatically impacted, before markets tumbled in the second half of February.  For example, energy names started falling in mid-January and continued to collapse in February; the S&P Energy Sector lost ~12% in January and then another ~15% in February.  In many cases, the losses in these sectors and stocks were at odds with fundamentals, which brings us nicely to Shipping!

Before we start, some things pulled from the last Shipping post as a reminder of the context around OM’s position:

• It’s a high conviction Dislocation position that is fully sized and ‘on the clock’.
• It’s treated as a quasi PE-position in the portfolio. This means it’s not a position OM looks to trade and it’s sized such that he’s willing to absorb the mark-to-market losses as long as fundamentals don’t change. In the long-term, OM expects to be paid for this volatility.
• It will require patience and will power.
• Here’s the plan!

 So with that said, it was barely a month or so ago that OM said he wouldn’t be reacting to every 20-30% move in shipping with a post. But a 30-50% move in crude & product shipping prices in 8 weeks was not pretty and deserves a post! The chart below shows OM’s position size and the P&L contribution from tankers:

Why so bad so fast? 

• Seasonality: It’s a very seasonal business!  Investors should compare rates to this time in prior years rather than what they were a week or month ago!  Rates started to fall from their highs in January and this seasonality seems to have caught a number of investors by surprise!
• China & Coronavirus: Anything that is a first order impact of the economic slowdown in China was sold, and sold heavily. Oil is down 30%+ from its early 2020 peak, and OM gets it crude/product tankers are a small ugly levered sub-sector that has something to do with oil. 

Given this what is OM doing? 

Well despite the coronavirus, economic slowdown in China, collapse in oil price, etc. the shipping day rates have held up remarkably well.  The below chart is for Medium Range (MR) tankers, but the rates for other tanker types show broadly similar stories. 

Source: Hellenic Shipping News, Allied

To add further context, despite everything many those rates are at or close to 10-year highs!

Thus, so far OM has done nothing.  There’s a huge dichotomy between shipping rates and its implications for companies’ revenue, earnings and cash flow, and the stock price action.  The stock price matters, the P&L matters, but position sizing matters most! This is where having a plan – the research, time frame, and data points you’re tracking for buying/selling – really helps.

At February-end, OM was largely back to his cost basis in individual names, with the overall position size much reduced as a % of capital.  As long as rates continue to track above previous years, OM won’t be selling.  If the discrepancy continues to grow between the market’s implied valuation and the companies’ likely earnings, he’s far more inclined to buy more.  Maybe a LOT more.  The stocks are trading at 0.5-0.8x NAV (or less than 1.0x EV/GAV, to account for the leverage) and at these rates they are generating a ton of cash. It won’t be today, it likely won’t be tomorrow but the longer the dichotomy persists and the less the stocks appear like a falling knife, the bigger a potential position OM is willing to countenance eventually taking. 

So what is he thinking on the individual names:

• Navigator Holdings (NVGS):  The one name OM will likely exit.  It is a liquefied gas transportation company not a crude/product transportation one.  Expect it to come out of the portfolio as OM focuses entirely on crude/product tankers.
• Scorpio Tankers (STNG):  OM will probably not add to this one as it’s the most levered.   The leverage makes it the one most likely to run into problems if the COVID-19 impact is prolonged.  If the impact is not prolonged, OM expects it will also be the one investors flock back to.
• Euronav (EURN): The safest name with a strong balance sheet, good management, reasonable operational leverage and is cheap (trading at 0.7-0.8x P/NAV and EV/NAV).
• Diamond S (DSSI): Refinanced its debt out to 2024, is very cheap (0.45-0.6x P/NAV and EV/GAV) but it has a stock overhang (PE lock-up rolls off in March 2020) and management has underwhelmed.
• Teekay Tankers (TNK): This is a name that OM will be adding to the portfolio to replace Navigator Holdings.  It’s a midsize crude tanker play that’s trading at ~0.75-0.85x P/NAV and EV/GAV, which refinanced its debt and during the first quarter.  Its results summed up the stock price/rates dichotomy; a $12.50 stock (at the time) earned over $2.47 for the QUARTER and is expected to earn over $2.60 for the upcoming QUARTER! Yes it is high season, and yes Q2 and Q3 won’t be close to as good - though analysts still expect them to be profitable - so the market really has to believe things are going to get a LOT worse.

In summation, OM suspects we’ll look back in a year or so and either have a good chortle about how inefficient markets can be or we’ll sadly sup our beers and commiserate about how foolish OM was!

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in NVGS, STNG, DSSSI and EURN and may invest in TNK - that’s a terrible reason for anyone else to invest in them.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.