Investment Activity Review-January 2015

I wasn’t planning to do much to start off the year, however the stock market doesn’t keep a fixed scheduled when it comes to opportunities. They often present themselves when you least expect it.  For January I ended up making a few moves.

ADDED TO Short position on S&P 500 (Via Ticker: HSD)

I’ve been short on the S&P 500 for exactly 2 years running now. My negative sentiment on the valuation of equities and specifically the overall US market remains intact. The conditions are there for a severe pullback as soon as interest rates start to rise. I’ve been adding to the short position every few months and so January marked my latest iteration for contribution.  Despite a blip last October, stock prices continue to trend up.  Right now Club Fed continues to spin the tunes to keep the party going, but it is starting to have conversations on the next move up. Many Soothsayers think it will occur this June,  but who knows given the malaise that is taking place in the global economy. It’s still a very hard position to maintain given the steroids based performance of stocks the past 6 years, however I remain convinced, that the status quo is not sustainable as long as economic growth is tepid and profits are being generated by financial engineering and not by tangible demand. It is a disconnect that at some point will be corrected.

SOLD position in Coke Cola (Ticker: KO) for  23.7 percent gain

I had to make decision on whether to hold on to Coke or to sell as my position had crossed my 20 percent return threshold that I try to achieve with my investments.  The stock historically trades in a narrow range of between the mid $30’s and mid $40’s. At the time, the stock was also trading near a 52-week high. As my overall sentiment on the market is negative, I decided that I’d be happy to bank the profit now. To give you a sense of how screwed up the market is. Coke, a company that has been reviled for all that is unhealthy in the world along with McDonalds, has seen its stock methodically rise over 2014 to its current levels. Sales continue to be flat (no pun intended), yet there is still a critical mass of people around the world that still drink sugary soft drinks and juices. I still think Coke is one of the most dominant brands in the world and if the stock were to fall off again, I would revisit buying back in.

OPENED position in Freeport McMoRan (FCX)

As oil and commodity prices continue to get slammed, companies that I’ve always wanted to buy but thought were too expensive suddenly look like downright bargains. One company that I’ve had on my radar screen is Freeport MacMoRan.  Again, I tried to analyze FCX by utilizing my 8 Questions format.

QUESTION 1: What do they sell?

FCX used to just mine and sell copper. They are still the dominant supplier of raw copper in the world. Recently though management as chosen to diversify into other areas.

Per Reuters:

"Freeport-McMoRan Inc. is a natural resource company with an industry portfolio of mineral assets, oil and natural gas resources and a production profile. The Company’s portfolio of assets includes the Grasberg minerals district in Indonesia, copper and gold deposits, mining operations in North and South America, the Tenke Fungurume (Tenke) minerals district in the Democratic Republic of Congo (DRC) in Africa and oil and natural gas assets in North America. The Company’s mining operations are in North America, South America, Indonesia and Africa. The Company has seven operating copper mines in North America, including Morenci, Bagdad, Safford, Sierrita and Miami in Arizona, and Chino and Tyrone in New Mexico. The Company has four operating copper mines in South America, including Cerro Verde in Peru, and El Abra, Candelaria and Ojos del Salado in Chile. Indonesia mining includes PT-FI’s Grasberg minerals district. Africa mining includes TFM's Tenke minerals district."

QUESTION 2: Who do they compete with?

The main players in the copper and mining sectors are BHP Billiton, Vale, and Rio Tinto who also have extensive mining assets globally.

QUESTION 3: Who buys their products and services?

Presently, copper is used in building construction, power generation and transmission, electronic product manufacturing, and the production of industrial machinery and transportation vehicles. Copper wiring and plumbing are integral to the appliances, heating and cooling systems, and telecommunications links used every day in homes and businesses. Copper is an essential component in the motors, wiring, radiators, connectors, brakes, and bearings used in cars and trucks. The average car contains 1.5 kilometers (0.9 mile) of copper wire, and the total amount of copper ranges from 20 kilograms (44 pounds) in small cars to 45 kilograms (99 pounds) in luxury and hybrid vehicles.  In a nutshell, copper permeates through our society. As emerging economies have growth, the demand for copper has been insatiable, especially from countries like China.  It is often said that as goes copper, so goes the economy.

QUESTION 4: Will people buy it over and over again?

As long as industrialization and urbanisation continues to grow, there will be a need for copper. China has been the big purchaser of copper as they have literally built cities and infrastructure overnight. The problem is those cities are pretty much empty and there is a threat that the economy will slow down materially which could constrain future demand for copper.

QUESTION 5: Do they make money?

Source: Valuentum Securities

Source: Valuentum Securities

FCX’s return on invested capital has been falling from 23% in 2011 to 7.5% by the end of 2013. With the falling of copper prices in late 2014, the trend does not look very good. In 2014 the company reported a net loss, however backing out a one-time charge, they were still profitable. With a cost of capital in the 8.6% range, the company has been creating tangible wealth, however again this will be constrained if copper prices remain low.

QUESTION 6: What do they own and who do they own money to?

The company is pretty much financed with debt, with a Debt/Equity ratio posting at near 100%. In terms of assets, there are no longer any intangible type or goodwill assets posted, so their uses of assets are pretty clean and tangible.  They have adequate liquidity with a current ratio near the 2 level so taking on high debt is palatable…for now.

QUESTION 7: How risky is their business?

With the company essentially financed with debt, the cost of capital is lower, however, the excess amount of debt, puts the company into higher level of risk.

QUESTION 8: Is the stock cheap?

Source: Valuentum Securities

Source: Valuentum Securities

The stock has been trading in the mid-30’s for the past few years, but in the recent crash of commodity prices, the stock has fallen dramatically to the high teens, which is what has peaked my curiosity on the stock.  It’s pretty much out of favour by the market. From a valuation perspective, the stock’s intrinsic value comes in around the $20-25 range, so the stock is trading at meaningful discount. It really comes down to how long copper prices remain depressed. If prices should normalize a bit then there is great opportunity for the stock to pop a bit. FCX is considered best of breed in the copper mining sector and you get a very healthy dividend yield to wait (6.70%) although that may come under pressure if the company is looking to preserve capital.  FCX fits one of the classic stock profiles I look for which is to buy well run, best of breed companies that are out of favour and selling at a discount. I have no idea when copper prices will come back up, so I have to be prepared to hold the stock for a long period and also be prepared to stomach some violent shifts in stock prices. At the same time, there’s nothing holding copper back from falling even further and this is where I have my stop-loss set at 20%, so I can control the losses.

OPENED position in Vanguard Canadian All Cap ETF (VCN)

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The combination of falling commodity prices, specifically oil and gas combined with a surging US dollar have done a number on Canadian stocks in the last few months of 2014. As a result, I saw the drop in Canadian stocks as a good opportunity to buy and to start getting some exposure. I chose the Vanguard VCN because it had broader diversification, specifically in terms of financial companies. The complementary Vanguard large cap ETF (VCE) tracks the TSX 60 which skews heavily into the big banks. I opened a small position, but if commodity prices continue to plummet, then I would look to add more to average down the costs. This is a long term position.

OPENED position in iShares Europe Developed Market ETF (XEH)

In January , the Euro Central Bank, finally put its money where its long winded mouth was announced its own version of bond buying (aka Quantitative Easing, aka money printing). The past several years, they have been jawboning the market with thinking out loud musings but finally it looks like they’re actually going to do something to address the European malaise. In previous iterations by other central banks, the act of buying bonds and dropping excess cash into the financial system, has created an environment for that excess liquidity to find its way into stocks. With the Euro version, the incentive is there for European stocks to benefit as increased purchases of Euro bonds will increase prices, lower interest rates, and consequently lower the Euro currency. A lower Euro will make their export cheaper and ideally induce some much needed economic growth. As much as I disagree with central bank planning to prop up and distort asset prices, you can’t fight them, so I decided to open a small position to get exposure to European stocks via Vanguard’s ETF product.