Oil, Banks and Fish

It has been an interesting week to be an oil and gas investor. While I am not an energy specific investor I certainly I have a bunch of oil and gas related names in the deep value portfolios. I was waaayyy early and have been administered a well-deserved savage, brutal beating by the market masters as a penalty for my overconfidence. If not for energy and resource names we would be having a right dandy little year in deep value portfolios in 2015. Instead we are down- not as far down as many other deep value types who advocate a fully invested at all time policy- but we are still down. I am not rushing to sell them and at some point will double down on them as my concern is oil prices five years today and not right now. I am confident we will see large profits from energy stocks at some point but it will be painful getting there. I have two divorces and several IRS audits in my past and am now entering the second round of teenage girl raising so I can handle pain. At least the energy stocks will actually increase my cash in pocket if I am patient enough!

This week we saw the International Energy Agency tell us that oil prices will remain lower for longer and only start to approach $80 a barrel sometime around 2020. They also outlined an alternative scenario that keeps oil prices between $50 and $60 for the next decade. While the economics of that scenario make sense it requires a politically stable middle east and I just do not see that happening. The see a growing role for renewables but the majority of the more than 30% growth in energy demand by 2040 will still come from fossil fuels. The only real change in here will be that natural gas will continue to take market share from coal. For now a combination of weak demand and excess supply should keep prices low according to the Paris based agency. That could mean our energy stocks wallow for longer.

But wait- theres more. Barclays was out this morning with a report that says energy stocks should start to lift in 2016. They thing we are entering a new regime. Their report said that U.S. interest rates have been a key driver of style and sector performance within global equities. If, as expected, the Fed starts raising rates in December this could have profound implications for style and sector leadership. We think the most robust conclusion is a market driven more by value than either quality or growth. Sectorally we think this favors financials, late-cycle cyclicals and energy. On the other hand, staples and healthcare, as well as utilities and telecoms could struggle globally. In addition to the so-called later-cycle cyclical sectors, the global energy sector has displayed a degree of robustness during periods of rising interest rates . Barclays Commodity Research Team anticipates a recovery in the oil price to around $70 (Brent) by the end of 2016. Such a rise would likely bring about a near doubling in estimates for oil company earnings, reducing the sectors earnings multiple to around 11 times.

If oil goes to $70 as the bank suggest there will be a party at Chez Melvin. We would recover all our losses and have some outsize profits in the bank as well. If the other late cycle cyclicals like newsprint, lumber , copper, steel and other resource stocks also pick up at last its going to big party. Of course consider they also highlight financial and we know from my almost constant chatter about it that rising rates are good for small banks if this report is anywhere near correct I will have to cancel the party. I will be house shopping in the keys. Will it? No clue but I have to say I like that scenario a lot more than grumpy folks at the IEA. We make money under either one but we make it a lot faster under the Barclays outline.

This morning a good friend sent me an article from Bloomberg that pointed out that The worlds six largest publicly traded oil producers have more than a half-trillion dollars in stock and cash to snap up rival explorers. Exxon Mobil Corp. tops the list with a total of $320 billion for potential acquisitions. Chevron is next with $65 billion in cash and its own shares tucked away, followed by BP Plc with $53 billion, according to data from corporate filings compiled by Bloomberg. Years of large buyback plans have left them all with huge stockpiles of treasury stock that could be used to fund takeovers as well. Exxon alone has $316 billion in treasury stock it could use to snap up discounted competitors.

I am counting on this activity developing at some point but so far it has not really gotten started. The recent Pitch Book Quarterly M&A report observed that The energy sector by and large saw the largest declines in M&A activity in the third quarter. $18.9 billion was invested across 138 deals, a decline in total value of 65% QoQ and over 53% compared to the same period last year They also pointed out the private equity has raised an enormous of money to invest in energy but have not yet begun to deploy it. Pitch Book concluded that We anticipate an increase in aggregate energy M&A over the next few quarters, especially as deals currently underway begin to close and PE shops step in to fill funding gaps over the next few quarters. Lets hope we get a double blessing and oil prices rise while deal activity accelerates in the energy sector.

See how I hardly mentioned community bank stocks this week. Arent you proud of me for that? Well, I am going to let you down because I want to reiterate for the 2,317,423rd time that if you are not investing in this space you are basically throwing away money. Steve Hovde, president and CEO of the Chicago-based Hovde Group spoke Tuesday at Bank Directors 2015 Bank Executive and Board Compensation Conference in Chicago. He told the conference that he expects consolidation in the industry, which has seen the number of banks fall from approximately 15,000 in 1990 to less than 6,500 today. Strikingly, banks under $1 billion in assets account for just 8.3 percent of the industrys total assets despite accounting for 89 percent of all institutions. This sharp decline in the number of banks, combined with the significant increase in market share for banks over $1 billion, has been accentuated by the dearth of new bank formations since the financial crisis.

The billion dollar and under segment of the banking industry is going to continue to see takeover activity and buying them at 85% of book today and sell them at 125% of book are engaging in an almost arbitrage trade. Start with the smallest and then you should see years of small fish being acquired by bigger which is acquired by mid-sized fish and all the way up the ladder of the banking industry. If you are not a subscriber of Banking on Profits you probably should be. Dont forget that next Monday the price of BOP monthly goes up to $199 so you only have a few days left to lock in $99 a year for life.

Thats about all for me this week. Have a fantastic week.

Tim

Right now in oil stocks try to keep in mind that

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Reasons Not To

The trade of the decade is happening with you or without you. I can think of two valid reasons not to join Banking On Profits Monthly for just $99. One, like me you have spent more than two decades investing in community banks, know who the activists and specialists are that can put pressure on community banks to improve shareholder value. You know which banks are likely buyers and which are sellers. You track insider and institutional buying in community banks on a daily basis. You know the industry inside and out and have consistently made money in small banks stocks and do not any assistance learning and exploring the community stock opportunity ;OR you just do not really like making money in the stock market.

There are two reason NOT to join is and lock in $99 a year for life before the price goes up to $199 a year on November 15th. Here’s a few reasons to join as described by industry insiders:

D.A. Davidsons Financial Institutions Conference has a track record of bringing together attendees to discuss the primary issues and trends impacting the community bank industry, said Rory McKinney, managing director in D.A. Davidsons Financial Institutions Group and co-head of Investment Banking. We had record attendance this year and we are encouraged to see banks discussing upcoming changes in the industry, including banking regulations, interest rate environment, growth opportunities and credit quality. We believe there will be a continued increase in mergers and acquisitions over the next few years as banks evaluate strategic alternatives and prepare for these industry changes.

Small and midsize banks seem to be having more conversations about consolidation, said John Kanas, CEO of BankUnited in Miami Lakes, Fla. “There does seem to be more chatter these days,” he said. “We are involved in multiple conversations with multiple parties.”

Low rates mean that M&A must be on the table to create shareholder value, said First Horizon CEO Bryan Jordan. Revenue constraints, along with a need for technology investments, are creating “an environment where there are greater opportunities for M&A,” he said.

I just think that we still have some holes in Florida that need to be filled, and whether we buy it or we organically grow into it, those are our opportunities, said Randy Sims, Home BancShares CEO, during a conference call with analysts. So, were still looking hard at Florida and Florida is the place to be for us.

“It sure seems like there is a connection,” Peter Wilder, an attorney with Godfrey & Kahn, told SNL. “I’ve definitely seen some specific examples of banks selling because the CEO wanted to retire and the bank had not adequately planned for a transition.” Wilder said CEO age is surely one of the accelerants to some of the consolidation the community banking industry is currently experiencing.

What we are focused on right now is making Mechanics Bank the best it can be and retooling it for what we see as its vision going forward: to serve as a platform for other acquisitions. “Acquisitions don’t come with a calendar,” Webb said, adding that his team is closely monitoring about 20 banks as potential purchases. Plus Webb says he’s receiving calls from banks eager to talk with him about how the Mechanics Bank transaction was structured since Ford took a majority stake vs. most buyers traditionally wanting complete ownership.”We have a big checkbook,” Webb said. “I don’t say that boastfully, but we do have the appetite, the expertise and the capital.

Traditional bank M&A has decreased the number of institutions even more. The vast majority of banks that sold since 2004 fell into the smallest asset group in SNLs analysis. Through the second quarter of 2015, nearly 2,300 whole banks had decided to sell since 2004 and 91% of those institutions had less than $1 billion in assets. The holding companies of the nations largest banks, meanwhile, have grown not only by acquiring banks, but also by acquiring a number of large nonbank financial institutions in the years following the credit crisis. SNLs analysis adjusted for those transactions by focusing on the banking subsidiary level. The analysis did not include bank holding companies, in an effort to focus on institutions engaged in traditional banking operations.

Just $99 a year. For Life.

Piracy, Legendary Returns and 104 Days of Darkness

pirates

I confess that I was at a bit of a loss about what to write today. I have sent a lot of content out this week including an hour long discussion with Chris Swatta of RBC in Annapolis on his radio show. I talked about markets, stocks and banks on the show so I am running low on ideas and new things to talk about at the moment. To top it off just as I sat down to write this sentence I had to run out to take the little one to a Science Olympiad meeting I had totally forgotten and spend an hour standing around a middle school hallway waiting for her to finish. Then a subscriber who apparently searches and reads as much as I do sent along an article form Business insider containing information about Baupost Fund. The fund has announced that Brian Spector is leaving Baupost to concentrate on family and philanthropy. Mr. Spector write a final letter to Baupost shareholders on the way out the door and it contains some absolute gems worth considering.

The letter discusses how the fund approaches the market. The departing analyst said that Baupost sees two types of opportunities in their approach to investing, “needle in a haystack investing” and “tide comes in and tide goes out investing.” That has very much been my experience. After several years of needle in a haystack market I have to confess I am looking forward to the next tide goes out phase of the market. For now we are stock in a needle-haystack market experiencing what the letter describes as “”Most of the time we are in periods of haystack investing. We sift through lots of investment ideas to find a few decent opportunities. We sell more securities than we buy and our cash reserves begin to build.”

My favorite part of the letter, as reported by Business Insider (and yes this article will contain in large part quotes stolen form a Businessinsider.com article that they stole from the Baupost fund. Just call me a Pirate) dealt with holding cash. Seth Klarman and his crew have always held high cash balances especially after an extended market advance. Mr. Spector wrote that” One of the most common misconceptions regarding Baupost is that most outsiders think we have generated good risk-adjusted returns despite holding cash. Most insiders, on the other hand, believe we have generated those returns BECAUSE of that cash. Without that cash, it would be impossible to deploy capital when we enter a tide market and great opportunities become widespread.”

He also describes a turn of the tide market in way that I remember well form 2000-2003. “We see distressed sellers, illiquid securities, huge redemptions, and an excess of paranoia and fear. We quickly find a number of interesting opportunities, deploying our significant cash balances as we trade our precious liquidity for mispriced securities. We may lose money in the short term, as we add to our portfolio while prices are dropping. But when markets turn, we expect multiple years of strong profitability.” That’s the lumpiness of value investing. Great sums of money are made in the first few years after the tide goes out , match the market as the tide comes in and begins to lag as we near high tide.

We must be nearing high tide. We are down about 8.5% in the deep value letter right now for the year and over the past two years we have returned a negative 7.43% total. Our oil and natural resources stocks have been crushed like a little league team playing the American League All Star team. Renewal rates are horrid and we haven’t sold a new subscription on a few weeks. I cannot tell you how happy that makes me. We are getting ever closer to an important turn in the market that creates great bargain buying opportunities. When? No clue but sometime. Oriably sooner than most think. As Sam Zell pointed out at the Invest for Kids conference this week ““We are in the tenth inning of a nine inning game.” When it happens I will be ready with more than 50% in cash.

Besides as I have said repeatedly I have a heavy tilt towards the community bank stocks in Banking on Profits. Right now I am about 80% BOP and 20% deep value. BOP is up 14.98% for the year and 18.63% over the last year. In fact although Deep value is lagging as I would expect 6 years into a bull market the combination is beating the market by more than 3 to 1 and still holds a cash component of roughly 20%.Its tough to get upset about that.

When I compare myself to some of the best value investors on the planet I am pretty happy about where we are right now. Baupost is down 6.6% year to date. Bill Ackman is down 16% so far this year as is David Einhorn. Third Avenue is down about 4.4%. Long leaf is down about 15%. Aegis Value is off by more than 14%. Even FPA Crescent Fund is basically flat for the year. I am not being at all critical of any of these folks and if you have the chance to get money with any of these folks while they are down I would consider doing so. I just want to point out that combining Deep Value and banking on profits is a successful approach to long term investing and I expect it will continue to be one for a long time. If you don’t already have both letters get in touch with me as soon as possible and I will work out some sort of deal with you.

Eventually deep value will come back into vogue, most likely right after the next collapse or sell off. Someday energy and resources will see stock prices soar. When that does we will see both sides of the portfolio beating the market by a huge margin.

I scooped up the new John Irving novel the minute it hit the whispernet this week, It as quirky, weird and well written as his previous books and well worth your time to read. I am also about a third of the way through David Robbins 2007 release Liberation Road: A Novel of World War II and the Red Ball Express. So far it is fantastic. The new release list for the next few weeks leading up to the holidays is a readers cornucopia that will help take some of the edge off not having baseball for a few months.
104 days until pitchers and catchers report.
Have great week everyone
Tim
When ot comes to ideas and stock picks it is often

Why should you care what I think?

26BoomOrBust

Why should you listen to me or care what I have to say about the markets or economy? Simple. I started in the investment business in 1984 with John Hancock Financial Services selling life insurance and mutual funds. In the aftermath of the Crash of 1987 I finally found a brokerage firm, Dean Witter Reynolds, who would take a chance on someone without a college degree but had a good sense of market and strong sales skills. The rest as they say, is history.

I have seen monster rallies and treacherous crashes and everything in between. I have had trades that had me puking in the garbage can by desk and hiding in the men’s room so the margin clerk couldn’t find me. I have had ten baggers, doublers, triplers and big arbitrage gains. If it can happen it has happened on my watch. Most of all more than 30 years later I am still here and prospering.

Over the years I have developed a strict adherence to valuation principles that have me buying during panics and selling when we neared a top. I was almost always early but I made a lot of money buying crashes and selling euphoria over the years.

It works really well. Below are blog entries from www.timmelvin.com during the credit crisis and market collapse, as well as the eventual recovery. Why should you care what I think? Because I have seen it all, prospered and I am still here.

December 5, 2006
“You might be able to sell me the fact that this market is fairly priced, providing I’ve been drinking heavily, but undervalued, I can’t see it. The bond market and the dollar are telling you it’s just not that good out there right now. We have rallied almost 12% since August without a real pause of any length and anybody who is not cautious now pretty much deserves what they get.”

April 1, 2008
“Even if I am dead wrong here I think the risk of being fully committed to stocks carries too many risks for the idea of a margin of safety to exist. I am willing to miss this run up to protect capital. There appears to be very little common sense being used on Wall Street these days when it comes to the overall economic and financial matters, as well as a total lack of fear. Bottoms are accompanied by fear and loathing not cheerleading and bottom predictions. The bullish arguments are laughable.”

June 20, 2008
“Interest rates are starting to rise. I continue to think that only an illiterate deaf mute kamikaze could be aggressively long the US stock market. Of course there are lots of those around. We call them mutual fund managers

November 20, 2008
“As for the market itself there is a fortune to be made over the next several years. I see companies that are profitable trading for less than 3 times E/EBITDA. I see an ever growing list of companies that sell for less than cash in the bank. We are fast approaching the depths of an ugly bear market and there is money to be made. I am buying DAR, HDNG, DOW,ASH and others like a crack addict at a rock convention.”

March 14, 2009
“You can buy stocks like ADPT, TECD, and ESIO for less than the value of the company’s liquid assets. You can literally build a portfolio of 40-50 of these that have a good credit scores, viable businesses and excellent recovery prospects. That’s enough to make me salivate at the possibilities for gains over the next several years.

“DIS trade for about two thirds of my appraisal value. That is provided we give no value at all to the film library or character rights and price the parks as raw land and put a 5 multiple on after tax earnings .DELL trade for less than two cash. HTH is a pile of cash in the hands of a proven investor in distressed banks and other financials. As a bonus the company landed a back door bank charter and will be able to bid on distressed assets and institutions. Southwest Airlines is stupid cheap, trading below tangible book value. Oil service companies like RDC and PTEN trade below net asset value at these levels. I like the idea of buying the Forest City senior debentures at a 30% YTM and what looks to be more than adequate asset coverage.”

January 16, 2010
“This is the type of trade I am hoping begins to develop in earnest in the first half of 2010. As commercial and real estate woes continue to fall I am looking for the market to wake up to the problems facing the small banks. When it starts the stock market, being the bastion of irrational insanity that it is ,the baby will go out with the bathwater. This type of activity created a situation back in the early 1990s that allowed many people to literally get rich over the next decade. When the good get sold with the bad I am looking to buy up a portfolio of small banks below tangible book value that have low loan losses and adequate reserves. As real estate improves-and it will someday- we will start to see a wave of mergers and acquisitions in the banking community. These transactions will occur at multiples of book, not at a discount. Those solid bank stock bought in this next sell off will lshow tremendous gains for those bold enough to step up.”

August 8,2011
“The current turmoil in the markets is creating some opportunities. Any type of corporate disappointments is leading to a steep and drastic sell off. Right now foreign banks are god-awful, point of maximum pessimism cheap. I like two of the larger Japanese banks, Mitsubishi UFJ (MTU) and Mizhou (MFG). Both sell at a fraction of tangible book value and for an investor with a time horizon of five years or more should be very profitable. The same is true for Royal Bank Of Scotland (RBS). The stock is at 40% of tangible book and management has a solid plan to de-risk the balance sheet and return to profitability. As a final foreign excursion the shares of Dutch insurer Aegon (AEG) are also very, very cheap. They have repaid the Dutch government for the emergency funding and should pay a dividend again starting next year.”

Thanks
Tim
PS If you go digging around the archives of the blog keep in mind that prior to 2014 or so it was s more of a personal endeavor for myself and a handful of friends. It is not edited at all and many of the topics and contents are far less than politically correct or socially acceptable!