Monday, January 31, 2011

Shale Gas - Wax on Fracs

Bad news for the shale gas plays.
(NYT) Oil and gas service companies injected tens of millions of gallons of diesel fuel into onshore wells in more than a dozen states from 2005 to 2009, Congressional investigators have charged. Those injections appear to have violated the Safe Water Drinking Act, the investigators said in a letter to the Environmental Protection Agency on Monday.
“We learned that no oil and gas service companies have sought — and no state and federal regulators have issued — permits for diesel fuel use in hydraulic fracturing,” said Representative Henry A. Waxman of California and two other Democratic members of the House Committee on Energy and Commerce, in the letter. “This appears to be a violation of the Safe Drinking Water Act.”
Oil and gas companies acknowledged using diesel fuel in their fracking fluids, but they rejected the House Democrats’ assertion that it was illegal. They said that the E.P.A. had never properly developed rules and procedures to regulate the use of diesel in fracking, despite a clear grant of authority from Congress over the issue.

Full story here:  www.nytimes.com/2011/02/01/business/energy-environment/01gas.html

From Rep. Waxman's letter:

Between 2005 and 2009, 12 of the 14 companies used 32.2 million gallons of diesel fuel or fluids containing diesel fuel.  BJ Services used the most diesel fuel and fluids containing diesel, more than 11.5 million gallons, followed by Halliburton, which used 7.2 million gallons.  Four other companies, RPC (4.3 million gallons), Sanjel (3.6 million gallons), Weatherford (2.1 million gallons), and Key Energy Services (1.6 million gallons), used more than one million gallons of diesel fuel and fluids containing diesel.
These 12 companies injected these diesel-containing fluids in 19 states.  Diesel-containing fluids were used most frequently in Texas, which accounted for half of the total volume injected, 16 million gallons.  The companies injected at least one million gallons of diesel-containing fluids in Oklahoma (3.3 million gallons), North Dakota (3.1 million gallons), Louisiana (2.9 million gallons), Wyoming (2.9 million gallons), and Colorado (1.3 million gallons).
The list of companies provided by the committee:


CompanyVolume (gallons)
Basic Energy Services204,013
BJ Services11,555,538
Complete4,625
Frac Tech159,371
Halliburton7,207,216
Key Energy Services1,641,213
RPC4,314,110
Sanjel3,641,270
Schlumberger443,689
Superior833,431
Trican92,537
Weatherford2,105,062
Full letter here:  democrats.energycommerce.house.gov/index.php

Friday, January 28, 2011

Apache - Egyptian Exposure Could be Troublesome

Riots in Egypt calling for "regime change" after 30 years of President Mubarak's rule.  No big deal, right?  Depends on what you are looking at.


Lets look at Apache.


From the company's Q3 2010 supplement:




Quick math tells us that 24% of the company's BOE/d comes from Egypt.  Do riots disrupt their production?  Maybe not, but maybe.  Riots are, by their definition, unpredictable. 


From the company:
Apache Corp. said its production operations in Egypt are unaffected by political unrest in the country.  Apache continues to monitor developments in Egypt as they happen, Patrick Cassidy, a spokesman for Houston-based Apache, said today in a telephone interview. He said the production of oil and gas isn’t affected by current events in the country. Even if the government were to change, Dodge said, anyone running the country would want to continue to work with Apache as a partner to produce petroleum.


 This is something we should keep in mind when looking at the company's valuation.


Bonds:
APA 20's -70
APA 21's -71 (yeah, I'd swap out of 21s into 20s should I want exposure)  was 75/2 on the 21st
APA 40's -92 was +87 on the 24th


Equity:






The equity market (admittedly a faster acting beast) has reflected the companies exposure to Egypt while the bonds have barely budged.  I think bonds can be bought cheaper and I am avoiding the equity if for no other reason than uncertainty and headline risk.

Thursday, January 27, 2011

Public Sector Unionization - It IS the States Problem

Saw this from the Bureau of Labor Statistics and thought it warranted a post.  Keep in mind that the public sector is grappling with massively underfunded pensions and OPEB and has to face some hard budget choices.  Now many say that the unions will continue to help their employer out by giving concessions in contract talks.  I ask:  why?  Who is negotiating from a position of strength?

Union membership declines in 2010

In 2010, the union membership rate—the percent of wage and salary workers who were members of a union—was 11.9 percent, down from 12.3 percent a year earlier; the number of wage and salary workers belonging to unions declined by 612,000 to 14.7 million. In 1983, the first year for which comparable union data are available, the union membership rate was 20.1 percent, and there were 17.7 million union workers.


In 2010, 7.6 million public sector employees belonged to a union, compared with 7.1 million union workers in the private sector. The union membership rate for public sector workers (36.2 percent) was substantially higher than the rate for private sector workers (6.9 percent).
Within the public sector, local government workers had the highest union membership rate (4.7 million members, or a rate of 42.3 percent). This group includes workers in heavily unionized occupations, such as teachers, police officers, and fire fighters.
Private sector industries with high unionization rates included transportation and utilities (1.1 million members, or a rate of 21.8 percent), telecommunications (167,000 members, or a rate of 15.8 percent), and construction (801,000 members, or a rate of 13.1 percent).

Now the question I have to ask is with the union being so deep in states and municipalities, what are the chances there will be meaningful concessions.  Perhaps people should recall one of the main reasons GM and Chrysler went into bankruptcy - the gain negotiating power with the unions.

Sovereign Update

Some news in the sovereign markets today:


Start with Japan:
Standard & Poor's cut Japan's credit rating on Thursday for the first time since 2002, saying Tokyo lacked a plan to deal with its mounting debt, in a warning that will rattle other heavily indebted rich nations.
The agency reduced Japan's long-term sovereign debt rating by one notch to AA minus, three levels below the highest possible rating. It said Japan's fast-aging population, persistent deflation and the loss of the coalition's upper house majority had compounded the government's fiscal challenge.
"The downgrade reflects our appraisal that Japan's government debt ratios -- already among the highest for rated sovereigns -- will continue to rise further than we envisaged before the global economic recession hit the country and will peak only in the mid-2020s," S&P said in a statement.
Japan is now rated lower than Spain with this downgrade.  The country has significant issues to deal with and nothing they have tried thus far has made significant headway.  One thing I will say is that their issues are on the table and really aren't that much more hot than they were a year ago.  The yen fell to a 15-day low of 83.23 against the US dollar at 3:10 am ET Thursday. This was down more than 1% from yesterday's closing value of 82.18.  The yen is also off approximately 1% vs the Euro.

Now lets move to Greece:
Greek Prime Minister George Papandreou ruled out defaulting on or restructuring his country's huge public debt but said he expected EU/IMF rescue loans to be stretched out and the interest rate reduced.
Papandreou told global business leaders at the World Economic Forum on Thursday that Athens hoped to return to capital markets even this year after implementing draconian austerity measures to slash its budget deficit.
"Of course the question of restructuring has been around. I can say that we're not going to default. I also say we're not moving to restructuring," he said.
"Yes, there will be a lengthening of the debt we have to the IMF and the EU, and there has been discussion about the terms of the loans. I think these are in the pipeline," he said, adding that easier terms would help Greece avoid a funding "bump" in 2014.
In other words, nothing is getting better in the Hellenic Republic.  Austerity measures look great on paper, but have yet to start filling the gap and will never be accepted by the populace which is used to something for nothing.  I am still cautious on the name while being long National Bank of Greece equity (a value play to say the least).  The Euro is stronger vs the dollar at 1.375, up 28bps on the day.

ECB:
European Central Bank policymaker Lorenzo Bini Smaghi warned on Thursday that an expected rise in imported goods inflation cannot be ignored, supporting the view that euro zone rates could rise sooner than previously thought.
Soon it will only be the US keeping rates artificially low.  How to win the debase race.

Wednesday, January 26, 2011

Chavez Threatens To Nationalize BBVA Sub

I hear Sheila Bair is a consultant to Chavez.


Jan 26 (Reuters) - Venezuela's President Hugo Chavez called a senior official at the local unit of Spain's BBVA bank live on television on Wednesday to threaten the financial institution with nationalization if mortgage-seekers were not better served.

The socialist president has frequently threatened to take over any banks that stand in the way of financing for much-needed homebuilding in the country, and has singled out BBVA'S Banco Provincial unit in the past. 

But he upped the ante on Wednesday when, after hearing complaints by would-be homeowners about lack of attention from Provincial, he phoned the bank official during a TV address.

"If Banco Provincial, which you preside over here in Venezuela, is not prepared to comply with the law and presidential decrees, then prepare to hand me the bank, I'll pay whatever it costs," Chavez told the official whom he named as Pedro Rodriguez, Provincial's executive president.

"I can expropriate it whenever I want."

Seeking Alpha Comment Rant

Recently I wrote an article for Seeking Alpha on rare earths.  Honestly, the comments posted ranged from insulting to insipid to additive.  What does this have to do with this blog?  Nothing.  Sometimes a fella just has to rant.  Check it out if you want, some comments are interesting.

http://seekingalpha.com/article/247901-rare-earth-recent-chinese-moves-only-support-the-investment-thesis

Bond Managers Up Their Credit Allocation

Below is part of an article from Reuters.  Essentially, it says that credit investors are overweight their benchmarks. In IG space, investors have been drawn to financials due to the improvement in their financial condition as well as the relative "cheapness" when compared to other sectors and on a ratings basis.  HY has focused on industrials and energy (two primary issuers) as these sectors stand to benefit from current trends in both sectors, an improved economic outlook and, realistically, the availability of bonds.  This should really come as no surprise as investors have been embracing risk for a while now and investors need yield.  I personally think that credit will continue to attract investors and outperform on an excess spread basis.

Bond investors boosted U.S. corporate debt exposure to the highest levels since at least 2005 as they took a more optimistic economic outlook, according to a Bank of America Merrill Lynch survey released late Tuesday.
The first-quarter survey found 89 percent of high-grade corporate bond investors were overweighted with those assets, well up from 29 percent in the fourth quarter. In riskier high-yield bonds, 71 percent of investors were overweight, compared with 30 percent in the prior survey.
Investment grade bondholders were most bullish on financial company debt. Nearly 70 percent of investors said they were overweight the sector, up from about 30 percent.
In high-yield, investors raised allocations to industrial and energy bonds but stayed bearish on financial companies.
Concerns of investors were topped by the European sovereign debt and municipal bond crises, the survey found. Almost half of them said Europe's management of its sovereign debt burden was the bigger problem for U.S. credit markets.

Tuesday, January 25, 2011

Muni Madness 2

From NY Times:

Federal regulators are examining disclosures by Illinois about its unorthodox pension funding method, trying to determine whether the state misled bond investors about the risks.
The Securities and Exchange Commission has said it has a special team devoted to investigating public pensions, and last year it brought its first case ever against a state, accusing New Jersey of securities fraud for claiming to have pension assets that did not really exist.
If the commission decides at some point to bring a case against Illinois, it would send another warning.
Some other states, including Arkansas, Ohio, Rhode Island and Texas, have used variations of Illinois’s method, which reduces their annual contributions to their pension funds. The effect is to save money at a time of tight budgets, but it can also weaken the pension funds.
The S.E.C.’s inquiry was disclosed in a prospectus for a $3.7 billion bond offering planned by Illinois for February. The state wants to use the proceeds from the sale to make its annual contribution to its pension funds, which are among the most poorly funded in the country. Illinois must sell bonds to come up with the cash because the state is low on money.
Okay, that bond issue is gonna be tough now, isn't it?  If you thought they were going to have to pay up before, just wait now (if the issue can even be placed).  This is gonna spread like European sovereign risk.

Municipal Madness

Saw this on CNBC:

Meredith Whitney's dismal prediction for municipality defaults is wrong and Whitney should probably do some more homework on the muni bond market, said Suzanne Shank, CEO and co-founder of Sibert Brandford Shank & Co, a municipal investment bank.
Now Shank admits she hasn't read Whitney's report on muni defaults in detail, but she sticks by her notion that Whitney's outlook is wrong.
"I have not read her report in detail. I have seen her on television. I admire her predictions of the banks, which she has analyzed for many years," said Shank. "I’m not sure she has the background in the municipal arena…And I just wish she understood the security structure underlying the bonds a little more.”
This is what I love about markets - a muni firm comes out and dismisses MW without reading what she says.  Self serving?  YES.  I am in the process of doing a piece on muni bonds which should address the various issues from a historical perspective and a forward looking perspective.  As I do this, any insight of information would be appreciated.

Monday, January 24, 2011

Apple - The Apple of Everyone's Eye

This from the WSJ:


Bill Shope, Goldman Sachs: The strong December results should underscore the underlying strength in Apple’s fundamentals, especially after the news regarding Steve Jobs’ planned medical leave. This is based on the following key points detailed in this note: 1) gross margins are recovering at a faster than expected pace, 2) iPad demand was far stronger than most expected, and 3) strong iPhone units exceeded our conservative expectations.
Gene Munster, Piper Jaffray: March Guidance More Aggressive Than Historical Guides: Apple Bullish On Verizon iPhone Opportunity (And Expanding Production Capacity). Apple issued EPS guidance above Street consensus for the first time in three years, 10% ahead of the Street. We believe this suggests Apple is, 1) bullish on the opportunity to sell iPhones to existing and new Verizon subs, and 2) working to increase production capacity.
Alexander Peter, Exane BNP Paribas: Apple recorded very strong traction in Asia, with sales up 67%. Sales in China quadrupled sequentially to $2.6 billion; Japan was another area of strength in all categories. Apple reported the highest traffic in its four stores in China.
Richard Gardner, Citigroup: [Gross Margins] of 38.5% was well above guidance, our est and consensus primarily due to more favorable component pricing. We were pleased to see q/q improvement in GM in most products, but especially pleased to see iPhone margins rebound several hundred basis points following last quarter’s steep drop.
Yair Reiner, Oppenheimer: The iPad delivered strong results, selling 7.3 million units in its third quarter since launch, comfortably above the Street’s 6.4 million target and our 7.0 million estimate. The performance is particularly impressive when one considers that many potential buyers are likely biding their time in advance of a probable iPad 2 release in late March or early April.
Scott Craig, BofA Merrill: iPhone units of 16.2mn exceeded our 15.6mn, with strong Y/Y growth in all regions. We think Verizon in F2Q11 should boost sales, while maintaining [Average Selling Price]/profit.
Shaw Wu, Kaufman: Inventory declined 16% Q/Q to $885 million from $1.05 billion last quarter as days of inventory declined to 5 days from 7 days last quarter, which is generally a good sign, but there could be concern that inventory levels are too low given still strong business level.
Brian White, Ticonderoga Securities: We believe Apple’s February 10 launch date for the iPhone 4 on the Verizon CDMA network is only the beginning of more CDMA announcements. Keep in mind, CDMA subscribers around the world are estimated at 550 million (2Q10) by the CDMA Development Group, with approximately 57% in Asia.

As we speak legislation is being introduced to make it illegal to say anything but good things about apple.  I have also heard that they are looking to use their cash hoarde to outright buy California and Greece.

United States Distressed Fund LLC - 27% Return over 2 yrs

On the tape from Reuters:
The U.S. Treasury's toxic asset funds have gained 27 percent since they were created to help revive the mortgage-backed securities market, according to data expected to be released later on Monday.
As part of the government's deeply unpopular $700 billion bailout program, the funds were set up to remove illiquid securities from banks by matching private capital with taxpayer money and Treasury loans via funds run by private investment managers.
Although furor over the bailout helped Republicans win control of the House of Representatives in the recent election, the government has been recouping taxpayers' money.
The eight toxic asset funds, run by asset managers such as BlackRock Inc, Invesco Ltd and Marathon Asset Management, are all profitable.
Since the funds were established in 2009, they have used about $5.2 billion of Treasury's equity investment to buy toxic assets. As of the end of 2010, the funds have gained $1.1 billion to about $6.3 billion, according to the data.
Including some $300 million in equity distributions, the Treasury's investment increased by 27 percent or $1.4 billion, according to the data.
The Treasury Department had initially proposed buying up to $1 trillion in illiquid mortgage-related securities to help clean up banks' balance sheets. But the program was scaled down considerably as banks proved they could attract private capital in both the equity and debt markets without first selling off illiquid securities.
As of December 31, the funds had about $29.4 billion of purchasing power and had drawn down about 70 percent of the total amount, according to the data.
Now, before opening the champagne and engaging in an emotional group hug, I have to ask - is a 27% return over two years in an ultra high risk investment really that good (Benchmark rference - S&P is up over 60% in the same time period)?  Now, before you baste me with the - "it was the end of the world", "its the government" "insert smack down here" "...you dumbass" comments, I realize why it was done, I realize no one expected much aside from losses - yes, I get this.  But, I also realize that the headlines will show just how clever the Treasury, Fed... was in making these investments which kinda makes me gag.

FT on Large Caps

On the FT today, we saw the following:

Even pessimists admit that US large-cap stocks are recuperating, with some fund managers forecasting that the S&P 500 may well gain as much as 15 per cent in 2011.
Bill Miller, the chairman and chief investment officer of Legg Mason, affirmed the sentiments of an assembly of US equity managers this month when he claimed that large caps listed in the US look “significantly undervalued”. Inexpensive valuations combined with a tepid improvement in macro-economic conditions stateside, as well as stronger corporate profits, hint that a renaissance for the US large-cap sector is likely. 
“Profit margins are at record levels and corporate balance sheets are very strong, yet stocks languish below where they were in late August of 2008 and that was hardly a bull market,” argues Mr Miller. 
“Big caps are cheap but you want to be sure to get them in the right sectors,” says Mr Wintle. He does argue, however, that the performance of large caps will be overshadowed by mid and small caps until the cyclical bull market reverses. “Mid and small caps are still leading. It’s true they look expensive, but they have higher growth rates than other areas of the market,” he concludes.
James Abate, manager of PSigma’s American Growth fund, echoes these sentiments. “We don’t expect larger companies to outperform mid and smaller ones but we expect the differential to decrease,” he says. “And a shift to defensive sectors appears premature and will be warranted only when Federal Reserve policy begins to shift to restrictive.”
Full article here:  FT Largecaps


I believe that small and mid-caps will continue to outperform (looking at all within the growth sphere) as they should benefit from the growth prospects of which we continue to see evidence.  Further, we might see emerged markets lead emerging markets as there are signs of nascent growth within the emerged markets.

The following is a chart for the last three months comparing small, mid and large-cap growth (as reflected through the Russell mid-cap growth IWP, the Russell small cap growth IWO and large cap growth S&P.


Small caps got knee-capped last week due to risk rotation and the never-ending negative Pollyanna news on the sector.  Yeah, I ate some Tums and injected more capital into the trade.

Friday, January 21, 2011

Rare Earths - China Tightens the Noose

China has further tightened the rare earth noose as it has invoked a seldom-used mining law to take direct control of 11 rare earth mining districts in southern China.

The ministry said in a statement, posted on its Web site Wednesday and briefly mentioned Thursday by the state media, that rare earth mining in those districts, all at the southern end of Jiangxi Province, had been placed under its national planning authority.

Interestingly, this is an area that produces HREE, which are more valuable and necessary to make magnets requires in hybrid vehicles and wind turbines.  China has been in the news with their export reductions over the last few months and this move, essentially, helps them enforce their export quotas.  Some feel that a large percentage of HREE production is illegal and can therefore take place under China's radar.

I still believe there is a strong case to be made for investment in rare earth operations such as Great Western (GWMGF), Lynas (LYSCF), Molycorp (MCP), Avalon (AVL) and Ucore (UCU) among others.  While these have run up, I still believe there is significant upside left as everyone seems to be focused on electric vehicles (I personally believe natgas is as viable, but we want to invest, not pontificate) and green power such as wind (which I do not believe to be a viable source without significant subsidies).

Wednesday, January 19, 2011

Wells Fargo Earnings - My Take

My take on Wells Fargo earnings:

  • Tier 1 common ratio is strong at 8.37% as is tier 1 capital at 11.25%.  This equates to a TCE improvement of 40bps sequentially and 190bps YOY.  Co has stated that their capital is approximately 6.9% under proposed BASEL III.
  • Revenue at $21.5B increased $600MM sequentially but fell $1.2B YOY.  The revenue increase is obviously good to see and the breadth of the increases is positive.
  • Net charge-offs continue to improve both sequentially and YOY.
  • Reserve release of $850MM helped drive results.  I do not consider these to be "quality" earnings, but as a % of earnings, I can handle their contribution.
  • Pick-a-pay and other "funny" loans down significantly - the balance sheet is getting cleaner.
  • Commercial PCI loans are driving results within the PCI book. Increase from 3Q10 reflects the reclassification to accretable yield from nonaccretable of $165 million during the quarter  I also take this a a glimmer of hope for the commercial mortgage market - a glimmer.  

WFC is also looking to redeem callable TRUPs upon gaining regulatory approval.  This is a continuation of a theme we have seen from the industry as the instruments will not be capital accretive under new regulation.  Essentially, this also makes existing tier 1 issues structurally "safer" than future issues which should lead to increased calls.  While much of this has been factored into pricing, it is one area to snoop around for value.


All in all, it was a decent quarter for the bank as the loan book is performing better, capital continues to increase and revenues have showed some improvement.  


While the bank has held in well throughout this mess, I find better value in C or JPM debt and equity.  Yes, C is more of a wildcard, but I believe it will outperform its peers in the coming year.


WFC CDS in 2bps to 98/103
WFC  4.75  2/15  +95 


COMPS: 
JPM 4.25     10/15/20         138/134
BAC 5.625  07/01/20         190/185
C   5.375     08/09/20          168/163 


Equity:
WFC  P/E:  19.1x
JPM   P/E:  11.3x
C        P/E:   NM
BAC  P/E:   NM


Disclosure:  Long BAC and C equity and preferreds.  Long XLF.

Tuesday, January 11, 2011

Alcoa - Bonds Look Cheap

Alcoa's (Baa3/BBB-) earning are out and look decent.  I have been waiting for the earnings to take a look at the bonds.  The company has been somewhat of a leper for a while now as it is somewhat overlevered and underearning.  Things are improving here.  Do I think the ratings will stabilize in investment grade space?  Yes, I do.  Do I see upgrades?  Not in the near-term as the company must show it is serious about debt reduction (through greater reduction in actual debt rather than increases in equity or EBITDA) and continue to de-lever their balance sheet.  Alcoa’s debt-to-capital ratio stands at 34.8 percent at the end of the fourth quarter, 90 basis points better than the third quarter of 2010, and 390 basis points lower than the fourth quarter of 2009.  Problem with this is that the company has an expressed target of 30-35% debt/capital, so its not gonna get much better from here.

Liquidity improved, with $1.5 billion in cash on hand at the end of the fourth quarter compared to $843 million at the end of the third quarter of 2010.  I would expect that liquidity (in terms of cash) will be somewhat reduced as the company increases capital expenditures.  CAPEX came in for the full year at $1B, down from '09 full year of $1.6B.  While yes, this does increase free cash flow, it will not help grow the business.  Depreciation was $1.4B, so essentially, the business shrunk (yeah, from an accounting perspective).  Capex is expected to come in somewhat higher this year ($1.5B +) which is necessary for maintenance (about $500MM for growth capex) and should help smooth things out.

Accrued pension and post-retirement have shown a marginal improvement as well (which will reduce adjusted debt metrics), but I would like to see a more meaningful reduction.  The company has stated it is evaluating the pension issues and will come up with a minimum funding target.  I would still like to see them go beyond the minimum and take a chunk of their pension down.  Pensions are the same as debt (or very close).

Outlook:

The company has said:  “In 2011, we see aluminum growing another 12 percent on top of last year’s 13-percent improvement. We are well positioned to outpace the recovery in the markets we serve and grow shareholder value.”  This is evidenced by the company restarting three smelters in the US which will increase Alcoa’s aluminum production by 137,000 metric tons over the course of 2011 and by 200,000 metric tons on an annual basis thereafter.

I agree with their assessment of the near-term business conditions and growth prospects (especially should China - isn't it always about China? - reduce their smelting capacity) and therefore think the company is in decent shape in the near to intermediate term.  We should see further financial improvement which should drive spread tightening.  I would be a buyer of the bonds.

Value:

AA      (Baa3/BBB-)  6.15    20   @ 210/200
AA      (Baa3/BBB-)  5.72    19   @ 195/185
RIOLN (A3/BBB+)    3.50    20   @ +79
BHP   (A1/A+)         6.50   19    @ 53/43
CLF    (Baa3/BBB-)  4.80   20    @ 185





Some stats and thoughts (emphasis mine):

2010 Full-Year Highlights
  • Revenue of $21.0 billion compared to $18.4 billion in 2009, up 14 percent
  • Income from continuing operations of $262 million includes a negative impact from special items of $297 million
  • Cash from operations of $2.3 billion, compared to $1.4 billion in 2009
  • Free cash flow of $1.2 billion, a $1.5 billion improvement over 2009 - (driven by changes in working capital - notably inventories)
  • Debt reduced, cash on hand of $1.5 billion
  • Debt-to-capital ratio reduced to 34.8 percent, 390 basis point improvement over 2009 - (due mainly to increases in the equity line ad debt is down by less than $600MM)
Improved earnings were driven by higher pricing, continued strengthening in most end markets and improved productivity as a result of the company’s Cash Sustainability Program. Results were offset somewhat by a weaker U.S. dollar and higher energy and raw material costs.


4Q 2010 Highlights
  • Income from continuing operations of $258 million, which includes a net benefit from special items of $35 million
  • Net income of $258 million
  • All-time record cash from operations of $1.4 billion
  • Record fourth-quarter free cash flow of $1.0 billion
  • Adjusted EBITDA improves to $782 million, 13.8 percent margin up from 11.4 percent in the third quarter of 2010 and 3.4 percent in the fourth quarter of 2009
  • Revenue of $5.7 billion, up 7 percent from third quarter and 4 percent from year-ago quarter
  • Projecting global aluminum growth rate of 12 percent for 2011

Art Funds - Old Money Meets the Street

I love this world, I truly do.  As soon as you thought the street had permeated every aspect of life, they come back and surprise you.  Art funds.  Yeah, I get it, I really do.  Art is an investment much like everything else.  You buy it, hang it (maybe) and hope the value goes up so you can sell it to someone else who runs a hedge fund, is flush with cash and wants to look old money.

The best though - 5 and 20.


(NYT) Art aficionados have long held themselves to be in a more elite class than Wall Street speculators.
Now, their worlds are colliding as a new crop of financial firms move to sell shares in pools of paintings — and some fear the results may resemble the chaotic splashed canvases of Jackson Pollock.
The two make for an odd combination. While many investors favor transparency and asset gathering, art dealers generally like secrecy and exclusive holdings.
The idea behind many art funds is relatively simple: A few big investors put up money to help a money manager buy paintings. Smaller investors buy ownership units, whose values are tied to the underlying art. For the privilege, they pay fees of around 5 percent of the assets and 20 percent of the profits. 
 The article:  Art Funds

Portugal - Just More of the Same

News out of Portugal is just more of the same.  Much like Ireland and Greece before them, they don't need a bailout - blah, blah, blah.  Anyone else tired of hearing it?  What's better is Portugal blaming the rest of the EU (read France and Germany) for not defending the Euro.  Seriously?  Europe is becoming a slow motion bad joke.

Japan has come out and said it will be buying European debt (on the heels of China saying the same) which has given the Euro and European Sovereign debt a floor.  Give it a week.  I am not buying this, a quick look at recent history will tell you where this is going to go.


(NYTimes) Officials from debt-burdened Portugal went on the offensive Tuesday, saying the country did not need a bailout and criticizing its European partners for not doing enough to shield the euro currency from the debt crisis.
There is a growing feeling in the markets that Portugal will soon need a financial rescue as borrowing costs are at potentially unsustainable levels despite government efforts to slash the huge public debt.
The government looks increasingly worried at the lack of help from its fellow European countries to avoid that fate — France and Germany are reportedly pushing Portugal to give in to market pressures and take a bailout like Athens and Dublin.
 Prime Minister José Sócrates said Portugal was making progress in reducing its budget deficit, noting that preliminary data indicated that last year’s deficit would be below the government’s target of 7.3 percent.
“The government is doing its job and is doing it well,” Mr. Sócrates said, while again stressing that “Portugal won’t request any financial help for the simple reason that it doesn’t need it.”        

Monday, January 10, 2011

Municipal Bonds - Bad News Continues

More news out that will be sure to drive the municipal bond market into a tizzy.  P&I Online has an article on how Newt Gingrich is trying to get a flag carrier for legislation that would allow states to enter bankruptcy in order to renegotiate union contracts.


Personally, I can't see a state filing for bankruptcy, but legislation allowing it would be that big stick if the carrot doesn't work.  I am sure the fear mongers will tell you that most states are insolvent (which, technically, I am sure they are) but you must remember that states financials are not meant to look like corporate financials with a healthy equity position. 


As all there is lately is bad news for this market, there must be opportunities.



Former House Speaker and possible GOP presidential contender Newt Gingrich is pushing for federal legislation giving financially strapped states the right to file for bankruptcy and renege on pension and other benefit promises made to state employees.
Proponents of the measure — which include Americans for Tax Reform, a Washington lobby group that fights tax increases — said the legislation is desperately needed to clear the way for struggling states to slash costs before they go belly up, and should be regarded as a preemptive move that could preclude the need for massive federal bailouts.
Mr. Gingrich discussed the proposal in a Nov. 11 speech before the Institute for Policy Innovation, an anti-big-government group based in Lewisville, Texas. According to a transcript of the speech on Mr. Gingrich's website, www.newt.org, he said: “I ... hope the House Republicans are going to move a bill in the first month or so of their tenure to create a venue for state bankruptcy, so that states like California and New York and Illinois that think they're going to come to Washington for money can be told, you know, you need to sit down with all your government employee unions and look at their health plans and their pension plans and, frankly, if they don't want to change, our recommendation is you go into bankruptcy court and let the bankruptcy judge change it, and I would make the federal bankruptcy law prohibit tax increases as part of the solution, so no bankruptcy judge could impose a tax increase on the people of the states.”
Concerns about the funded status of public pension plans are increasing because the aggregate public pension plan funding level dropped to 80% for the fiscal year ended June 30, 2009, the most recent year for which data are available, from 85% a year earlier, according to the National Association of State Retirement Administrators, Baton Rouge, La.
States whose plans have the lowest funded status ratios, also as of June 30, 2009, were Illinois, with 51%, and Kansas, Oklahoma and New Hampshire, each with 59%, according to an analysis of state pension fund annual report data by investment bank Loop Capital Markets LLC, Chicago
Article here:  PIOnline - State Bankruptcy



A snapshot of MUB - iShares S&P Natl AMTFr Mncpl Bd Fd 



Small Caps - Continue to Position

As I have been pontificating for some time, large cap growth is not the place to be.  I have been a big proponent of mid-caps with a keen eye on small caps.  Just a snapshot of what we have seen generally across the capitalization spaces:


Having a focus on growth (instead of value, which to me does not make sense at this juncture) we see the following:


Over the last three months, small-caps have outperformed mid-caps by 200bps.  Yeah, when markets are choppy, small-caps will have more volatility, but if you are invested, continue to shift into small-caps.

Now this probably isn't news to many folks, but I feel the need to get it out there.

Interesting trade idea though might be a growth/value arb.  Long IWO, short IWN.

Portugal - Dominoes are Tipping

More on Portugal from Reuters.  As I have been stating, a Portugese bailout is all but done.  I found the comments from Spain somewhat amusing as they have the most to prove and the most to lose.  Another day in the trenches.


As much as it makes me fundamentally nauseous, long USD, short EUR, long UST, short beta.

The European Central Bank threw Portugal a temporary lifeline on Monday by buying up its bonds, traders said, as market and peer pressure mounted for Lisbon to seek an international bailout soon.
A senior euro zone source told Reuters on Sunday that Germany, France and other euro zone countries were pushing Portugal to seek an EU-IMF assistance program, following Greece and Ireland, in a bid to prevent contagion spreading to much larger Spain, the fourth biggest economy in the euro area.
The interest rate premium on Portuguese sovereign debt fell on Monday after rising sharply late last week as traders said the ECB intervened to buy government bonds on the secondary market.
"They're buying five-years and 10-years in Portugal, whatever people are offering really," one trader said.
Another trader said the ECB appeared to be buying Greek and Irish bonds too. EU sources say the central bank has not yet bought Spanish government debt.
Spanish Economy Minister Elena Salgado said Portugal did not need to apply for aid because it was meeting its commitments to reduce its budget deficit. And the European Commission said no discussion was currently under way on assistance for Portugal or any other country. Spain knows it is next!

Saturday, January 8, 2011

Portugal - The Dominos Are Lined Up

Read the following news from Reuters and it reminded me of another European case (yeah, Ireland).  When they start pushing, it isn't for optics, its because its about to hit the fan.  Now its Portugal, but if you follow debt spreads, can you guess who's next?  Top up a bailout fund?  Friends, if Spain chokes there is going to be a lot more topping needed.  And when Greece defaults, that will be the cherry on top.  If Portugal gets a package, I would expect the Euro to briefly rally and then roll over as the markets figure out the path that is being followed.  Would also expect the dollar to rally (least worst???) as well as the pound.
(Reuters) Germany and France want Portugal to accept an international bailout as soon as possible in order to prevent its debt crisis spreading to other countries, German magazine Der Spiegel reported on Saturday.
Without citing its sources, the magazine said government experts from both European heavyweights were concerned Lisbon will soon not be able to finance its debt at reasonable rates, after its borrowing costs rose at the end of last year.
Berlin and Paris also want euro zone countries to publicly commit to do whatever it takes to protect the bloc's single currency, including topping up a 750 billion euro ($968 billion) rescue fund if necessary.
Portugal is viewed by many economists as the peripheral euro zone country that is most likely to follow Ireland and Greece to seek an international bailout as it grapples to cut its debts and borrowing costs. It holds its first bond auction of the year next week.

Wednesday, January 5, 2011

ADP - Continues Favorable Data

ADP payroll data was released this morning.  Rather than concentrate on the recent divergenge between ADP and NFP, let me just say that I believe (as I have stated previously) that there is a nascent job recovery occurring.  Most of the stats I have looked at seem to be pointing to the recovery having teeth.  Should this be the case, we have to begin positioning small cap stocks (of the growth variety).




Private-sector employment increased by 297,000 from November to December on a seasonally adjusted basis, according to the latest ADP National Employment Report  released today.  The estimated change of employment from October to November was revised down but only slightly, from the previously reported increase of 93,000 to an increase of 92,000.  
This month’s ADP National Employment Report suggests nonfarm private employment grew very strongly in December, at a pace well above what is usually associated with a declining unemployment rate.  After a mid-year pause, employment seems to have accelerated as indicated by September’s employment gain of 29,000, October’s gain of 79,000, November’s gain of 92,000 and December’s gain of 297,000.  Strength was also evident within all major industries and every size business tracked in the ADP Report.
Employment among large businesses, defined as those with 500 or more workers, increased by 36,000 while employment among medium-size businesses, defined as those with between 50 and 499 workers, increased by 144,000.  Employment among small-size businesses, defined as those with fewer than 50 workers, increased by 117,000. 
 Full release here:  ADP December

Monday, January 3, 2011

Rare Earths - A Brief Summary and Focus Elements

I have occasionally written on rare earth elements and some of the factors influencing prices.  What I have never written is a background report on rare earths, the uses of them and market conditions.  Here is my attempt at rectifying that oversight as well as addressing those rare earths that I feel will offer the most upside potential.

There are many who currently believe that the rare earth market is super hot, on the verge of bubble. To this I offer the following:
  • One country controls the supply chain, and when that one country decides to tighten supplies (export quotas) while demand increases, price increases naturally follow.
  • While I believe that China is currently "flexing its muscle" with export quotas, and that these quotas will be loosened somewhat, China will be increasing domestic usage that will ultimately catch up with production capacity.
  • Given defense concerns (in the US and abroad), countries will be forced to diversify their raw material sources, leading to further development of non-Chinese mines and production facilities.
  • The lead time required to begin mine production is significant enough that demand will continue to outpace supply in the near-term. This will continue to drive prices of rare earth elements up until production capacity comes online.  
With that said, I continue.

Description

There are 17 rare earth elements (REEs), 15 within the chemical group called lanthanides, plus yttrium and scandium. The lanthanides consist of the following: lanthanum, cerium,
praseodymium, neodymium, promethium, samarium, europium, gadolinium, terbium,
dysprosium, holmium, erbium, thulium, ytterbium, and lutetium. Rare earths are moderately abundant in the earth’s crust, some even more abundant than copper, lead, gold, and platinum.

The lighter lanthanides, when compared with their heavy analogues, have an enhanced distribution in the crust. This crustal enrichment relative to the mantle is most pronounced for Lanthanum and tails off relatively smoothly towards Lutetium, the last member of the series. The light lanthanides are thus significantly more abundant than the heavies.

Rare-earths production is derived from the rare-earths ores bastnasite, monazite, xenontime, and ion-adsorption clay. Bastnasite is the world's principal source of rare earths and is produced in China and the United States. Significant quantities of rare earths are also recovered from the mineral monazite. Xenotime and ion-adsorption clays account for a much smaller part of the total production but are important sources of yttrium and other heavy-group rare earths.

In 1990, rare earths were produced by at least 14 countries. The United States was the largest rare-earths-producing country, followed by China, Australia, India, and Malaysia. Except for one primary mine in the United States, essentially all rare earths are produced as byproduct during processing for titanium and zirconium minerals, iron minerals, or the tin mineral cassiterite.


Location

Most rare earth elements throughout the world are located in deposits of the minerals
bastnaesite and monazite. Bastnaesite deposits in the United States and China account for the largest concentrations of REEs, while monazite deposits in Australia, South Africa, China, Brazil, Malaysia, and India account for the second largest concentrations of REEs.

Rare earth element reserves and resources are found in Colorado, Idaho, Montana, Missouri, Utah, and Wyoming. Heavy rare earth elements (HREEs) dominate in the Quebec-Labrador (Strange Lake) and Northwest Territories (Thor Lake) areas of Canada. There are high-grade deposits in Banyan Obo, Inner Mongolia, China (where much of the world’s REE production is taking place) and lower-grade deposits in South China provinces providing a major source of the heavy rare earth elements.  Areas considered to be attractive for REE development include Strange Lake and Thor Lake in Canada; Karonga, Burundi; and Wigu Hill in Southern Tanzania.  



End Uses

Clean energy technologies:  Lanthanum, cerium, praseodymium, neodymium, cobalt and lithium are used in electric vehicle batteries. Neodymium, praseodymium and dysprosium are used in magnets for electric vehicles and wind turbines. Samarium is also used in magnets. Lanthanum, cerium, europium, terbium and yttrium are used in phosphors for energy-efficient lighting. Indium, gallium and tellurium are used in solar cells.

The U.S. Department of Energy (DOE) released a report examining the role of rare earth metals in clean energy based on data collected and research performed during 2010 . Its main conclusions include:
• Several clean energy technologies—including wind turbines, electric vehicles, photovoltaic cells and fluorescent lighting—use materials at risk of supply disruptions in the short term. Those risks will generally decrease in the medium and long term.
• Clean energy technologies currently constitute about 20 percent of global consumption of
critical materials. As clean energy technologies are deployed more widely in the decades
ahead, their share of global consumption of critical materials will likely grow.
Of the materials analyzed, five rare earth metals (dysprosium, neodymium, terbium,
europium and yttrium), as well as indium, are assessed as most critical in the short term. For this purpose, “criticality” is a measure that combines importance to the clean energy economy and risk of supply disruption.

Defense and military systems: The primary defense application of rare earth materials is their use in four types of permanent magnet materials commercially available: Alnico, Ferrites, Samarium Cobalt, and Neodymium Iron Boron. Neo magnets, the product derived from Neodymium Iron Boron, and Samarium Cobalt, are considered important to many defense products. They are considered one of the world’s strongest permanent magnets and an essential element to many military weapons systems.
Here is a brief summary:

Supply and Demand
World demand for rare earth elements is estimated at 134,000 tons per year, with global
production around 124,000 tons annually. The difference is covered by previously mined above-ground stocks. World demand is projected to rise to 180,000 tons annually by 2012, while it is unlikely that new mine output will close the gap in the short term. New mining projects could easily take 10 years to reach production. In the long run, however, the USGS expects that global reserves and undiscovered resources are large enough to meet demand.

The following is taken from the US DoE Critical Materials Strategy report dated December 2010 (full report here: DoE critical-materials-strategy well worth the read):
 

And the medium-term assessment:


What these graphs mean to me is that the rare earths that should be focused on are:  Dysprosium, Neodymium, Terbium, Europium and the quasi-rare earth Yttrium.

Future Production Potential

While given the current market for REE many companies are in the process of beginning or expanding REE production capacity, there are currently some companies with recognized (ie, on the map and feasible) plans for increased production of REEs.

Molycorp, which has an exploration program underway to further delineate its rare earth mineral deposits, has plans for full mine production in the second half of 2012 and has plans to modenize its refinery facilities. Molycorp’s Mountain Pass deposit contained an estimated 30 million tons of REE reserves and once produced as much as 20,000 tons per day. Mountain Pass cut-off grade (below which the deposit may be uneconomic) is, in some parts, 7.6%, while the average grade is 9.6%. U.S. Rare Earth (another U.S. based company), in the pre-feasibility stage of mine development, has long-term potential because of its large deposits in Idaho, Colorado, and Montana.

Canadian deposits contain the heavy rare earth elements dysprosium, terbium, and europium, which are needed for magnets to operate at high temperatures. Great Western Minerals Group (GWMG) of Canada and Avalon Rare Metals have deposits with an estimated high content (1%-2%) of heavy rare earth elements.  Avalon is developing a rare earth deposit at Thor Lake in the Northwest Territories of Canada. Drilling commenced in January 2010. Thor Lake is considered by some in the industry to contain one of the largest REE deposits in the world with the potential for production of heavy REEs.

GWMG owns a magnet alloy producer in the U.K. When GWMG begins production in Canada and elsewhere, they plan to have a refinery near the mine site allowing greater integration and control over the supply chain. Great Western’s biggest advantage could be its potential for a vertically integrated operation.  


Regulatory Sidebar

Rep. Mike Coffman (R-CO) made the following statement on the House Floor today during consideration of an amendment he has offered to the National Defense Authorization Act for Fiscal Year 2011.  Coffman’s amendment, which builds on the GAO report he pushed for in last year’s defense bill, would require the Department of Defense to develop a plan for establishing a domestic rare earth magnet capability.  Rare earth magnets are currently used in many critical weapons systems:
“The Department of Defense is facing a near-term shortage of key “rare earth” materials necessary to support our defense weapon systems, and rare earth magnets are especially critical.  Currently, over 97% of rare earth production is controlled by China.”
“Today, the United States does not have a manufacturer of neodymium iron boron rare earth magnets, yet they are found in our precision guided munitions, ships, aircraft, and other critical weapons systems.”
“One key finding of the GAO report was their determination that some U.S. defense contractors are currently utilizing “neo” magnets from Chinese sources and incorporating them into the weapons platforms delivered to the Department of Defense.   At present, we have almost no alternatives to these Chinese components, as the United States is not currently producing these magnets.  Though America is not currently producing these magnets, we have the technological know-how to do so, combined with significant deposits of rare earths.”

This is a brief overview of the rare earth market, I hope it helps.  The next part of my analysis (due very soon) will focus on the firms that are involved in the mining and production of the critical rare earths identified earlier.

About Me

A student of the markets that has held portfolio management, analysis and trading positions for over 15 years.