It looks like crude oil (USO) overproduction will continue.
Dashing hopes that any rational behavior would prevail in the energy resource markets, member nations of OPEC February 16 said not that they would cut output but that they would not increase crude-oil output any further, as if the current pace of production isn’t already drowning the world in the black liquid. It turns out the rumor from last week had some basis to it, “Your Hard-Earned Money,” but it didn’t have much substance, in our view, especially since the deal hinges on cooperation from Iran, which remains dedicated to increased production to reach pre-sanction levels. We’re not reading much into the news, as Saudi Arabia, while included in the parties willing to hold production steady, will likely not jeopardize all of its work thus far to put the backs of US shale independents against the wall. In any case, we would expect any production slack to be picked up by other producers across the globe, which continue to hemorrhage cash.
There are no two better instances, at least in recent memory, than the untimely insider purchases by executive teams at Kinder Morgan (KMI) and Energy Transfer Equity (ETE) to remind investors that not all insider buying is a good thing. Of course it is fair to say that in some cases insider buying is a signal by management that the team believes the long-term is a bright one, but management knows that you know this, too. Often in some cases, however, it can viewed as a distraction away from the core business fundamentals, an effort to lure you away from doing independent research and analysis yourself, instead putting full faith in the executive team as if they are stock market gods. Most insider purchases as of late seem to have taken the shape of being “distractions” rather than anything else. With bank shares getting shellacked so far in 2016, it was almost expected that someone with “buy-back” swagger would step up to the plate to steady the markets. That person was none other than CEO of JP Morgan (JPM) Jamie Dimon, who bought 500,000 shares or nearly $30 million worth of JP Morgan, February 11.
Somewhat counterintuitively, however, we can’t help but be even more concerned after the purchase, particularly in light of the more recent examples. After all, the markets are only 10%-15% from all-time highs, and it is already required that the markets need the heavy-hitters to step in? What might still be looming? We outlined in our piece, , how important confidence is to the banking sector, and we applaud Mr. Dimon’s move to reestablish such a dynamic to a degree, but the recent track record of executives jumping in front of oncoming trains with insider purchases has frankly made us even more nervous. We hold diversified bank exposure in the Best Ideas Newsletter portfolio in the form of the Financials Select Sector SPDR (XLF) and SPDR S&P Bank ETF (KBE), so we don’t mind the bounce in the sector too much, but we’re keeping our eyes focused on the fundamentals, concerns about slowing global economic growth and rising bad energy loans. Remember: management knows that you know that you want them to step in to buy shares, making any insider buys suspect at best, at least from our perspective.
The see-sawing by global equity markets has many investors sick, and the most recent move has been of the upward variety, led by a bounce in China (FXI) shares, which has spilled over to the US markets. Local equity exchanges in China are still far from all-time highs, however, and it may be years, if not decades, before any sustained recovery may be in order. The Shanghai Stock Exchange Composite Index (SHCOMP) closed at 2,836 February 16 down from 5,166 in June 2012, while the Shenzhen Stock Exchange Composite Index (SZCOMP) closed at 1,821 down from 3,140 over the same time period. Forgive us for not getting too excited about the bounce. For Alibaba (BABA) holders, a nice high-single-digit move following the overnight rally is welcome news, even though shares, too, have nearly been halved from all-time highs set shortly after initial public offering. Shares of Yahoo (YHOO) are also higher in sympathy. In case you missed our open letter to the board of Yahoo, please visit here, “VALUENTUM ISSUES OPEN LETTER TO MARISSA MAYER, CHIEF EXECUTIVE OFFICER OF YAHOO!”
February 16 was quite the day for short covering. Groupon (GRPN), for one, apparently woke up to the fact that none other than Alibaba had taken on a 5%+ position in the company, driving shorts to cover en masse. Shares have now rocketed to the high end of our fair value range, and we think Alibaba’s presence will keep short-sellers at bay, if only because they don’t want to wake up one day with Alibaba buying all of Groupon out at a substantial premium. Outerwall (OUTR), the owner of RedBox kiosks, also caught a bid as activist Engaged Capital amassed a stake of ~14%, spooking short-sellers that had been hoping for uninterrupted business model deterioration, “Three Blow Ups after the Close February 4.” We recently slashed our fair value estimate of Outerwall in half on account of reduced revenue expectations due to disturbing movie-rental declines and the resulting earnings deleveraging that ultimately will follow, “16-page Valuation Report.” Competition from the likes of Netflix (NFLX) and Amazon (AMZN) Prime won’t let up, and we posit that even shares of Netflix are in jeopardy, “Alert: 5 Reasons Why We Think Netflix’s Shares Will Collapse.”
On July 14, 2015, we issued a report, “Warning! 5 Heavily-Followed Dividend Paying Stocks to Avoid,” a list that included Zoetis (ZTS), McDonald’s (MCD), Kinder Morgan (KMI), Yum! Brands (YUM), and the combination of Linn Energy (LINE) and Legacy Reserves (LGCY). Shares of Zoetis have dropped nearly 20% to ~$40 from ~$47, Kinder Morgan’s shares have collapsed to ~$15 from ~$38, Yum! Brands’ shares have dropped to $70 from over $90, while Linn Energy’s and Legacy Reserves’ equity prices have fallen flat to 40 cents per share and ~$1 per share, respectively, from over $8 and ~$10 at the time of the July article. One company, McDonald’s has managed to buck the trend thanks to some help from all-day breakfast initiatives and increased refranchising initiatives, but we have serious doubts the company will reach consensus estimates of $6 per share by 2017, which itself implies a company trading at 20 times earnings two years from now. Any slip up in McDonald’s will send the shares tumbling in a big way, in our view.
On February 16, animal health giant Zoetis cut its top- and bottom-line outlook for revenue and earnings for both 2016 and 2017. The company now expects revenue of $4.65-$4.775 billion (was $4.75-$4.875 billion) in 2016 and revenue of $4.95-$5.15 billion (was $5.025-$5.225 billion) in 2017. For earnings, Zoetis cut its adjusted net income target for 2016 to the range of $855-$905 million (was $925-975 million) and for 2017 to the range of $1.09-$1.16 billion (was $1.125-$1.195 billion). Restaurant Brands International (QSR), the owner of Burger King and Tim Hortons, noted that comparable store sales were quite robust during its fourth quarter, with Burger King experiencing comparable store sales increases of 5.4% in constant currency. In this light, it may be fair to say that perhaps McDonald’s improving same-store sales trends are more industry-driven, perhaps buoyed by the collapse in prices at the gas pump, stimulating demand. We remain skeptical of McDonald’s valuation at present levels, even as we bumped up our fair value estimate recently, “.”
Following Valuentum’s note that had been picked up in Barron’s, “Is Kinder Morgan on Road to Recovery,” where we painted a rather optimistic picture of Kinder Morgan and reiterated its fair value estimate of $20 per share, we’re starting to witness some bottom-fishers and distressed investors move into the energy MLP space. Though the risks remain, “Market’s Swooning: Bye Bye Energy MLPs, Part II,” Appaloosa Management’s David Tepper established new stakes in several equities tied to the midstream space, including Kinder Morgan, Energy Transfer Partners (ETP), and Williams Partners (WPZ), in hopes that a bottom might finally be in. Even Warren Buffett, the Oracle of Omaha himself, opened a new 26.5 million share stake in Kinder Morgan today. We like the optimism, and we hope the midstream space finally turns decidedly for the better. The biggest challenges, however, are still ahead, as contracts will inevitably be renegotiated both in and out of the bankruptcy courts, as the weakest upstream entities fail. We continue to prefer diversified exposure Energy Select Sector SPDR (XLE) in both newsletter portfolios. Kinder Morgan is a top weighting in the ETF.
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