THE CASE FOR FINANCIAL INSURERS

In my last article I said that financial insurers could very well be the subject for another piece, always about financial conundrums. In fact, the conundrum here is very well explained by the unfair behaviour of some folks who were shorting those securities, helped by the usual behaviour of mainstream media (a megaphone for the strongest screaming at any given time).

Since then however there have been some very good pieces, which have done a very good job restoring the truth and exposing the bad faith of some market actors and the lunacy of the rest. As I could not do better and as I hate to waste words (there are already tons of vain words in every field of our life), I refer to them.

Steve Lukather

Tom Brown

Tom Armistead

I’ll limit myself to add a different perspective to point the compelling opportunity to pick these businesses at their current price, resorting again to plain, cool, cold numbers. These companies (MBI, ABK, RDN) have been producing free cash in past years as they were the US Federal Reserve. In the past ten years to 2007 RDN has delivered 4.575 $ of average annual FCF to shareholders, MBI has minted cash at 5.39 $ rate average every year and ABK has done even better: 7.154 $ every year on average, a figure equaling almost two times its current stock price. In 2007 fiscal year RDN has cashed 3.71 $ per share, MBI 8.09 $ and ABK 9.3 $. Impressing, isn’t it?

Sure, I know your objection: those were just the good old times, the party’s over now, you can forget about that free cash. Well, in fact ABK and MBI have delivered free cash even in the first half of this year, 0.4 $ and 1.84 $ respectively; just RDN has burned 2.3 $ of cash in that period. Not the end of the world, admittedly. Of course, in the years coming it could be very well possible that they will lose cash, but I don’t think these (eventual) cash loss will be of the magnitude necessary to justify their current stock price; in fact, a strong case could be made that actual defaults on the securities they insure will be much less than everybody seems to assume now; moreover, the actual defaults will be paid over a long period.

You see, it’s not only a free cash case here. Apart from book value (6.76 $ for ABK, 16.67 $ for MBI and 30.54 $ for RDN, but you should adjust here and the numbers will be much better), and even considering a mere run-off scenery, for every share you buy of ABK you get 59.76 $ of investments pool, 81.26 $ per share if you buy RDN and a whopping 159.64 $ per share if you choose MBI. A very conservative 4% annual return on those investments would mean 2.39 $ per share for ABK, 3.25 $ for RDN and 6.38 $ for MBI, every year. Again, I invite you to check their current stock price one more time.

In short, my friends, here you have the opportunity to make a bet risking 1 to get 4-5 times what you risk, and with very good probabilities on your side, better than 75% in my humble opinion. No bookmaker would give you such a deal but Mr. Market, with its schizophrenic problems. In fact, it’s possible to build a scheme to limit your loss to a 25-30% of that 1 if things will develop for the worst. I’m working over this, there are other stocks in different sectors which present the same opportunity, and I hope to present a concrete action to subscribers in a few weeks.

You can play it even more safely, with Old Republic (ORI). This insurance company is not a pure player, just a part of its business is about financial insurance, so it offers a cushion and a good discount at the same time. It’s a cash machine as almost every insurance company: 2.73 $ average annual free cash flow in the last ten years to 2007, 3.68 $ in 2007 and 1.43 $ in the first half of 2008. You can buy a share for a little more than 10 $ today and get 17.59 $ of (not adjusted) book value and 37.67 $ of investments pool. It yields just shy of 7% and it’s been around since a century; my guess is it will still be around a long time from now.

P.S. – To address current and future financials crisis a very good start would be to dismantle rating agencies and their hateful, nefarious legal monopoly. They are really a joke!

Disclosure – no personal position (yet), RDN and ORI are picks of my model portfolios.

SHOW US THE STUFF, DUDES

A good piece, above all the first part, explaining in details what I tried to synthesize with a few ironical lines.

Of course, this paper game can work just so far with gold and silver, because their printing machine is run by a God.

THIS MAN HAS NO CLUE

Someone should explain him that extraction cost for oil are not less than 40-45 $ for barrell (add about the same amount for exploration cost), and only for the most efficient companies.

Moreover all the oilsands and deep water oil, even a lot of the oil in actual producing fields, would be gone with the price under 65-70 $, becoming uneconomic to extract.

Oil at 30 $ would mean just one thing: no oil in the market!

Another guy with no knowledge of that constant of our contemporary life: inflation!

“SPECULATORS” AND “REGULATORS”

Dear FDIC,
I apologize if I’m going to rob you a bit of your precious time, time that you in a so commandable way employ to protect commodities’ markets and the people taking part at them.
I have just a fast question for you.

I’ve read proudly of your great efforts to fight those dirty speculators who were manipulating the oil market at the expense of the poor people, and I’ve appreciated your last address of the matter, promising them heavy fines if they don’t stop that obscene conduct. It should be really considered a crime to think that energy supply is tight and that the cost to get that energy has skyrocketed thanks to the FED doing very well its job, by consequence buying oil.

So I want now to ask you: how should we call those eight or less entities that in the Comex silver futures’ market are selling a fantastizillion silver ounces, silver that they don’t have and can’t possibly get anywhere in the world, sending the silver price down by 35% in a week?

I guess we must call them patriots, reserving the speculator fame for those that in the same market wish to buy more than 1500 contracts and can’t do it thanks to your fair rules, even if they have all the cash needed for a payment of that silver in full.

I beg your authoritative confirmation. Am I right?

Disclosure: long silver future, SLV is a pick of my model portfolios

THE CONUNDRUM

This year has been a really interesting time for financial stocks indeed.

Most of them have had their stock price literally destroyed, a few are no more, fewer are astonishingly at their high. Generally it has been a very tough time for every company operating in the sector. Some of them however has faced the storm in a privileged position, so that are showing a better (price) shape at this time.

Take the Almighty Goldman (GS). Encircled by universal admiration, it has seen its share price barely punished by the worst market ever for financials. From last October to present day it has lost 32.5%, a very good performance if you compare to the sector’s index, a stellar performance if you compare it to other peers or financial insurers, down even 70-80%.

Financial insurers could be very well a good subject for another article, or you can rely on this excellent piece, so I’ll pass over them today. But take for example Regions Financial (RF), whose share price has been curtailed nearly 70% in the same period. Why this enormous difference in their performance? You’d think it’s a function of their operating performance or other real world reasons.

Alas, I’m afraid it’s just a function of the market schizophrenia I talked about in my last report.

The perception about the operating performance of Goldman is very good; everybody and his wife talk about how smart and dandy this guy is. I guess they refer to the shorting of the very crap it was at the same time selling to its clients. Ethics aside, it’s true that Goldman earnings have been very solid, even in this tough times. It’s also true however that even Regions earnings performance has been very good; in the last 5 fiscal years to 2007 it earned north of five billions $, never showing a loss, not even in this year first half (opposite, it earned a healthy 540 millions $).

So maybe it’s because of an untenable leverage of Regions’ balance sheet. But wait, its leverage is 7.2, not the end of the world for a bank I’d say. An untenable leverage seems rather what Goldman presents: its assets are 24 times equity. And I don’t think that all the crap is on the Regions’ assets side, while all the pearls are on the Goldman one.

Why then that different share performance? Why the market thinks it’s right to value Regions 0.32 times the book, while Goldman deserves a rich 1.6 times book?

Apart from some obvious differences in their business (I’d think anyway that put more risk on the Goldman side), they in the real world differ just in one thing. That is, in the last 22 quarters (5.5 years) Regions has delivered almost 9 billions $ of free cash to the shareholders (it now capitalize just two third of that figure), while Goldman operations in the same period have used nearly 170 billions $. Yes, you read it right: while Goldman posted exceptional profits, its operations bled 170 billions $ of cash in five years and half.

(someone someday will explain how that’s possible, and I think he will turn to metaphysic)

So I must confess to be at complete loss here.

Disclosure: no personal positions, RF is a pick of my model portfolios.

AM I CRAZY ?

A subscriber doubts about my mental sanity.

To summarize his remarks:

“You should be crazy to pick Gannett (GCI). Don’t you know that internet will kill this business?”

Yes, I know. As cars ought to kill the train business, airplanes exterminate all the other transportation business, television the cinema business, et cetera. Oh, I was forgetting: video killed the radio star too.

Internet then was presented as a real serial killer, it should kill almost every other communication business: books, printing, telecom, newspapers, you name it.

In fact all those businesses are still around. They suffered, scaled back, restructured, reinvented themselves and even found a way to profit from the new possibilities offered by their supposed killer.

So I humbly suggest to take the Microsoft CEO’s position on this matter, that is newspapers will not exist anymore ten years from now, with a grain of salt.

Of course, a lot of the companies operating in those sectors were forced out of business and many others will fail in the future; just the stronger ones did and will make their way out of the challenge.

Is Gannett one of them? I think it has a strong chance. Its top management may be highly remunerated, but judging from their past and even present performance they don’t seem to be stealing the money. They did not stupid things as ultrapay for peers acquisitions at the top of a cycle loading the company with tons of debt (the McClatchy way), and Gannett’s operating performance has been stellar in the past years. In the last ten fiscal years to 2007 the company has managed to deliver a whopping 53.18 $ per share in structural free cash flow, nearly 3 times its current price.

Boy, THAT’S a performance!

Just past splendour? Let’s keep on running cold numbers.

In the last quarter the company had sales that were down 10.9% year over year, while EBITDA was down 22.6% over the same time span; EBITDA margin was down less, just 13.2% from 28.8% to 22.6%. So things seems really difficult. But if you compare the last quarter to the precedent, you’ll see sales up 2.45% and EBITDA up 8.7%, while EBITDA margin was up nearly 6%, from 23.6% to 25%.

Moreover if you go to the old cool cash, you’ll find out that structural operating cash flow (i.e. CFO before changes in the working capital and deferred tax, my preferite way to analize a company’s cash power) was actually better in the first half of this year compared to past year, scoring 3.41 $ per share vs. 2.98 $, up a fine 14.4%. That cash from operations covers 13.4 times the capital spending vs. 11.64 last year, and 4.2 times the dividend. It’s true that last year it covered the dividend 5 times, but in the meanwhile the dividend has increased 30%. Gannett yields 8,6% at current stock price.

Are you worried about the debt? You should not, in my humble opinion (even if I’d like to see a smaller figure here). Total debt stands at 4.3 mld $, a decrease of 5,1% yoy, but net debt decreased much more, -15.6% at 3.7 mld $. If you annualize this year first half structural CFO, that figure could cover the net debt in less than 2.5 years. Besides, the interest coverage has gone from 8.36 times in last year second quarter to 9.77 times this year.

In short, this dying business has generated an average annual structural free cash flow of 5.32 $ in the last ten years to 2007, 4.41 $ in 2007 fiscal year and 3.46 $ just in the first half of this year.

I’d love to die this way.

It’s true that the business is slowing and the company has quite a challenge to face, a shift of paradigm. But it’s also true that its expertise could very well capitalize on the new opportunity. The moat of an established publishing company (Gannett is one of the world leaders) can’t be seriously challenged by me and you or start-up companies even in the internet era. All the googles of this world will not be able to completely eat its lunch, it will keep a defendable niche and even counterattack exploiting the convergences of the contemporary world’s media. By the rest, guessing about the future of a business resembles more to a prophecy than an analysis, but that’s true for everyone. And today you can buy Gannett for 18.9 $, that is 61% less than one year ago.

I could be very well crazy, but if someone offers me to buy a business whose enterprise value discounts just 6.64 times the average annual structural FCF of the last ten years, 8 times that of 2007 and 5.1 times that of the first half of this year annualized, well, I’d buy.

After all, I’m not betting the ranch.

Disclosure: Author is long GCI common, short GCI call.