The Aspiring Analyst

Fool's Gold

2012-02-18T01:57:00.001-05:00

I've written on this issue before, and last week, our investing hero Warren Buffett also weighed in, in an op-ed piece for Fortune magazine. I strongly recommend everyone read Warren's excellent article. Ofcourse, when Warren speaks, people listen (and criticize, like this post from a commentator for the WSJ).

Essentially, what Warren is saying is exactly my thesis on the yellow metal - it has no productive value! Yes, one could argue that as governments continue to print money to satisfy their mountains of unfunded liabilities and deficits, gold may be relatively more attractive than paper currencies like the US dollar. Afterall, governments cannot print gold. No, they cannot print gold; but they sure as hell can confiscate gold (Google 'Executive Order 6102'). As a sidebar, if you are really afraid of government failures and the end of paper currencies, you should buy guns and canned food, not gold (although that seems to be what some goldbugs have been advising too!). You cannot eat a gold bar (or more precisely, your body cannot digest gold), and most certainly, you cannot eat a claim on a bar of gold stored in a vault.

But since this is an investing blog, let's focus on the investment aspect of gold. Investing is the forgoing of current consumption in exchange for a claim on future consumption that is hopefully higher than current consumption. When you invest in gold, all you are betting on is that there are more people behind you who would want to own gold more than you and would be willing to exchange more goods and services (or paper money!) for your bar of gold than what you've paid. The classic Greater Fool Theory of investing. Sure, if you time your purchases correctly, or play up to people's fears, you can make a lot of money (again, we come back to the paper currency; am I the only one to see the oxymoronic contradiction?). But that's it.

Every ounce of the yellow stuff that's dug out of the ground (at huge expenses, one might add), is added to global supply. Gold, unlike oil, a true finite resource, never gets used up. An ounce of gold dug up and refined in 1000 BC can be resmelted into a gold coin in 2012 (incidentally, has anyone looked at recycling the tons of electronic waste we produce each year? All those dead or unfashionable phones and gadgets could be a treasure trove of gold and other minerals!). For now, demand for gold is high because of rampant fears of inflation and government defaults. But when the tide turns, don't be surprised if the price of the yellow metal falls dramatically (we note the marginal cost of producing an ounce of gold is ~$600) as investors (speculators) rush to the exits.

- The Aspiring Analyst

Brasil Telecom - Playing Out As Expected

2012-01-25T22:14:00.001-05:00

We wrote about Brasil Telecom's ADRs (BTM-NYSE) back in October, and our thesis is that BTM is an undervalued telecom player in Brazil where Management is working to unlock hidden value by simplifying its corporate structure. Today's press release from the company announcing the shareholder's meeting to vote on the reorganization simply confirms that our thesis is playing out.
To refresh your memory, each Brasil Telecom ADR represents 3 shares of BRTO4 (BRT04-BOVESPA), one of the many public listings of Brasil Telecom S.A. (Oi. S.A.), the second largest telecom group in Brazil with approximately 25% market share of the Brazilian market.
Oi has always been known to have a convoluted corporate structure, leading to its shares trading at a significant discount to its peers (it trades at just 3.5x EV/EBITDA vs. global peers between 4.0x - 7.0x). The management team recognizes this problem and has decided to simplify the ownership structure of Oi by consolidating into 2 public listings (BRTO3 and BRTO4 and the NYSE-listed ADRs).
What is especially interesting about BTM is that prior to the reorganization, each shareholder of BRTO4 and BRTO3 (and by extension the ADR holders) will receive a special dividend equal to R$2.54 (or ~$4.20 per ADR). Combined with modest multiple expansion from a simplified corporate structure, it is not unreasonable to expect each ADR to be worth north of $30 per share over the medium term, with a near-term $4.20 dividend kicker.

- The Aspiring Analyst

2011 Report Card - C+

2012-01-07T18:15:00.000-05:00

Dear readers, we have posted our newsletter for January. All in all, 2011 was a tough year. Although we beat the index marginally, our investing performance left a lot to be desired. Hopefully, 2012 will be a better year for your analyst.

- The Aspiring Analyst

Where Have We Seen This Movie Before?

2011-12-03T17:22:00.001-05:00

We have to admit, the most recent coordinated central bank liquidity measures seem awfully familiar with those announced in 2007/2008. To find out why, please see our December newsletter.

- The Aspiring Analyst

Special Edition On Canada

2011-11-05T20:57:00.005-04:00

This month, we do a little deep dive on Canada to see whether it really is as strong as everyone thinks. The short answer is no. To find out why, please read our newsletter!

- The Aspiring Analyst

Starting To See Value

2011-10-02T18:00:00.000-04:00

With recent market volatility, we are beginning to see value in particular securities, as detailed in our October newsletter. Our advice for investors is to look at as many good companies as you can, find their intrinsic value, and be prepared to buy when Mr. Market gives you an opportunity in the coming months.

- The Aspiring Analyst

About That Gold...

2011-09-23T19:10:00.000-04:00

As we wrote back in May, we are not fond of the yellow metal. It has no productive purpose, although lately, with the ever skyrocketing price of gold, supporters have claimed that it could simultaneously protect against inflation (Central Banks using quantitative easing to monetize governments' debts) and deflation (caused by a double-dip recession). Again, how something can simultaneously protect against two fundamentally different views of the world is beyond our comprehension.

We certainly hope the price action in the past few weeks (racing to recent higsh of over $1,900 / oz before crashing to ~$1,600) will serve as a stark reminder of the inherent speculative nature of gold. Remember, in 2008, gold actually fell along with the value of all assets. If anything, you should buy gold equities (with low-cost production or unrecognized assets), since they actually generate cash flows from their productions of gold.

- The Aspiring Analyst

I'll gladly pay you Tuesday for a hamburger today...

2011-09-08T20:27:00.001-04:00

Our thoughts after hearing President Obama's speech today is aptly captured by Jim Quinn of The Burning Platform (brilliant post - one of those, why didn't I think of that calibre post.)

POTUS wants $447 BB in new stimulus. Everything will be fully paid for, according to POTUS. The only catch is, he doesn't know from where. So he'll ask the Congressional Committee tasked to find $1.5 T in cuts before the end of the year to find another $447 BB. Brilliant. POTUS gets the photo-op. Congress gets stuck doing the hard work.

- The Aspiring Analyst

Ben Is Set Up To Fail

2011-09-04T15:34:00.000-04:00

Dear readers, through a recent email exchange with a Canadian thought leader, we came across an interesting idea. Why do we, as a society, continue to rely on men to do superman's job? Aren't we simply asking for failure? We explore this idea a little bit in this month's newsletter.

The Aspiring Analyst

Almost Time To Be Greedy

2011-08-06T01:57:00.001-04:00

Dear Readers,

Our August newsletter has been uploaded. Although we believe the recent market downturn still has a ways to go, we think value investors should begin sharpening their pencils to take advantage of some upcoming fire sales.

- The Aspiring Analyst

We Are Not Surprised...

2011-07-22T21:30:00.000-04:00

We hate to be the harbinger of bad news, but we are not surprised that US Debt Ceiling talks have collapsed. Our analysis in our previous post explains why. Unless the game changes, both Democrats and Republicans have incentive to fight rather than co-operate.

- The Aspiring Analyst

US Debt Ceiling Is An Unstable Prisoner's Dilemma

2011-07-19T23:30:00.002-04:00

We do not like to comment on politics, as politics can be a very emotional subject for a lot of people. However, we feel compelled to point to the dilemma the US finds itself in currently, with the stalemate over the debt ceiling. For those that are not familiar with the issue, here's a refresher from Wikipedia:

"Article I Section 8 of the United States Constitution gives the Congress the sole power to borrow money on the credit of the United States. From the founding of the United States through 1917 Congress authorized each individual debt issuance separately. In order to provide more flexibility to finance the United States' involvement in World War I, Congress modified the method by which it authorizes debt in the Second Liberty Bond Act of 1917. Under this act Congress established an aggregate limit, or "ceiling," on the total amount of bonds that could be issued."

The current debt ceiling was set in February 2010 when it was raised to $14.3 Trillion dollars, and unless Congress passes another increase by August 2 (the US Treasury estimates it will run out of room by this date), the US government may be forced to default on its debt obligations and a financial crisis far larger than the so called 'Great Recession' may result. Why do we care?

We care because the outcome of the debt negotiations between the Democratic White House and the Republican Congress will directly impact the value of our portfolio. We also cannot stand to watch the grandstanding that is taking place right now.

To us, the current stalemate (notwithstanding Obama's endorsement of the Gang of Six's plans earlier today) is a classical prisoner's dilemma in game theory. Let us illustrate:

Both (D)emocrats and the (R)epublicans can either choose to (C)o-operate or (F)ight. Obviously, if both sides choose to co-operate and negotiate a credible deficit reduction plan that includes both tax increases and budget cuts, the world would be a better place. But both sides would be seen to 'compromise' by their constituents, so politically, the payoff of State I is (D,R) = (1,1) (see figure below).

           Democrats
   R _C__ __F__
   e    C | (1,1) | (3,-3) |
   p         |_S1_ |_S2_ |
   u    F | (-3,3) | (X,X)|
   b         |_S3_ |_S4 _|
                 .
If either side choose to fight while the other side choose to co-operate, then the fighting side (who stands 'firm and wouldn't give an inch') would be able to claim 'victory' come the next presidential election in 2012, and their opponents would be seen to have 'caved-in'. State II is if Democrats fight and Republicans co-operate, with a payoff of (3,-3). State III is vice versa, with payoff of (-3,3).

Unfortunately, in this game, we will never get to the globally optimal State I, no matter the outcome of State IV, when both sides choose to fight and we get an eventual US default.

First, consider the case that both sides view a State IV as a political 'cop-out', allowing them to save face in front of their constituents while ramping up the 2012 presidential campaign. We can reasonably assign a payout of (-1,-1) for State IV. Since Democrats are better off choosing to fight no matter what Republicans choose (i.e., D2 > D1 and D4 > D3), they will naturally choose to fight. Same for Republicans (R3 > R1 and R4 > R2).

Even if the payout for Stage IV is terrible, i.e. a US debt default and armageddon, we still don't get to the globally optimal State I. Consider if State IV had the payout (-5,-5). As a Democrat, if we are starting off in State I (both co-operate), then it 'pays' politically to fight, since D2 > D1. Same for Republicans, it pays to fight, since R3 > R1. However, if both choose to fight, we get State IV. But if we are in State IV, D2 > D4 and R3 > R4, hence both would choose to co-operate, leading to State I. This is an unstable game, and would oscillate between Democrats and Republicans choosing to fight or co-operate (quite like real life, actually).

Although we can recognize the game, we cannot solve it. Solving it for the global optimal will require changing the game's rules and payoffs such that D1 > D2 and R1 > R3. If we can convince both parties that it 'pays' to co-operate, then the game will naturally conclude with both parties co-operating on a settlement to reduce the deficit and lift the debt ceiling. Unfortunately, politicians are not game theorists and it is very hard to change the political payout of this game.

- The Aspiring Analyst

CMHC - The Elephant In The Room

2011-07-10T18:59:00.000-04:00

Dear Readers,

This month's newsletter takes a deeper look at what we believe is the real reason Canada's housing market performed as well as it did during the recent recession. Our research indicates that the CMHC provided over 50% of the financing for the Canadian housing market over the past few years through its NHA-MBS securitization trusts and this level of intervention has not decreased even as the economy has improved. In addition to worries about rising interest rates, real estate investors should also consider what happens when/if CMHC removes this level of support.

As always, your comments are most welcome.

- The Aspiring Analyst

Back In Business; Update On Becker Milk (BEK.B-TSX)

2011-07-01T22:05:00.000-04:00

Dear Readers,

We are finally back in business! After a hectic couple of weeks including marrying my beautiful wife and honeymooning in Hawaii, we are finally back in Toronto doing what we like second best (second after spending time with my wife, of course!).

What a roller-coaster ride June has been. We will be providing an update and our thoughts in the next couple of days in a full letter, but let's just say our portfolio took a sizeable hit. We have reviewed our positions and given the theses remain sound, we are not too worried.

The purpose of today's entry is to provide a brief update on one of our favourite investment ideas in the last couple of months - Becker Milk (BEK.B-TSX). If you recall, a couple of months ago, we wrote that Becker Milk was a wonderful little company that has quite a bit of hidden asset value. Well, just this week, the Company announced its 2011 year-end results and it appears the auditors agree with us (although not to the same extent as we had hoped).

The actual quarterly/annual results were ho-hum, as the Company incurred some one-time expenses for the implementation of IFRS accounting standards. However, what really caught our eye was hidden in the IFRS disclosure in the MD&A, the Company reported that the Company's portfolio of real estate is worth $29.8 MM, instead of the $12.5 MM it is held on the balance sheet for. This is interesting for two reasons.

1) As disclosed in the MD&A, when the company starts reporting under IFRS in F2012 (sometime in August for Q1/F12), the investment portfolio will have to be carried at fair value on the balance sheet, meaning book value will jump from $8.80 ($15.9 MM / 1.8 MM shares) to $16.50 due to the $13.9 MM in net unrealized gain on the real estate portfolio. We agree with reader MR that Q1/F12 may prove to be a catalyst for the company as it reports a significantly higher book value.

2) The fair value appears low. Recall in March, we had valued the investment portfolio at $40 to $50 MM by using a cap rate of 8 - 10% on the rental income of ~$ 4 MM / year. What we find interesting is how did the auditors come up with a $29.8 MM fair value? A few paragraphs up in the MD&A, the company said that in May 2010, the real estate portfolio was valued using a 8.25% cap rate. Assuming it's an 9% cap rate in 2011 (unlikely, since real estate values have recovered in 2011 vs. 2010, but let's be conservative), $29.8 MM fair value means the NOI on the investment portfolio was $2.7 MM. But the rent is $4 MM. There's no mortgage. What gives? We suspect it may include some corporate SG&A and management salaries (we would love to hear your ideas?). But if that's the case, it also means a strategic buyer will be willing to pay more than $29.8 MM to acquire this portfolio, since they won't have to incur these expenses (or incur as much expense). Let say a strategic buyer can manage all 69 properties by spending $500 K instead of $1.3 MM. That means they can reasonably pay $3.5 MM / .09 or $38.9 MM or over $20 / share!

Anyway you look at it, BEK.B remains extremely cheap at these levels. On a purely book value basis, it is trading at 70% of intrinsic value with a 5% yield. If you believe in our analysis of a strategic buyer being able to offer more than book value for the portfolio, it is trading at a 50% discount to intrinsic value. Definitely a strong buy in our opinion (Disclosure, we own shares of BEK.B).

- The Aspiring Analyst

Pipes and Theories: Keynes v. Hayek Rap Battle, Part II

2011-05-29T08:51:00.001-04:00

Pipes and Theories: Keynes v. Hayek Rap Battle, Part II

A great visual demonstration of what is wrong with our centrally-planned economies. The facts speak for themselves, we do not need the fed bailing out the losers...let the losers lose and set the markets free!

Sell In May And Go Away

2011-05-08T19:31:00.000-04:00

We continue to hold approximately 40% of our portfolio in cash, as we feel there are too many near-term risks to justify going all-in, especially in an environment where we do not see great investing opportunities. More details can be found in the May edition of our newsletter.

The Aspiring Analyst

US deficits, debt, and unfunded liabilities

2011-04-20T19:36:00.001-04:00

It was widely feared a few weeks ago that the U.S. government would be forced to shutdown over an impasse on the federal budget as Demograts and Republicans stood miles apart in their negotiations. Luckily for the whole world, President Obama and the Republicans were able to compromise on a deal at the 11th hour that would see $38 BB cut from federal spending for the rest of this fiscal year. Politicians immediately began taking credit for the deal and the President claimed that America was "beginning to live within its means".

Putting aside the fact that the Congressional Budget Office estimates that the bill will only cut $350 MM in the 2011 deficit instead of $38 BB, we would like to take a step back and ask how significant these cuts would be in the grand scheme of things?

$38 BB is 2.6% of the CBO forecasted deficit of $1,480 BB for fiscal 2011.
$38 BB is 0.55% of the cumulative CBO forecasted deficit for fiscal 2012 to 2021 of $6,971 BB
$38 BB is 0.27% of the $14.3 T in U.S. public debt outstanding (which incidentally, is already above the $14.3 T debt ceiling that will be the topic of debate for the coming weeks)
$38 BB is 0.038% of the U.S. government's $100 T in unfunded liabilities, as estimated by Dallas Fed President, Richard Fisher back in 2008

Seriously? American politicians are fighting tooth and nail over $38 BB in federal spending? Even Obama's much heralded $4 T in deficit reductions in 12 years is barely a drop in the bucket!

We see 3 scenarios out of this mess:

The U.S. government will have to raise taxes significantly (90% top marginal tax rate, anyone?)
The U.S. government will have to renege on its promises (Come on, the unfunded liability is 7 times the U.S.'s GDP! How can the government possibly ever satisfy these obligations?)
The U.S. will have to inflate away the obligations (note that some obligations are inflation adjusted)

None of the scenarios are pleasant. We would like to know if anyone has thoughts on possible alternatives out of the mess.

The Aspiring Analyst

64 Million And Counting...

2011-04-05T22:37:00.000-04:00

Dear Readers,

Our April newletter is now available for download. Comments are welcome.

Cheers,

The Aspiring Analyst

Road To Nowhere?

2011-03-22T19:19:00.001-04:00

Normally, we do not comment on politics and government policies. However, there was a proposal in the 2011 Canadian Budget that irritated us to no end. Labeled as "Completing Canada's Highway Coast To Coast To Coast", the Federal government plans to contribute C$150 MM over 5 years from the 2012-13 fiscal year towards building a highway between Inuvik and Tuktoyaktuk.
We must apologize in advance to the 870 inhabitants of Tuktoyaktuk - we do not mean to be disrespectful or rude. But in an era of austerity, when governments the world over are looking for ways to trim budgets and find savings, earmarking C$150 MM towards a road to almost nowhere is not the right answer. The federal deficit is projected to be over C$40 BB in the 2012-11 fiscal year, for crying out loud!

Canada is not the U.S. in terms of fiscal largess. But that is not saying a whole lot. In trying to emulate our southern neighbour, we should try to copy the good parts (the proposed dismantling of Freddie Mac and Fannie Mae) and not the bad parts (Bridge To Nowhere).

- Your Disappointed Analyst

Asset Value: Getting Paid To Wait With Becker Milk Co (BEK.B-TSX)

2011-03-08T20:54:00.000-05:00

On the surface, The Becker Milk Company (BEK.B-TSX; We are long the Class B non-voting shares) does not seem like a very interesting company. Just today (March 8, 2011), the company announced 9 month revenues of $3.0 MM and earnings of $0.58 per share. This financial result annualizes to $4.0 MM in revenues and $0.77 in earnings. Trading at a bit less than $11.00, the shares are trading at approximately 14x annualized earnings. So where is the value?

To figure out the value of Becker Milk Co., we need to take a trip down memory lane. The Becker Milk Co. was founded in 1957 by Dr. Geoffrey Pottow (President & CEO) and operated a chain of convenience stores with its own dairy production facilities until 1996, when the operating business was sold to Silcorp. Silcorp itself was acquired by Alimentation Couche-Tard (ATD.B-TSX) in 1999. Since 1996, the Company has downsized most of its operating staff (BEK only has 5 full and part-time employees in 2010) and the Company effectively operates as a real estate investment company with a portfolio of 69 retail commercial properties. One property is in Toronto while the rest are dispersed in Southern Ontario. Mac's (a subsidiary of Alimentation Couche-Tard) is BEK's largest lessee, with approximately 80% of BEK's rental income coming from Mac's. The Company also has 4 parcels of undeveloped land and 2 unoccupied buildings.

What attracted us to BEK was this legacy real estate. For a portfolio of retail commercial real estate that generates $4 MM in annual rental income, the book value of the portfolio is carried at just $12.7 MM. Imagine that! The reason this real estate has such a low book value (and the reason BEK has become an orphaned company with little investor following, in our opinion), is because this portfolio of real estate was acquired over the decades at significantly lower valuations than current market value. To put the value of this real estate in perspective, applying a market cap rate (used to value commercial real estate) of 8 - 10% on this portfolio implies that the real estate is worth between $40 - $50 MM or $22 - $28 per share!Moreover, the Company itself is debt-free and has $2 MM in cash. Altogether, we estimate the Company has an intrinsic value of $24 to $30 per share.

The analysis above sounds great, but what's the catch? The catch is that insiders (Dr. Pottow and his associates) hold 540 thousand of the 640 thousand outstanding voting shares. An investor in the Class B non-voting shares participates in earnings and dividend but has no say on the future of the business. However, we believe one upcoming catalyst is the age of Dr. Pottow and his associates. Although Dr. Pottow's age is not disclosed in the Company's filings, we deduce he is well above 75 (Company was started 54 years ago after he received a PhD) and may be contemplating selling the business. In fact, the Company did put itself up for sale in 2008 by hiring TD Securities, but no deal was consummated due to the credit crisis. With the economy recovering and credit markets more stable, we believe it will not be long until BEK once again explore opportunities to sell its real estate portfolio and realizes the hidden value of its assets.

In the meantime, investors get a 5.5% dividend yield (semi-annual dividend of $0.30 that has been paid since 1999) and the possibility of sizeable special dividends every few years ($1.75 in 2004 and $2.30 in 2009). If we assume that a special dividend of $2.00 will be paid every 5 years, or an average of $0.40 per year, then the dividend yield on BEK is closer to 9%. Essentially, investors are paid to wait for the eventual realization of full value of BEK's real estate portfolio (unless Dr. Pottow pulls a Frank Stronach and demands a significant premium for his voting shares - a real possibility!). We therefore believe BEK.B should definitely be on the radar screen of any value investor.

-The Aspiring Analyst

Now Is Not The Time To Buy The Indices

2011-03-06T13:48:00.000-05:00

Dear Readers,

Our March newsletter has been uploaded.

Cheers,

The Aspiring Analyst

February Newsletter

2011-02-06T11:46:00.000-05:00

Dear Readers,

Our February Newsletter has been uploaded.

Cheers,

The Aspiring Analyst

Japan offers to buy Euro debt

2011-01-11T06:37:00.000-05:00

Japan offers to buy euro debt with it's euro reserves, is this akin to the blind leading the blind?

2010 Review And 2011 Outlook

2011-01-09T17:19:00.000-05:00

We have finally completed our inaugural letter!

Please download it here The Aspiring Analyst.

Free resources that you might find useful...

2011-01-07T23:33:00.000-05:00

Here is a list of free resources that I regularly read and follow:

www.frontlinethoughts.com - John Mauldin's newsletter is a great read for U.S. and global macro analysis.

www.gluskinsheff.com - Sign up for David Rosenberg's free daily letter. A great interpreter of economic data.

www.pimco.com - Bill Gross's monthly Investment Outlook is a must read.

www.calculatedriskblog.com - Bill McBride is a full-time blogger on finance and economic data, mostly on the U.S.

- The Aspiring Analyst

Disclaimer

2011-01-04T20:09:00.000-05:00

Our goal through this blog is to provide analysis and ideas that you, the reader, might find useful in forming your own independent investment decisions and hopefully improve our analytical skills in the process. We are not soliciting for the management of your investments nor seeking to provide financial advice. The Aspiring Analyst blog and letters will not take responsibility for any investment losses incurred by readers through the trading of securities and strategies mentioned in this blog or its accompanying letters. The views expressed in this blog and its accompanying letters reflect the author(s) personal views about the subject company(ies) and its (their) securities. The author(s) certify that they have not been, and will not be receiving direct or indirect compensation in exchange for expressing the specific recommendation(s). Readers are cautioned to seek financial advice from qualified persons such as a Certified Financial Planner prior to taking any action in regards to the securities and strategies mentioned in this blog or its accompanying letters.