Category: Articles

Oil and Dow Chemical’s Q3:: Updated

Post author By ToddSullivan
Post date September 3, 2008

Now that august is in the books, let’s look at where we are and update an earlier post.

Prior Post

In the call the following exchange was had:
Jeffrey Zekauskas – JPMorgan
“Good morning. On average shouldn’t your raw material costs be down sequentially in the third quarter? Natural gas has gone from — I don’t know — $12 to $9 and oil has come from $135 to $125?”

Geoffery E. Merszei – Executive Vice President and Chief Financial Officer; Member of the Board of Directors
“Yeah Jeff, this is Geoffrey here. Just to take oil, Brent crude average price as of this morning, let’s say, $124, $125. At today’s level it is still higher than our average cost during the first quarter. The average cost in the first quarter was around $122. I’m using crude as a reference point. And we are already towards the end of the first month of one-third of the quarter. So if you use an average rate for the third quarter of let’s say around $125, $126 then you are talking about over $0.5 billion additional cost for the company to absorb.”

It would look like that based on current demand for its products every $3 plus or minus in its cost of oil results in about a $500 million cost increase or decrease.

Dow’s Q2 average was $122 and change and oil now sits at $117. What is also of interest is the price increases announced earlier this summer were only about 40% implemented during Q2. By the time Q3 is finished, they ought to be fully implemented which means revenues ought to post another record quarter assuming no dramatic demand destruction (unlikely).

What does it all mean? Should oil prices remain lower than $122 for the quarter and with the price increases now fully implemented, the 66 cents a share earnings that analysts anticipate are beginning to look as though it is far too low.

Where are we at? July crude averaged $134 and August finished at $115. September has started off at $108.

We are essentially flat vs Q2 for the cost of oil (USO) for Dow (DOW) $122 vs $124. The difference will be the price increases that will be fully implemented in this quarter (they were only 1/3 implemented during Q2). Should prices remain where they are for the month ($108), Dow will finish the quarter at about $119 a barrel of cost, adding $500 million to the bottom line for shareholders, price increases not withstanding.

Of course one should also assume Dow may be entering into more contracts at lower prices now and that this will reduce the average purchase below just a simple daily average reading in the example above.

This is a fun exercise but when you look at it, as the year goes by it becomes far less necessary. Dow has essentially traded 50% interest in its oil dependent commodity business to Kuwait for Rohm and Hass (ROH) in its entirety and picked up Berkshire Hathaway’s (BRK.A) Warren Buffett as an investor to boot. Not a bad deal when you look at it that way.

It is still only 2/3 of the way through the quarter but I am thinking there are going to be a whole lot of shareholders very happy with the earnings surprise Dow turns in after Q3 is over…

Disclosure (“none” means no position):Long Dow, none
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ESL Files 13D/A in Sears Holdings

Post author By ToddSullivan
Post date September 3, 2008
4 Comments on ESL Files 13D/A in Sears Holdings

Eddie Lampert’s ESL Investments just filed a 13D/A with the SEC in regards to Sears Holdings (SHLD)

“This Amendment No. 12 to Schedule 13D (this “Amendment”) relates to shares of common stock, par value $0.01 per share (“Holdings Common Stock”), of Sears Holdings Corporation (“Holdings”). This Amendment No. 12 supplementally amends the Statement on Schedule 13D, as amended, filed by the Reporting Persons (as defined below) by furnishing the information set forth below. Unless set forth below, all previous Items are unchanged. Capitalized terms used herein which are not defined herein have the meanings given to them in the Schedule 13D, as amended, previously filed with the Securities and Exchange Commission.

Based on the most recently disclosed number of outstanding shares of Holdings Common Stock, the Reporting Persons are filing this Amendment to report an increase in their respective current beneficial ownership percentages of Holdings Common Stock, which for certain of the Reporting Persons is 51.9%, resulting from a decrease in the number of outstanding shares of Holdings Common Stock. “

FULL FILING

Disclosure (“none” means no position):Long SHLD
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Wednesday’s Links

Blackmail, Thain, Snow, iPhone

– “They made me do it”? classic

– This makes one

– Once summer is over, let it snow

– A real blow for its business use

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Time to Get Back In Oil?

Post author By ToddSullivan
Post date September 2, 2008

With the current price roughly 25% of its high, it is time to put oil back on the radar screen.

Watch what Boone Pickens has to say.

I sold my USO position in May for $106.85, a 140% gain in 16 months (purchased for $44 in Jan. 2007). It now sots at $89, 16% below the sale price.

Buy now? No.

The global economy by almost every measure is slowing. Will it be a “global recession”? No. The pace of expansion will just slow. That will relieve some demand stress on the whole equation. The US economy, the main consumer of oil looks as though it will muddle through 2009.

With that being said, the supply / demand equation for oil, tilted to the demand side for the last year, ought to begin to stabilize. As it does, interest in the commodity will wane as easy profits will diminish. As it does, the price of oil (barring any significant geopolitical event) will slide with it.

How far? Under $100 or another 7% to 10% lower. Long term, the demand for oil will rise, significantly. Any temporary demand reduction from China or India is just that, temporary. The US will wake from its current snooze and demand at home will grow along with it.

What could offset this? A cellulose ethanol breakthrough that could quadruple US ethanol production almost overnight and displace 900 million barrel of oil demand for gasoline. That essentially equates to 90 days of oil imports becoming unnecessary.

Natural gas. Should actually go it it (it is right off our coasts) we could use it to power vehicles. It would be cheaper than oil, reduce exports and be cleaner.

Here is the thing. either of those two events are at least a year off in the case of ethanol and probably almost a decade for natural gas. That means China, India and a resurgent US demand rule the equation until then. That means higher prices..

It may take a while and you may have to weather a hurricane or two that will pump a temporary rise in prices but I think if you are patient, you will be able to pickup the USO and the price equivalent of crude under $100.

Disclosure (“none” means no position):None
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Now, Some Borders Math

Post author By ToddSullivan
Post date September 2, 2008

I was emailed a research note on Borders (BGP) by a reader and based on that, we can take closer look at FY 2009

Deutsche Bank – Equity Research

Borders Group {Ticker: BGP.N, Closing Price: 6.55, Target Price: 6.00, Recommendation: Hold}

*Key thoughts

Overall, this week’s BGP results were mixed, but more positive than negative, in our view. Primarily, we can’t overlook the positive P&L impact of continued cost cutting, especially if mgmt.’s confidence of hitting $120M over the next two years is realized. That said, top-line weakness and concerns on its timing and degree of recovery were highlighted by the 2Q reporting season, as BGP’s results and BKS’ 2H
plan disappointed, we believe.

At this point, our biggest concerns on BGP are (1) if/when will brick & mortar sales meaningfully improve, (2) the ongoing competitive threats from the internet and print digitization, and the effects on superstore sales/margins, (3) can substantial cost cutting be delivered, and without ‘hitting bone’ (hurting sales)? (4) BGP
announced its ‘strategic alternatives process’ on 3/20/08, but to date Paperchase (and the company) has not been sold. Notably, if Paperchase is ‘put’ to Pershing (among other reasons), expect a more modest selling price and potentially, further share dilution.

Cost cutting and liquidity were the big positives in 2Q, we believe.

*Few changes to our model

We’ve tweaked our FY08/FY09 models, but we haven’t yet run the full $120M in cost cuts through the P&L (we’re at roughly half that). For FY08, we are now at -$0.14 from -$0.13, with FY09 at +$0.06 from
$0.03.

The bold section is the one that is important. On the Earnings call, Borders was not only adamant they would hit the $120 million in savings, but said they expected to beat that. Now, with 60 million shares outstanding, and only $60 million in savings baked into the above estimates the simple math tells us the is another $1 a share (or more) in potential earnings that are not being accounted for.

If they hit the extra savings and get $1.03 a share in earnings in FY 2009 and the stock trades at a comparable premium to Barnes & Noble (BKS) of 12 times earnings, then we are looking at $12.36 a share for a price target.

Perhaps this is the reason the stock has raced past their $6 target?

Disclosure (“none” means no position):Long BGP, none
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Book Review: "Black Swan"

Nassim Nicholas Taleb, if you read his book “The Black Swan” ought to change the filter you look at life through.

I do recommend reading Taleb’s prior effort, “Fooled By Randomness”. You can purchase it below. I think reading it first is helpful, though not necessary.

Now, onto “Black Swan”:

Taleb argues that “Black Swans”, or drastic events (to simplify it) are both unavoidable and unpredictable in life. Whether they be an assassination, accident, weather event, geopolitical event, terrorist etc., the world we live in cannot be predicted with any accuracy, save for the fact these events will happen. Again, the “when” is unpredictable.

There will be those who predict these events, but Taleb compares these to the broken clock is that is still right twice a day. There is always someone who predicts an event, it is just never the same someone.

What Taleb does is change the filter you see information through. For instance, value investors see a stock drop and think, “hmmm, let’s look closer”, growth investors see the same price action and think “run away”. Same situation, different filters (I know the above comparison is overly simplistic but I hope the basic point is made).

Taleb will change the filter of “risk” you have AND, more importantly, alter the way you look at those who predict macro events. The argument can be made, successfully, I might add, that predicting GDP or the Fed. Budget more than 6 months out is an effort in futility. Taleb argues that investing and relying on these predictions is a recipe for disaster.

For instance, a nuclear reactor melting down in Iran, shutting its oil fields would be a “Black Swan event that would throw every economic prediction made in the last two year out the window, not only for the US, but the world. Taleb says that events like that, on various scales happen all the time and make long range predictions is useless.

This was one of those books you look back on after reading and just say…..”wow”.

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Value Investor’s Rejoice: "It is Dead"

Post author By ToddSullivan
Post date September 2, 2008

A recent article said, “More than a few cynics have proclaimed value investing to be dead. Its plight hasn’t been this dire since the height of the technology bubble.” That bubble also lead to a near decade of outsized return for value investors.

Remember that tech bubble? It was the one before the recent housing bubble? Remember? Berkshire’s (BRK.a) Warren Buffett was mocked and called “out of touch”?

Yahoo (YHOO) traded at 144 times earnings? There were scores of $100 stocks that actually had NO earnings. Good times…..until it all came crashing down.

What survived? Yup, “Out of touch” Warren’s stock went on to almost triple over the next 7 years (“b” share climbed from $1790 to $4900 a share).

Meanwhile, shares of Microsoft (MSFT), Yahoo, Dell (DELL) fell and have never regained anything near their prior levels. There are countless other ones but most of those businesses no longer exist.

Value investing seems to be at its most valuable right when people proclaim its “death”. It is ironic because that is often when we start getting interested in the stock of a company, when the masses hate it.

In Seth Klarman’s “Margin of Safety“, he says “Security prices sometimes fluctuate, not based on any apparent changes in reality, but on changes in investor perception.”

He concludes his first chapter with this:

“The financial markets offer many temptations to vulnerable investors. It is easy to do the wrong thing, to speculate rather than invest. Emotion lies dangerously close to the surface for most investors and can be particularly intense when market prices move dramatically in either direction. It is crucial that investors understand the difference between speculating and investing and learn to take advantage of the opportunities presented
by Mr. Market.”

When people begin to speculate about the demise of histories most successful investing strategy, emotions are running the days an great opportunities will arise.

Disclosure (“none” means no position):none
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Tuesday’s Links

Post author By ToddSullivan
Post date September 2, 2008

Gustav, Palin, Geothermal, Dykstra

– Maybe the most hyped weather event this century?

– They are just like us

– This is very interesting

– If you still listen to Lenny after reading Adam, you are beyond helping..

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ADM 10-K Notables

Post author By ToddSullivan
Post date September 1, 2008

Some notables from the recent 10-K filed by Archer Daniels Midland (ADM)

Cap Ex for Expansion:

During the past five years, the Company has experienced significant growth, spending approximately $5.3 billion for construction of new plants, maintenance and expansions of existing plants, and the acquisitions of plants and transportation equipment. The Company is constructing two dry corn milling plants which will increase the Company’s annual ethanol production capacity by 550 million gallons to 1.7 billion gallons. In addition, the Company is currently constructing a polyhydroxy alkanoate (PHA) natural plastics production facility, a propylene/ethylene glycol production facility, two cocoa processing facilities, and two coal cogeneration facilities. Construction of these plants is expected to be completed during the next two fiscal years. The Company expects to spend approximately $2.5 billion to complete construction of these facilities and other approved capital projects over the next five years. There have been no significant dispositions during the last five years.

Sales by Product:

Soybeans= 16%
Corn = 14%
Soybean Meal = 11%
Wheat = 10%

Hedges

The Company uses futures and options to fix the sales price of anticipated volumes of these ethanol sales in future months. These derivatives are designated as cash flow hedges. The changes in the market value of such derivative contracts have historically been, and are expected to continue to be, highly effective at offsetting changes in price movements of the hedged item. The amounts representing the ineffectiveness of these cash flow hedges are immaterial. Gains and losses arising from open and closed hedging transactions are deferred in other comprehensive income, net of applicable income taxes, and recognized as a component of cost of products sold in the statement of earnings when the hedged item is recognized. As of June 30, 2008, the Company has recorded $81 million of after-tax gains in accumulated other comprehensive income related to gains and losses from cash flow hedge transactions. The Company expects to recognize these after-tax gains in the statement of earnings principally during fiscal year 2009.

Status of New Products

The Company continues to expand its business through the development of new products to meet the growing demands for food, animal feed, chemicals and energy.

The Company’s researchers continue to develop custom low-trans fats and oils for bakery and quick-service restaurants that utilize the Company’s Novalipid portfolio of low-trans fats and oils. These products have enabled customers to comply with various municipal trans fat bans.

The Company’s cooked, dried edible bean products are finding a number of new applications due to the increased interest among our customers in improving nutrition, especially in the area of foods designed for children.

The Company’s alliance with Metabolix for production of PHA, a biodegradable plastic, is proceeding. Semi-works production of PHA is being used for market development by Telles, a joint-venture company between the Company and Metabolix. The construction of the Company’s 50,000 metric ton per year commercial manufacturing facility is scheduled for completion in fiscal 2009.

The Company is proceeding with construction of a 100,000 metric ton per year commercial propylene/ethylene glycol facility. These products are principally used in industrial applications such as antifreeze and coolants, the manufacture of certain plastics, and paints and coatings.

The Company has entered into a joint development agreement with ConocoPhillips (COP) that will develop renewable transportation fuels from agriculture, forestry, and crops grown specifically for energy. This development effort is focused on the production of bio-crude oil that can be used by conventional petroleum refineries to produce transportation fuels.

FULL FILING

Disclosure (“none” means no position):
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Monday’s Links

Post author By ToddSullivan
Post date September 1, 2008

iPhone, Scams, Cullen, Fuld

– So many problems

– Do not invest in any mail solicitations until you check them here

– James Cullen ponders what Warren bought

– Should have been “over” months ago

Disclosure (“none” means no position):
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Saturday Viewing

This didn’t take long………

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Credit Conversation (video)

Post author By ToddSullivan
Post date August 29, 2008
1 Comment on Credit Conversation (video)

Watch this video, there is a great conversation between Don Luskin and Kudlow about credit.

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Phillip Morris International Ups Dividend 17%

Post author By ToddSullivan
Post date August 29, 2008

The current yield at the new level is 4%

The Board of Directors of Philip Morris International Inc. (PM) today increased the company’s regular quarterly dividend by 17.4%, to an annualized rate of $2.16 per common share.

The new quarterly dividend of $0.54 per common share, up from $0.46 per common share, is payable on October 10, 2008, to stockholders of record as of September 15, 2008. The ex-dividend date is September 11, 2008.

This is a rock solid yield on a company growing earnings in the mid-teens. As close to a no-brainer as you can get..

Disclosure (“none” means no position):Long PM
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SHLD…Updated "Short" Math

Some updated Short Math…

Holder Name—Shares—%

ESL Investments, Inc.—65,639,184—51.0%
Fairholme Capital Management LLC—16,110,090—12.5%
Legg Mason Capital Management, Inc.—12,503,168—9.7%
Pershing Square Capital Management—6,746,568—5.2%
ClearBridge Advisors—4,789,523—3.7%
Perry Capital—2,694,95—22.1%
Davis Advisors—2,020,96—11.6%
Dalal Street, Inc.—517,608—0.4%
T2 Partners Management LP—50,625—0.0%
Greenlight Capital, Inc.—11,240—0.0%

Total held by above—111,083,919—86.2%

Total Outstanding—128,800,000

Short Interest—33,656,888—26.1%
Share Not held by Above Holders—17,716,081—13.8%

Here is why I added some shareholders to the list.

ClearBridge Advisors is actually owned by Legg Mason and considering Bill Miller’s influence at the entire firm I wouldn’t think it is crazy for the ClearBridge PMs and analysts to be communicating with or with directly with Bill Miller and his team.

Perry Capital is a no brainer to be added to the list as Rchard Perry is actually on the Board of Directors at SHLD. One other interesting tidbit is that Richard Perry worked on the Arb desk at Goldman during the Robert Rubin years (according to this months Fortune magazine). This is te same desk that Eddie Lampert worked on.

Dalal Street (Mohnish Pabrai), Davis Advisors, Greenlight (David Einhorn) and T2 (Whitney Tilson) are all well known for being value guys who will hold onto positions for extended periods as long as the position is trading sufficiently below intrinsic value. Einhorn, Tilson and Pabrai will all be presenting at the upcoming Value Investor Congress.

So over 86% of the shares outstanding are being held by long-term value investors which is really a great sign. The shares sold short is almost double the number of shares that we estimate are in the trading float…but the real question is does it really matter? If the long-term holders listed above hold their shares in a margin account, then those shares can be borrowed and shorted. So the answer to the question really is no. However if all these holders were to move their holdings to the cash account or requested their share not be lent out then that would create a situation where the maximum number of shares that could be borrowed at approximately 17.7mm.

Disclosure (“none” means no position): Long-SHLD
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Sears Holdings 10-Q Notables

Post author By ToddSullivan
Post date August 29, 2008

Some very interesting items in this mornings 10-Q from Sears Holdings (SHLD).

Short Term Borrowings:
Credit Agreement

“We have a $4.0 billion, five-year credit agreement (the “Credit Agreement”) in place as a funding source for general corporate purposes, which includes a $1.5 billion letter of credit sublimit. The Credit Agreement, which has an expiration date of March 2010, is a revolving credit facility under which Sears Roebuck Acceptance Corp. (“SRAC”) and Kmart Corporation are the borrowers. The Credit Agreement is guaranteed by Holdings and certain of our direct and indirect subsidiaries and is secured by a first lien on our domestic inventory, credit card accounts receivable and the proceeds thereof. Availability under the Credit Agreement is determined pursuant to a borrowing base formula, based on domestic inventory levels, subject to certain limitations. As of August 2, 2008, we had $800 million of borrowings and $1.0 billion of letters of credit outstanding under the Credit Agreement with $2.2 billion of availability remaining under the Credit Agreement. The $800 million in borrowings, borrowed in the first half of fiscal 2008, are classified within short-term borrowings on our condensed consolidated balance sheet as of August 2, 2008 as we intend to repay the entire amount within the next 12 months. The Credit Agreement does not contain provisions that would restrict borrowings or letter of credit issuances based on material adverse changes or credit ratings.”

Reorganization:
“In January 2008, we announced that we would implement a new organizational structure and operating model designed to simplify the way our business lines are managed. While we have begun the process of transforming the Company to this new model, it will take some time to build the processes and information systems necessary to support the structure. We continue to assess the impact our new organizational structure will have on the business segment information used by our management to operate Holdings on an on-going basis. “

Interest Expense
“We incurred $65 million in interest expense during the second quarter of fiscal 2008, as compared to $71 million in the second quarter of last year. The reduction was attributable to lower average borrowings outstanding during the quarter.”

“We incurred $131 million in interest expense during the first half of fiscal 2008, as compared to $144 million in the first half of last year. The reduction was attributable to lower average borrowings outstanding during the first half of the year in 2008.”

Investing Activities
“For the first half of fiscal 2008, we used $277 million of cash for capital expenditures as compared to $278 million used during the first half of fiscal 2007. In addition, we received $75 million of proceeds from sales of property and investments in the first half of fiscal 2008, which was mainly related to the sale of Sears Canada’s Calgary downtown full-line store. In the first half of fiscal 2007, $60 million of collateral was returned to us related to our investments in total return swaps. There were no total return swaps outstanding as of or during the period ended August 2, 2008.”

From May 4th to August 2nd, Lampert repurchased 5.6 million shares at an average price of $78.22. The stock, currently roughly $90 a share sits 15% above that level.

FULL FILING

What I find interesting in much of the commentary out there is that the general thought is that Lampert “is cutting spending and using debt to fund operations”. Yet, the reality is that capex is flat, debt down & share count down.”

It is odd that so much of the commentary revolving Sears is factually inaccurate. It is one thing to look at the numbers and come to different conclusions, it is another entirely to not bother looking at them before making those conclusion because it is the general consensus.

Disclosure (“none” means no position):Long SHLD
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