#20 New position- COW

First chart: COW, which is an ETF reflecting the price of live cattle (65%) and lean hogs (35%).
Second chart: Live cattle prices
Third chart: Lean hogs prices







It is getting hard to find good investment ideas. The stock market is up substantially from its March lows and valuations have rebounded significantly. This leads me to (1)not want to chase stocks higher and (2)try to be diligent about finding ideas that haven't experienced the March to May rebound.

One thing I have noticed is that the price of beef has come way down. At the end of 08 (when I first started cooking at home), filet mignon at Costco was $10.99/lb. A few months later it fell to $9.99/lb and most recently it's been at $8.99/lb. I have also noticed that at our neighborhood Whole Foods, beef is often on sale, with NY strip steak most recently around $7.99/lb (a good price in NYC at a Whole Foods!). These observations led me to take a look again at COW - a livestock ETF. The COW tracks the price of live cattle (65%) and lean hogs (35%).

Here is an interesting article on falling beef prices.

It seems to me that there has been an overall decline in beef demand due to the economy, but also a glut of beef slaughters leading to higher supply. This has obviously led to a big decline in the index. One can argue that as the economy stabilizes, we should see a stabilization and improvement in demand (and hence prices). We would add that buying the COW is also a derivative play on livestock feed, primarily soybean and corn. This is the primary reason for our position.

Below are some recent charts on soybean and corn futures. There is presently a shortfall of soybeans from Argentina (which accounts for 20% of global production) and a delay in Midwest corn plantings due to rain. Our thesis is for both livestock demand to improve and for supply to shrink (based on higher recent slaughters and higher input costs). We have built a roughly 6.5% position in COW at $30.

#19 Sold USBp

Sold the USB puts. Got lucky that the co decided to raise capital ($2.5b common stock offering at $18 announced last night/this am). Stock trading at $17.50 now so our 19 strike puts are in the money ($1.50 itm which is the premium we paid). We sold them at $1.70 figuring we were wrong on our stress test thesis and lucky to escape this having actually made money on those puts.

Overall, the market feels range bound now. Stocks are sharply off their lows and banks have gone thru the stress test. Bears like to talk about commercial real estate which is a 100% legitimate concern, but it isn't like that is anything new. CRE should have been a concern in January (before CNBC started talking about it). There may still be markdowns left, but between the stress test and various government programs to support real-estate backed loans, I think we can reasonably hope that CRE won't fall as much as residential. I think the market has priced in a lot of these concerns. Still, you won't see us going long any banks. Hardest part is finding reasonably priced stocks. The S&P 500 at 900-ish levels imply a 15-16x p/e multiple for the market, a level that we don't find particularly cheap. We're going to hang onto names like MSFT (12x p/e, 6x ev/ebitda) and look for names that are either cheap (not that many) or offer a better GARP-like (growth at reasonable price) valuation.

#18 Dead wrong

Dead wrong on USB (no capital required) and STI (needs capital equivalent to 1/3 of their mkt cap). Good thing I am not a banks analyst. At least it was a small position. On the bright side, COT has saved us so far this month and UNH, ETR and TBT were strong performers today. YTD up 29.7% net of fees, due mostly to COT (up 200% this month).

#17 New Position: USBp

Bank stress test results are supposed to be released on Thursday. As an exercise, I went through 10k's and sellside reports to compile data to do my own stress test. My numbers came out pretty clear in favor of Suntrust (STI) and against PNC and USB. This is the exact opposite of consensus opinions that favor USB and PNC and hate STI (bc of the Southeast (FL) exposure). To have some skin in the game, I did want to be long the name I like and short the other two. However i am cognizant that these names can rip hard and fast in either direction so I thought it would be more prudent to minimize downside by buying options. With stocks up today, the calls are more expensive so I have delayed in buying STIc and just took a 1% position in USB puts with May expiry.

#16 Sold BRK/B

Sold our BRK/B position at $3089. We bought it in the first week of March and earned a 27% return in 2 months. It stinks we have to pay short term gains on the sale, but I have been burned too many times in the past by not selling bc I didn't want to pay Uncle Sam. Berkshire held its annual meeting over the weekend and overall the tone, based on my read of news articles, was cautiously optimistic. The utility and insurance businesses will do fine (but not great) and everything else will be impacted by the economy. When we first bought the shares in March, we noted they were trading at around 1x book value. Now the shares trade closer to 1.4x book value if you consider the price appreciation since March AND Buffett's comments about BV having declined 6% in 1q09. During the 2005-2008 timeframe, BRK traded at an almost 2x P/B value--a reflection of the premium placed on Buffet's expertise. Going forward, sure the stock could go from 1.4x to 2x book value, but we prefer not to hope on multiple expansion to make us money, at least not to 2x when most insurance companies trade below 2x book. Plus, the book/earnings don't appear to be accelerating (again per press reports on Buffett's comments this past weekend). So we are happy to take our gain here and look for other opportunities.

#15 Followup on TBT

This is why we are short 20+ year treasuries: TBT

#14 Position breakdown: April

I also included March for a comparison.

#13 April month-end results

April was a very good month for us, up almost 11%. Even better we managed to outpace the S&P's 8.3% monthly gain despite the fact that we were 30% cash at the beginning of the month. To give a recap of the year, our outperformance is mainly due to being underinvested in Jan/Feb and then having been fortunate enough to start buying in earnest during the March lows. Most of our picks (save RX) have worked, and they have worked very well. Unfortunately stock levels have rallied so much that it feels as if the easy money has been made. It may be that absurdly cheap (trading below asset value) opportunities like COT are no longer widely available so we are now looking at opportunities like MSFT or ETR where the market is either underestimating the earnings or the deserved multiple. I think this marks a shift from value based style to GARP (growth at reasonable price). Stay tuned.

#12 New position: TTWOc

On 4/30 we took a small (1%) position in Take-Two Interactive through Sep 15 calls (15 is the strike price). We paid $0.23 for each call, which is the right, but not the obligation to buy TTWO shares at $15 on the third Friday in September. TTWO is trading at around $9. First off, these calls are way out of the money. For us to make money, TTWO would have to rise to over $15.23 in September! That is a low probability event and explains why we were able to by a 4 month option for just $0.23.

However our thesis is that TTWO could be a takeover target. Last year, Electronic Arts bid $25 for the company and was rebuffed. We think it still makes sense for EA, or Activision (who has mentioned it is interested in acquisitions) or a large media company to make a bid again. A deal signed in September could close by February 2010, far ahead enough of the holiday 2010 season when TTWO's next iteration of Grand Theft Auto is scheduled to be released.

So this begs the question: why would anyone in their right mind pay $15+ (we think a deal could be had at $20) for a company trading at $9? Our answer is this: TTWO has a bloated SG&A and distribution system. A takeover by a larger player would allow the purchaser to eliminate (we think) at least 50% of TTWO's SG&A, which would be worth over $1 in TTWO eps. This means that if you put a 10x multiple on the post-tax synergies, you are getting a $10 value! This would also enable the deal to be accretive to the buyer's EPS. By the way both EA and Activision have large cash positions which make littl ein the way of interest income. Plus both stocks trade at 16x multiples (above TTWO's FY10 p/e of 10x)....all this leads me to think that a takeover of TTWO would be accretive to the buyer and thus a logical deal.

This is a small, 1% position because it is a lotto ticket. Our risk is that we lose our $0.23 premium. However our upside on a $20 deal would be $20-15-0.23 = $4.77. This is a 20:1 win/lose ratio for a scenario i think is possible.

#11 New position: ETR

We took an 8% position (4/27) in Entergy, a utility in the South (Louisiana, Texas, Arkansas) with a large Northeast nuclear plant presence. Our entry point was $64.27. ETR trades at an in-line valuation with the utility group but our purchase is based on belief that over time, the company's nuke portfolio will be worth more as the Obama administration and Congress become more focused on a carbon tax (nukes produce no CO2 emissions). Some sellside analysts peg the value of ETR's no-carbon nuke portfolio to be as high as $15/sh. We do not think this value will be immediately realized, but we have a long term view that over time this value will be recognized as policy is formed and timetables set. The second core reason for our purchase of ETR is that it is a long play on natural gas. Here is my attempt to explain why:

Power (electricity) comes from many sources, including coal, renewables, nukes and gas plants. The cheapest plants to run are nuclear and renewables (though they are mosre costly to build in the first place). The next cheapest are coal plants (US has lots of coal, but unfortunately it emits lots of CO2). Finally there are gas plants which are the most expensive to run, and their costs to run are driven by the price of the fuel they use, natural gas.

The curve below represents the electricity production curve. A few things to note: (1)the first power used is from renewables/nukes. That makes sense because you obviously want to use your cheapest sources first. As your demand for power increases, the utility company is forced to bring into operation the higher cost plants (coal and then nat gas). In most markets, the demand for electricity is high enough to require the operation of nat gas plants. In the case of the nat gas plant, the price of the marginal (or last) GW produced is the price charged for each GW produced regardless of source. If one follows the chart below along nat gas Curve 2, one can see that the profit at a nuke plant is the area represented by A. Additionally, when prices of nat gas are high (Curve 1)one can observe that the profit of the nuke plant is even larger (rectangles A+B).



The nat gas portion of our thesis is predicated on the gas curve (which looks like Curve 2) eventually looking like Curve 1. Presently the price of nat gas is roughly $3.50/Mcfe vs historical levels of closer to $6-8. If the gas prices do move higher, it will make all of ETR's nukes more profitable and worth more.

By the way, the reason for the low nat gas prices are: (1)low industrial demand in the US for electricity bc of the recession, (2) higher liquefied nat gas imports from abroad bc nat gas exporting nations are sending less to Japan and Korea (who are experiencing their own recessions), and (3)too much domestic production of nat gas. Eventually prices should climb again as US production is cut (we are already seeing drilling rigs down to 750 from 1200 a year ago) and industrial demand picks up.

#10 COT 1q earnings review

Going to make a quick comment after a 2min review of the COT earnings release:

Cott reported earnings this morning, reporting EPS of $0.23 and soundly beating consensus estimates of a loss of $0.05. The conference call is 90min away (and we'll probably have to read a transcript later), but the news looks very good so far. We had hoped that Cott might be profitable at a pace of just $0.10 per quarter and they more than doubled that. So what happened? In short, North American volumes were way up (thank you recession for giving us more private label soda drinkers), which in turn drove 13.5% gross margins (whereas we are at 9.5% for the year). SG&A was higher than we would have expected since, according to our notes, the guidance was for $65m in annual SG&A and this quarter SG&A was $35m (you can see our prior post on COT to get an idea of the model we had). Nonetheless, the beat on volumes and GMs more than offset higher SG&A. Again, we don't have the benefit of the conf call comments, but on paper, this was a very good quarter. As we've mentioned before, the best quarters of the year are over the summer months, whereas the calendar 1q is typically a slower quarter. We hope management will be cautiously optimistic in telling us things can get even better.

How good can things get is something we can only speculate on at this point. Most if not all sellside analyst reports I had seen expected a loss for the year. Based on today's earnings and the historical seasonal pattern of earnings, a $0.75 annual EPS number may not be crazy. This would depend however on no cola price war breaking out over the summer. If we haircut this to $0.50 (to be conservative), COT even at $2.50 (we expect it to trade up today), would be trading at a 5x p/e. This compares to 10x-12x for bottlers like CCE, PBG etc. Thus, I think this stock could be a double from here even on conservative numbers (if you give a 10x multiple on $0.50 in earnings), and on an optimistic scenario the stock could get to $8 (8x multiple on a potential of $1.00 in eps). So we have a long ways to go upside wise I hope. So far we have made 4x on our initial investment (where we bought the shares at $0.60 in early March)--not so bad!

PS: BTW, you might think we are crzy to think COT can get to $8 from $0.60 where we bought it...but just for a frame of reference, the stock has traded over $30 pre-05 and the average price in 2005-2007 was around $15. Not saying it gets back up there, but relatively speaking $8 may not be so crazy.

PPS: We are definitely, 100% going to sell before it even gets close to $8. This is a value/misunderstood story play, not a get greedy on eps and p/e multiple expansion play.