Friday, July 31, 2009

To be of not to be?

Conventional wisdom, as measured by a quick straw poll of the financial press, has the breakout of the USD on Friday due to increasing risk appetite - which translates into losses for the safe haven currency.

I'm getting a little concerned maybe I have been reading the tea-leaves all wrong. The resounding bounce in the CRB off the lows is making me nervous. The key reversal stands, but a breakout in commodities over the recent high seemingly negates this indicator.

So while sentiment data is pushing to levels that suggest capitulation buying - money piling in before it is too late (Traders Narrative has an even more recent summary sentiment indicators), there is nothing to say that this run couldn't just keep on keeping on.

We are counting swallows here. And while we have had a bird or two breaking from the pack, the flock has yet to take wing and follow. The liquidity that the Fed (and its central banking clan) have injected into the world's economy may be overwhelming the fundamentals.

One final question with all this - is the USD still a 'safe haven'? What I mean be this is - does the USD breaking down signal a further appetite for risk - or the opposite? Time will tell, and being the cautious type I'm going to wait for confirmation one way or another.

For the moment, I'm sticking with the short...but my conviction is waning.

Thursday, July 30, 2009

Another twist of the urn?

What is the digital age equivalent of 'another nail in the coffin'? Anyways we have one, with latest sentiment readings tipping into 'maybe just one more' territory. That leave's the 'roadie' and 'make mine a double' (slurred to the surprisingly good looking bar tender) to come.

The Pragmatic Capitalist has the latest AAII and State Street Confidence readings - both of which support the capitulation buying that we are witnessing. Bespoke has a less pessimistic take on the AAII survey results. Note too this confirms a trend noted in Mark Hulberts newsletter readings from a week ago.

Now with the XJO hitting my near side target for this rally (~4230 per the chart below), it's time to head for cash...

Doesn't mean the market can't push higher- 4400 is a stretch target from here - but my money is on at least a pullback in the near term.

In terms of individual positions on the blog, how does this translate? (For clarity, I have disclosed 'new' positions on this blog as I have put them on. My portfolio's were established before the blog got going - hence, I have not covered all my holdings. We will get there eventually.)

Happy to sit on a smaller balance in DUE and CEU for the moment. I'm nervous about QBE given its earnings exposure to USD and GBP - will probably lighten (need to do some analysis on this beast). I'm happy to add to NCM on dips to $29.50ish. As for WBC - it supports the case for another push higher - maybe $22.80?

Wednesday, July 29, 2009

Short XJO at the close

Just can't help myself. Like a lazy susan that lost its way, I'm back on that short XJO...

Trend reversal in CRB

Was busy doing my hair and almost missed it. CRB tipped over on Tuesday. Just goes to show how sensitive these markets are to the China growth story. Wouldn't be surprised to see it around 220 in this move down (note it closed at 243.55 not 143 last night per the chart)

Interestingly, a wash of European markets also marked out key reversals on a daily basis, while a suds (following the shampoo theme) of Asian markets are still powering higher.

Sold out of BHP at $37.00...

ALZ - On reflection...I'm a buyer at 40 cents

Thought more about Australand overnight. On balance, I'd be happy to start accumulating if it trades down to the rights issue price of 40 cents.

The logic is:
- the downside is priced in. I modelled a scenario where avg cap rates rise to 11%. While I think this is realistically conservative - it is a stretch from here. In any event, the conclusion was that a security price of 40 cents was pricing in this type of cap rate.
- major property market wipeout risks are contained. With gearing down, exposure to an even bigger fall in commercial property (to rival that in Japan in the early 90's) is manageable.
- a 10% tax deferred yield is about right. It compares favourably to current long end rates and in a sense implies a 1% management fee is being paid for passive property ownership (plus the developer).
- the development risks are being reasonably managed. This is a little bit of a leap of faith given it is difficult to quantify the risks around this part of the business from a distance (for example, there are $150m of performance guarantees that sit off balance sheet?). So I make the assumption that, at the very least, this part of the business will continue at breakeven. This is fine as at 40 cents, you are not paying for the development capabilities. It is a call option where the premium are the costs of maintaining the development capability for the longer term

As for the AAZPB, they had a good day yesterday (up close to 20%). At a running yield around 11.5%, there is maybe a little but left in them (eg. GMPPA at 10.2%) but most of the juice has been squeezed from this lemon.

Tuesday, July 28, 2009

Australand - buy into rights issue?

It was the former managing director of Australand, Brendan Crotty, that told me that property was all about demographics. It's true for investing generally, but has special resonance for property.

Australia has an immigration regime that underwrites our continued population growth - over 200,000 new mouths in 2008 (that's both permanent and non-permanent residents). Even when times get tough, Australia is captive to its immigrant legacy. The demographics of Australia support the builder.

This is not the say the property owner will always have it their way. They won't. We have had easy credit for so long, it is going to take a while for excessive valuations to unwind. But that's property ownership - there is a distinction.

So to Australand's half year results. They are a builder and an owner in equal measure. The question I'm asking myself is - are they value at 40 cents?

Let's try to break it down...

Property portfolio - investment and development ownership

Let's look first at property ownership - the questions here are a) how much pain is priced into the portfolios? and b) how much pain can they bear? Here's a quick summary of the investment portfolio:

30/6/08 30/6/09
Investment Portfolio value $2,288 $2,015
Weighted avg lease expiry 6.6 6.4
Avg cap rate 7.54% 8.34%
Avg cap rate - office 7.28% 7.91%
Avg cap rate - industrial 7.75% 8.81%
Occupancy (incl rent support) 98.80% 99.10%

And a quick sensitivity check of how this translates to total property holdings:

Reported invt portfolio value 2015.0
Reported avg cap rate 8.34%
Implied rental income 168.1
Assume cap rate +1% 9.34%
Implied portfolio value 1799.3
Change in value 215.7
Covenant impact 37%
10% decline in devpt assets 143.8
Total Covenant impact 39%

My conclusion from this...
Post the entitlement issue, it's unlikely that Australand will have to pass around the hat for more equity again. Even if property values were to fall by another 25% from here (putting the average cap rate around 11%), the gearing covenant should not be breached (my numbers have it remaining well under 50% in that scenario).

That is not to say the portfolio valuation is cheap at the moment. (Remember shopping centres were priced in the low to mid teens in the early 90's.) I wouldn't be surprised to see the average cap rate push into double digits before this market cycle is done.

So let's assume something like this occurs...again on my numbers (I can't quite match up Australand's rental income, cap rate and valuation - so I have taken the conservative valuation), assuming a 25% decline in valuations from here and an avg cap rate of 11%, this puts the NTA on the securities at $0.39. Given the placement is at $0.40, it is starting to look like reasonable value.

Property development

Now to property development. It's volatile business at the best of times - when the going is good, the BRW Rich list is littered with property developers. Trouble is, times ain't so good.

So how are Australand placed? The theme that comes from their outlook is that they expect the market to remain soft (with some hope of a lift in 2010). Essentially, they remain in 'monetisation' mode - selling assets as and when they can. The residential development business is basically breakeven as margins are being squeezed as they focus on offloading stock. Commercial and industrial development is about one third of the size of 2008 - with no office projects and a few pre-commited projects in the industrial sector. All in all this business could better be classed as 'care and maintenance' for the moment.

On the plus side, if you are buying the securities at 40 cents, then you are basically picking up the development business for nix. This is not a bad deal as Australand are managing down the risks from this part of the business while maintaining the development capability longer term. In particular, the capital commitment looks to be well contained ($44m for the 2009 year) and the model of developing assets that are sold into the trusts remains on foot ($113m for 2009).

So add it all up and what do we get?
Australand at 40 cents looks okay. The yield of ~10% seems about right - they are only paying distributions from the trusts and (as you would expect) nothing from the developer. With rent escalating at ~3% per annum and a reasonably good quality portfolio, the longer term yield is sound as well.

Looking at relative value, Australand looks pretty good. Consider the comparisons Australand published with the rights issue documentation...

DPS yield Discount to NTA
Australand 10.30% 43.50%
Stockland 6.80% 12.30%
Mirvac 7.10% 24.80%
GPT 7.50% 27.80%
C'wealth Office 8.50% 38.40%
Dexus 8.50% 38.60%

But maybe that says more about the sector than the absolute value on offer.

Think I have convinced myself that Australand at 40 cents is a reasonable deal. Does that mean I'll be buying it ahead of it going ex-rights tomorrow? Probably not - as my macro view of the market remains bearish. I reckon there will be opportunities to buy quality property companies at deep discounts to fair value in the not too distant future.

There will come a time to invest in the property sector again. The demographics demand it. But based on this latest instalment from Australand - there is no need to rush.

(Postscript - a consolation prize is that the AAZPB are a winner from this latest capital raising. I'll have a quick look at relative pricing tomorrow - but my guess they are a buy...)

Monday, July 27, 2009

In the shadow of the Matterhorn

Having read the latest newsletter from Matterhorn Asset Management, I'm feeling positively lightheaded with my relative euphoric outlook on life. It is suitably gothic in tone for a venerable Swiss asset management firm (I have images of the author closeted away in a half lit vestibule that has stood since thumb screws were an acceptable negotiation tactic). It also has what must surely become the cliche for this period of history "The Dark Years" - assuming they are right that is.

For those that want the cuneiform summary - you should read it but, still, I understand there are so many hours in a day - the main thesis goes something like:

1) The US (and some good friends) are in for hyperinflation. Hyperinflation is always a currency driven event - and the USD is set to crumble.

2) The USD will collapse simply because the government will keep printing money.
  • It will print money to prop up the banks - again (when the commercial property loans go bad, followed by student loans and credit cards)
  • It will print money to support the swelling banks of the unemployed (who can't pay taxes but still need food to eat)
  • It will ultimately have to print money with which to pay the interest on the money it has previously printed.
3) All this money printing will cause government bonds to plummet in value. Investors everywhere will be looking for an exit out of the US. Interest rates will climb to double digits in the next 6 months. The stock market will bury its head in the sand - literally not metaphorically - what equity premium do you need against a double digit 10 year Treasury?

4) And all this in a world which is facing its first synchronised downturn in eons while already in a parlously fragile state. The UK, Baltic States and parts of Asia will join the US in hyperinflation land. The rest of us will just struggle. (Oh, except Europe where the EUR will fall apart - for my sins I once wrote a thesis on the EUR - and yes I'd agree with Matterhorn on this, the EUR will not survive it's first inflationary test.)

...Where to hide? They say gold - physical gold - under the bed - next to the shotgun and cans of baked beans...

Sunday, July 26, 2009

Australian Sentiment Indicators

And so the WBC consumer confidence index (showing rather a steep bounce) and the NAB Business Confidence Index (which reflects a little more closely the economic reality). Guess these suggest that complacency has already moved in to a neighborhood near you...

Not drowning, waving

Got pulled out of the rip by my friendly market maker. Closed out short on XJO.

The Sentimental Bloke

Australians aren't typically a sentimental mob...just occasionally the beer gets wet...
 The world 'as got me snouted jist a treat;    
 Crool Forchin's dirty left 'as smote me soul;  
 An' all them joys o' life I 'eld so sweet    
 Is up the pole. Fer, as the poit sez, me 'eart 'as got 
 The pip wiv yearnin' fer -- I dunno wot.

Still, it sometimes pays to know where sentiment is at.

My read of the current market is that the trend followers are still jumping on board, reinvigorating the current wave higher.

What we are looking for is a crescendo in market sentiment - where insiders and 'smart' investors sell into indiscriminate public buying. The logic is that since there are a smaller number of players in the know, their holding must be several times the magnitude of public demand. If they are selling, they need mass buying. Hence sentiment readings of 90% bullish. This is classic definition of distribution.

Sentiment indicators are few and far between in Australia. The US has a plethora of them, and some good blogs that keep track of these measures (such as likeTraders Narrative and The Technical Take in addition to those that comment a little less frequently such as TPC)

To run through a few of the better known indicators:

Investors Intelligence - read a quick description at Investopedia or at Investors Intelligence
American Association of Individual Investors Survey - overview at Sentiment Traderand AAII
CBOE Put/call ratio at CBOE
ISE sentiment - at Sentiment Trader and ISE
Rydex Nova/Ursa ratio -Investopedia andMarketHarmonics
Hulberts Newsletter Sentiment Index - CXO review found that there was no correlation b/w readings and market direction

In Australia - the cupboard is pretty bare. The ASX doesn't publish put/call statistics and we don't have a measure for fund activity or financial advisor sentiment. This is something I would like to address...but anyway here are what I could dig up:

ING Investor Dashboard survey - it's not a simple line chart but some useful info at ING
WBC Consumer Sentiment survey and NAB Business confidence - the guys at the Melbourne Institute don't want to make it easy for you nor do NAB. Thankfully, the RBA publisheshistorical data...
IFSA Coredata Investor Quarterly Investor Sentiment survey - its new and infrequent, have a look at it for March here and for June here

The Woman's Day approach to investing

Well not quite - but following are the criteria that I'm going to apply for the beauty pagent...

1) P/E versus AAA bond
2) Dividend yield
3) EBIT multiple benchmark
4) Price to NTA

5) Gearing - debt to debt plus equity
6) Interest cover - EBIT to interest
7) Gearing - change year on year
10) Change in working capital - CA/CL year on year

8) Return on assets - NPAT to Total Assets
9) Operating cashflow to total assets
10) Change in ROA year on year
11) ROA versus CFROA
12) EPS trend
13) EBIT margin
14) Change in EBIT margin year on year
15) Dividend payout ratio
16) Change in Asset turnover - Sales to total assets at beginning - year on year

17) Quality of Management - measured by decisions, reputation, pay structure, M&A, equity issuance
18) Competitive positioning - industry growing?, pricing power?,
19) Change in shares on issue - year on year

Thursday, July 23, 2009

Jumping ship?

Hanging tough with the XJO put - see how the US plays out post MSFT, AMZN and AXP earnings - look to Trader Mike for insights.

... and exiting more of the CEU. With 4200 on the horizon we are getting close to my jetty (the rambling wooden one with the overgrown vines dripping into the water). Time to start moving to cash - also tipped out some NWS with BHP soon to follow (would like to see it re-test its highs first, so its still on board with the rest of us rats). The financials have lagged so will sit tight for the moment - hoping for WBC near $22...

back later

Wednesday, July 22, 2009

Small XJO short as a trading hedge and selling CEU

I like the odds of a pullback to around 4000 over the next couple of days - the market remains overbought and momentum has drifted over the last 48 hours. So have put on small XJO put position (strike at 4000 - I hate paying up for volatility at the best of times, at least with a closer to the money strike you aren't fighting the smile). The plan is to trade out of it if the market does peel off, while hopefully the trading longs (BHP, WBC, QBE, NCM) will hang in there. See how we go.

Also, took half the CEU position off the table. The buying volume has picked up over last couple of days (looks like 1 buyer got things going yesterday with a volume bid around $0.35), and I can still see further upside from here. But as they say "you never go broke taking profits" and a 26% gain in a couple of months is a reasonable return.

Tuesday, July 21, 2009

How far can we go?

The markets have a head of steam up at present, and while there's probably a few points to be made for the gazelles amongst us on a near term pullback, chances are we have a ways to go yet in this group therapy session.

Looking at XJO, there is little in the way of resistance before we get to ~4200 - where the trendline kicks in and the top of the bollinger band awaits. Would like to see a tradeable pullback from there (maybe tipping through 4000 at a stretch). But even then I get the sense that we could at least test and maybe push through the next most recent high around 4340.

Note that while the weekly volumes and momentum is still trending lower, the daily is picking up a rises in both measures. Guess that confirms the current move, but undermines it longer term.

From my perch in the tree, I reckon the current uptick will take us through to late August - and the time will have come to unfurl the bear banner once more.

(Based on this view I have been placing a few long side bets over the last few days - long BHP at $35.05, long NCM at $30.30, long QBE at $20.10, and long WBC at $20.00...Note these are trades not long term holds)

Stocks for review (comments welcome)...

Here's a list of the stocks that are on my broader radar. It's not exhaustive. There are stocks that I've had a history in trading that don't make the cut (at my peril perhaps) simply because last time I looked something was not quite right (eg. management, business model). That doesn't mean I'm a believer in all these. Just there is something in all these that has caught my interest.

I think the objective is to use the reporting season to review (some?) these. I'll take a "Womans Day" questionnaire approach (something I haven't done since way back in 2000) to cover more ground. A score of 7 out of 10 suggests having deeper look - you get the picture.

If there are any that you think I should include please pipe up. Similarly, if you have any views on priorities...I'm all ears (even if I only have two of them).

Technology Financials Industrial
ISS Group QBE Leightons
IRESS Westpac RCR Tomlinson
Wotif CBA Worleys
Seek Macquarie Hastie
Reckon APN Property Group HGL
Praemium Retail Media
Fantastic Furniture Mitchell Comm's
Property The Reject Shop Photon Group
Australand SuperCheap STW Communications
Goodman JB Hi Fi Austar
Westpac Office Wesfarmers Newscorp
Bunnings Property Metcash
Infrastructure Energy Cochlear
Connect-East AWE Biota
Transurban Beach Petroleum CSL
Envestra Karoon Gas Neuren
Deuts Woodside Blackmores
Viridis Paladin
ERA Telecom
Resources MEO Australia IINet
BHP PIPE Networks
Newcrest Gaming
Orica Tattersalls

Monday, July 20, 2009

Trading Rules - CXO Advisory

I love this post from CXO Advisory - a summary of their 'Eight Simple Rules from Financial Markets Research' follows...

#1. Broad financial market hypotheses explain what we have seen rather than predict what we will see.

#2. The more sources you consult, the less likely you are to be wrong, or right. The average of all opinions is approximately no opinion.

#3. If you track enough indicators, you can come to any conclusion you want.

#4. Short-term indicators offer returns that are small compared to variability. Noise swamps the signal.

#5. Some long-term indicators offer returns that are large compared to variability. It takes a patient lifetime with just a few trades to capture these returns, as a triumph of optimism.

#6. Sentiment indicators lag the market. Most people invest in the past.

#7. It will take 100 years to verify reliably the forecasting accuracy of your favorite apocalyptic oracle.

#8. The [fill in the blank] effect tends to disappear when researchers announce its existence.

Sunday, July 19, 2009

Market commentary on economic barometers

Some recent commentary on the indicators that are yet to signal a turn in the economy:

- from John Maudlin on the problems with European banks here
- from Mish on US housing here and Dr Housing Bubble here
- from Zero Hedge on commercial property here and here

Not to mention the indicators around valuation and earnings etc that are still far from a refresher, here is a list of Tuen Draaisma's tells...

Thursday, July 16, 2009

'The Financial Instability Hypothesis' of Hyman Minsky

The simplicity of the arguments presented by Hyman Minsky in this 1992 paper are truly beautiful to behold. In it, he looks to unravel the mysteries of how our modern capitalist economy cycles from boom to bust and back again. In doing so he neatly captures how our thirst for more is at the heart of the industrial complex.

Download it in its old-world typewriter-smitten glory here. But for those that want the poorer, glue-sniffing cousin’s version…read on

Minsky starts on the basis that capitalism is driven by a societal desire to accumulate money over time – he calls it ‘capital development in the economy’. To achieve this goal, some of us are prepared to part with our ‘present money’ and exchange it for ‘future money’.

“The present money pays for the resources that go into the production of investment output, whereas future money is the ‘profits’…”

So in our capitalist system, we can seek to grow money by buying production with our ‘present money’ with the hope that the things we then own will give us back more ‘future money’.

Helpfully, we don’t even have to use only our own money to buy into the capitalist dream. As Keynes put it…

“There is a multitude of real assets in the world which constitutes our capital wealth – buildings, stocks of commodities, goods in the course of manufacture and of transport, and so forth. The nominal owners of these assets, however, have not infrequently borrowed money in order to become possessed of them.”

Its our banking system that facilitates the financing process – interposing a ‘veil of money’, where banks take depositors funds and, after the necessary due diligence, lend them to the new owners. “Institutional complexity may result in several layers of intermediation” but ultimately this process promotes the capitalist system to (hopefully) grow through time.

And ‘through time’ is the point, as Minsky says:

“Thus, in a capitalist economy the past, the present, and the future are linked not only by capital assets and labor force characteristics but also by financial relations.”

Inescapably, then, our debt supported system becomes prone to the whims and fancies of humanity. The process whereby ‘money is lent to owners on the basis of expectations about future profits’ is necessarily a subjective one. Thus:

“Expectations in relation to ‘profits’ determine both the volume of financing and its market price. Conversely, actual ‘profits’ that are realised determine whether these financing commitments are fulfilled.”

So when expectations of profits are running high, more money is available for borrowing and at cheaper rates. If the reality of profits falls short of expectations then, well, someone loses some of their ‘future’ money.

“The financial instability hypothesis, therefore, is a theory of the impact of debt on system behaviour and also incorporates the manner in which debt is validated.”

With this framework set out, Minsky goes on to identify three types of financing:

1) Hedge financing – where cashflows from operations are sufficient to cover all repayment commitments

2) Speculative financing – where cashflow from operations are sufficient to pay interest but little else

3) Ponzi financing – where cashflows from operations can just about cover the Christmas party expenses but fall short of being able to pay either interest or repay principal.

No prizes for guessing which we have recently been witness to.

With these types of financing in mind, he then posits two theorems (dammit, gotta get me some of those theorems):

Theorem 1: An economy has financing regimes under which it is stable, and financing regimes in which it is unstable.

Theorem 2: Over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.

So, for Minsky the current malaise we are struggling through was a product of our own hubris. Through an over-abundance of good times, our expectations for the future money from profits simply outstripped our real profit potential. As our expectations stepped up, we were forced to push the blinkers ever closer together to avoid noticing the sizable shortfall that was accruing between our expectations and reality. In the half-light, where let’s face it we all look better, the Ponzi schemers could buy the drinks (while emptying our pockets).

So what does all this mean for us here and now? Well, a couple of things.

1) The great unwind – not sure we have made it to home-base yet. If we accept the definition of a ‘hedge financing’ and its implications for a stable system, it’d be fair to say that while we have come a long way, the global finance system doesn’t appear to be self-sustaining yet. Indicators to look at are home loan defaults in the US, commercial property valuations versus debt covenants (the global CMBS seraglio), and banks capital adequacy in Europe.

2) Perhaps more interestingly, are Minsky’s comments on the rising role of governments and how that impacts his model.

“…much greater participation of national governments in assuring that finance does not degenerate as in the 1929-1933 period means that the down side vulnerability of aggregate profit flows has diminished. However, the same interventions may well induce a greater degree of upside (ie. inflationary) bias to the economy.”

Compelling stuff (well at least to my vapour intoxicated synapses). My take on this? The government stepping up may soften the blow but can only prolong the pain. Inflation is the longer run reward.

Some kinda crazy 5th wave

Following are charts of a few of the bellweathers for the Aussie market - BHP, CBA and WES. They are all displaying some type of desire to push higher. While I'm not a big fan of trying to dissect the minutae of the market by wave counts - there is something to the overall psychology that elliot wave offers - and these all look to me like there is some kind of 5th wave thing happening. On this evidence, while the market may need to a have a breather in the absolute short term, the chances are that we are in for a positive couple of weeks with the prices of all three to at least revisit their highs, if not push higher. That's a good thing. Let me tell you why...

I'm a believer in the idea that we are in a game changing market - that the excesses that accumulated over the last 10 years will be unwound in the most painful way possible. At the end of the process, the Matrix will be reset, no one will want to own shares and leverage will be a thing of the past. We are not there yet.

When I look around at the various stocks I follow (and we are gradually meandering our way through them on this blog), there are not many that I would consider truly cheap. There are some that are reasonably cheap, but too many are closer to fair value. This doesn't fit with the idea that things should be really cheap for a material length of time before a bottom can find a find a comfy resting place.

Also, while leverage is being unwound at the corporate level, there are still too many legacy issues persisting in the property, infrastructure and banking markets to say categorically that we are through to the other side. And in the face of consumers turning from spenders to savers, governments around the world are diving deep into debt. Conclusion - that we are getting closer to the end of the cycle, but haven't got there yet.

So when I look at the charts above I see a market that is likely to push higher, but in opposition to what really needs to happen for the re-birth to begin. It's a rally ahead of the fall - as indicated by the lack of endorsement from rising volumes and a continuing divergence in momentum. If we track higher these will be the things I'll be watching. What we really want is for sentiment measures to tick higher in favour of the bulls and for the market to stretch to the top of these trend channels. That'll be the time to start strategising for the next downleg...

Wednesday, July 15, 2009

TTS - dodgy analysis

A short mea culpa before I go on. I bought TTS (13July09) on the back of some dated analysis and a, potentially, good looking chart. After running through the numbers I don’t think TTS is great value above $2.60. Still like the management. Just the broad numbers don’t suggest terrific upside from there without a meaningful win on some of the bids they are likely to lodge. Anyways, its all grist to the mill…on with where I have got to.

I subscribe to the theory – if the value isn’t obvious, or at least readily understood, then it’s probably missing. This is particularly true of financial models. I have been guilty of trying to build the million-variable model in my youth. No more.

So to a quick summary of my views on TTS. I’m going to simply extrapolate the Dec 08 half yearly result. I know there is some seasonality in their business – but for these purposes a straight line from the latest numbers will suffice.

My current take on TTS splits the overall business in two – 1) there are the steady state operations (Tatts Lotteries, Unitab, and MaxGaming) and 2) the run-off and growth potential (Tatts Pokies, the international operations and upcoming local opportunities).

In valuing the business I therefore assume there is a core business that is pretty easy to get a broad grip on. Take the following for example,

Dec-08 EBIT
Unitab 71.3
Lotteries 46.5
MaxGaming 20.3
H/O costs -17.0
Group EBIT 121.1
Annualised 242.2

EBITmultiple 8 10 12 14
Valuation 1938 2422 2906 3391

You could argue the group EBIT is conservative – given it includes the corporate costs associated with Pokies as well – but this is an impressionist portrait.

Take your pick which EBIT multiple is appropriate for a business like TTS. From my perspective, I reckon 10 to 12 times would probably work (equivalent to P/E of around 15x). Gaming businesses typically command a reasonably high multiple (CWN trades in a P/E range of 15 to 20). On the flip side, state governments have been a tad unfriendly of late – so there should be compensation for the heightened regulatory risk.

Okay, that’s the ‘core operations’. How about the rest?

I think we can ignore the international for the moment. There is potential there – but nothing has come of this as yet and they have been at it a while. Let’s value these at zero then.

That gets us to the Tatts Pokies business. Let’s assume that the EBIT of $116m for the Dec08 half is replicated across the remaining term of the licence (6 half years). And let’s also assume that TTS is successful in extracting $600m from the government per the original licence agreement (the IPO prospectus assumed $598m). PV these back (I’ve assumed 7% - no particular reason, seems like a healthy premium to the risk free rate) and voila, you get a present value of $1,100m.

Finally, TTS had net debt of $734m at balance date. Capex of ~$45m was running just below depreciation of ~$50m – let’s assume it’s a wash.

So what have we got:

Core business $2,400 $2,900

Tatts pokies $1,100 $1,100

Less debt $ 730 $ 730

Market value $2,770 $3,270

Or, given 1,270m shares on issue, a share price between $2.20 and $2.60.

Conclusion – This analysis is clearly rough. It’s also probably conservative. And it doesn’t take into account upside from TTS winning new business – something I think the management is very capable of doing. But on the face of it, if I want to own TTS, better off waiting for a retest of the lows. I sold out of the position today.

Follow your green glow

Another large inter-continental-ballistic-market-move coming our way.

Timing markets is fraught with improbabilities. Hence, the refrain that has served well this week "where are the stops?" (sung to the tune of "Where is the sun...") The time will come to get short - but it's not yet. (A small win at this end - as my XJO short came within a whisker of being filled yesterday...)

The primary trend is down but there is room on the upside for the market to run here. Scanning through the various stocks I follow last night, there was a greenish glow emanating from just about all of them. The S&P can make new highs for the year and our market could visit 4200 and beyond (hell - it could even stretch to 4400 where MA and trendlines converge).

Conclusion - there is no need to rush here. See how far the market can run - we want a wash of bullish sentiment to settle in and that will take some time. Once the market is long, and sentiment indicators are running at their highs again, then the risk/reward will tip in the shorts favour. On the plus side, might get a chance to make a quick turn on the DUE and TTS, in addition to lightening the CEU position.

Tuesday, July 14, 2009

XJO versus XAO

Apologies to anyone who didn't pick it up...the charting software I have been using somehow picked up the All Ordinaries rather than ASX 200 under the code XJO. A little confusing particularly when talking levels...XJO is trading at an approximate 10 point premium to XAO. (Probably should have picked it up earlier - not the first time I needed an editor.)

XJO to follow the US

Following the stop devouring surge on Tuesday, the S&P continued to squeeze higher today. Looks like it should test the downtrend. On balance I favour shorting around there, but wouldn't be surprised to see a quick move through the trendline to clean the shorts out and start the process of a few longs being established at the wrong level (after all we need these to create some downside momentum when the market does finally crack lower).

We are at the front end of earnings season where the good news is plentiful. It is reassuring to know that the stankers at Goldmans have been able to slip a few crumbs in their pockets while helping out at the soup kitchen. And in after-hours, seems that Intel has impressed with its numbers. I'm not that close to it - but I take David Rosenberg's lead...expect core earnings to disappoint over the reporting season.

So, while it's not out of the realms of possibility that we could get a 6 week rally that would take us through 1000, I'm still plumping for the short side. On timing, I'm expecting that we will settle around 900 for the expiry. Then look for market to test lower next week. Question is whether to establish shorts sooner (because levels are attractive) or later (because likely to chew through some theta as the market gets positioned for the next big thing). I like Tim Knight's analysis on this...

For XJO - the Aussie market spent last week trying to pre-empt the US. The failed crap-out on Tuesday put an end to this (and must have hurt quite a few). My guess is that its unlikely that we will have any big moves without a lead from the US.

Looking to the divining rods...
The Weekly chart is still pointing down - we got MACD rolling over and the momentum divergence undermining higher prices. On the Daily however, things are a little more bullish - stochastics have turned up and a run up to the longer term downtrend is not out of the question (~4200!). You can also see the H&S everyone has been muttering about (even though it is a poor facsimile of the one in the US). For mine the most attractive level to short would be around 3940/3950 which is the confluence of previous highs (and lows going back), and moving average convergence.

Defensives looking bid?

Wonder what the equivalent of "my internet connection is down" was in the Victorian age? Wait, I was around then (well almost). Guess I just went to the pub early...

Anyway, to finish on this defensives theme from earlier...a couple of points:

1) Note that Tuen Driasma has suggested buying defensives in the current market...TPC has the relevant slice of Morgan Stanley's research.
2) Seems like there has been a undercurrent of institutional interest in the infrastructure sector locally over the last month - apart from the buying of CEU by CP2, I'm hearing of bids in the likes of SKI and DUE, and even the diminutive VIR had Australian Ethical go 'substantial' recently.

My picks for the sector are:
- CEU as a growth asset, attractively priced with corporate appeal but not without its probloms
- TCL as a diversified portfolio with good mgt and inflation linked revenues and manageable leverage
- ENV as a mature portfolio with fully cashflow funded incremental growth and manageable leverage
- DUE as a mature portfolio with fully cashflow funded incremental growth and a strong balance sheet
- VIR as a renewables portfolio that is dysfunctional at the corporate level as it reduces debt

More on this later...

And back to that TTS chart...the things I like about this are:
1) Momentum and RSI have consistently been trending higher since the low in March 2008. That's a relatively long time to fluff around in consolidation mode - particularly in the context of the market lows in March 2009.
2) Resistance around $2.60 is close. It's where the trend line from the absolute highs comes in, and also where the moving averages have flatlined to as price has traded the broader $2.00 and $3.00 range.
3) Slow stochastics are at a level where a buy signal is also not far away.

Conclusion - maybe I'm early in dipping the toe into the water and buying some at these levels (a lower risk position might be on a break of $2.60). But I like the stock - its management and its risk/reward valuation (more on this later too). And it fits with my defensives theme.

Monday, July 13, 2009

Long DUE and TTS

Don't get me wrong, I'm still a bear on this market over the next 6 to 12 months (heck - I expect a breakdown in the commodities complex sooner than that). It's just that I like the look of defensives at the moment.

We've already spoken about CEU and TCL (at the right price)...and I will get around to having a run through VIR that is part of my super portfolio...but today its DUE and TTS - both of which I bought today.

Time is short - so in brief:

I look upon it as a quality cashflow business valued on the basis of continuing operations - with upside from potential to win gaming business from Tabcorp.

The Victorian pokies business finishes up in a couple of years. It's a rapidly amortising annuity with a large kicker at maturity (there is no way that the State govt can get around not having to pay the $550m they owe to TTS). The current valuation places little value on this lump sum.

Dick McIlwain is one of the best managers in the country. A clear strategic thinker, he knows how to get the best out of the limited opportunities to bid for licenses. I'm happy to back him as Tatts seeks a booth at the track in Victoria.

Have a look at the chart - I like the stock at current levels. But I'd be buying with ears pinned back if it were to revisit its lows.

...having trouble with my internet hour has passed since I wrote this note, I should have known it right from the start...or something like that...gotta go pickup the kids

Sunday, July 12, 2009

That's whose been buying CEU

Well, I guess it vindicates my view that CEU is a buy for a long term 'infrastructure' friendly investor. CP2 put in a change in substantial holding yesterday (from 27.0% to 28.8%). Guess they have finished now?

Watch for stop hunting into OPX expiry

When I was a young buck, I worked on a night desk trading currency through New York hours out of Sydney. It was a tough job - not only because the highlight of the night was often re-runs of The Streets of San Francisco (RIP Carl Mulden) - but because it was an isolated existence. All our counterparties were in another part of the planet. We could ‘talk’ via the direct dealer, a screen that enabled 4 conversations simultaneously (this was 1995 - the internet hadn't taken hold yet) but we were effectively alone.

The first task of the night (around midnight) was to call all the AUD desks in London and see how they were seeing things. Now the point of this story is that 9 times out of 10, if they were all saying the same thing (eg. it's going higher), then the opposite would happen (it's lower!). They were all of the same view and positioned accordingly. New York would come in – see the stop loss orders protecting these guys and immediately take them out.

Now the media and blogosphere have been alive over the last week or two with the news that a head and shoulders is developing in the US equities markets. This is a trend reversal pattern – a tradition signaling exhaustion as the smart money sells to the retail investor. It has good form.

If this is the consensus call - my question is where are the stops? My gut is telling me that this week will be the one where they get taken out – and given that 'green shoots' sentiment has trickled lower in cahoots with all this H&S grooming – my guess is that the stops are to the topside.

The Evil Speculator has summarized the levels – have a look at his charts for a sense where the stops may be. For mine, the downtrend channel that comes in around 910 looks like the goods - at worst a quick run-up through that should have everyone short at current levels out of the market. (I also like Fujisan’s observations about the OPX expiry – my experience suggests crowded strikes have a force equivalent to gravity - if the market is close, price will be drawn in…she notes 890 and 900 as having the largest open interest).

After that the way is clear down to 800...