Arise Valuation – 50% Target Reached, Now What?

In March I set a 50% year-end price target for the Swedish windpower company Arise and this has now been reached. So is now the time to sell?

In my opinion no. I estimate the risk/reward to be roughly the same as back in March when the price was 12.50 SEK/share (now 19 SEK). Granted, the risk has increased but the upside is also significantly higher now as my calculations further down will show.

And by the way these calculations are based on current market conditions and are not dependent on blue sky scenarios, which would only provide further upside not accounted for here.

The reason for the greater downside is that the price has further to fall in case the electricity market reverts back to the unprecedented slump that plagued it in the period from 2015-2017.

So how have market conditions changed? The basic drivers are:

  • The project sales market is stronger than ever. For the last three years projects were generating 1.0 MSEK/MW of profits or less while recent sales ranged from 1.5 MSEK/MW for a project of average quality to 1.1 MSEK/MW for a project of below average quality. And I expect the hunger from institutional investors to result in increased sales of at least 100 MW per year – and more likely closer to 150 MW per year.
  • Electricity prices are much higher. Short-term in part because of weather conditions (this effect is excluded from my calculations further down) but more importantly due to what I believe is a sustained trend in CO2 emission quotas. The two electricity analysts I have spoken to believe this trend is set to continue because of rising environmental concerns.
  • E-certificate prices have gone up dramaticallyThis impacts years 2018 and until 2020. Post 2021 is more of a question mark but in prior periods politicians have stepped up to secure a system that favors a continuation of the renewable build out.

As a result of the above I estimate EBITDA to more than double within the next couple of years from currently 135 MSEK to 275 MSEK. A word of caution though: Other analysts have much lower estimates in the 160-180 MSEK range. Not exactly sure why but I assume this is due to lack of updating to reflect the new reality.

Let me split up how I arrive at that much higher number:

  1. 40 MSEK additional EBITDA from e-certificates. Here are my calculations for the years 2018-2020 (results in grey cells). Hedges are accounted for. Post 2021 the numbers are currently uncertain.
  2. 40 MSEK additional EBITDA from electricty prices. This is based on current CO2 quotas alone resulting in 140 MSEK/MWh higher prices (15 Euro higher * 0,9 Euro = price). Per 100 MSEK/MWh in price EBITDA increases/decreases by 34 MSEK. Lots of other factors influence electricity prices but most of those are weather dependent, and others are impossible to predict and model out due to their complexity so this and forward curves are all we can rely on in my opinion.
  3. 60 MSEK additional EBITDA from project sales. (100 MW * 1.2 MSEK/MW vs. previously 60 MW * 1.0 MSEK/MW)

The above number is a conservative estimate in my view. I actually think they will sell closer to 150 MW on average per year but I have discounted the number to account for possible permitting/construction problems that may come about. Note though that in its short 10-year history Arise has not encountered construction problems before and only once, with Kölvallen in 2017, have run into permitting problems.

When will the effects kick in?

#1 and #2 have started to kick in but the full effect ought to be evident from the full year 2019. #3 will take effect from late 2019 and onwards and I expect EBITDA to gradually arrive at 275 MSEK for the full year 2020 and be in the range in the yeaers following.

Despite the above mentioned effects starting to kick in from now on my base case for 2018 is only 160 MSEK in EBITDA due to low winds in H1 – and as a kite surfer I know this spring to be an unusually disappointing season! In addition to this project sales that are being delivered this year were sold in 2016/2017 when they had a lower value than those that can be expected going forward.

Valuation and some key metrics

EBITDA 2017: 135 MSEK

Estimated EBITDA going forward: 275 MSEK

Current enterprise value: 1628 MSEK

Estimated EV/EBITDA: 5.92

Price-to-book: 0.82 (Asset-light competitor Eolus Wind: 1.58)

Since 2011 Arise has traded at an EV/EBITDA multiple in the 11-15 range. Companies trading near 5 are often takeover candidates.

As a result of the above estimates I believe the current fair value of Arise to be in the 35 SEK range +/- 5 SEK.

Note that the above is my base case scenario and all of the above numbers are based on current market conditions and prices. Be aware that the volatility has been quite extreme for all three factors historically and that the risk is significant. For that reason I have erred on the side of caution in my estimates, especially when it comes to project sales.

Post Mortem

Let’s say two years from now the above thesis has been proven wrong and the numbers above did not materialize. What killed the case?

  • Project sales volume was lower than expected due to institutional investors finding other ways of deploying their capital at a higher rate of return, perhaps helped by higher interest rates. The realized prices were lower than expected because the energy market went into a slump, perhaps as the result of an abundance of natural gas hitting the market from Russia and the US. Also, the politicians failed to move ahead to squeeze out coal via increased CO2 emission quotas.
  • The E-certificate system that was widely expected to get fixed was not fixed and as a result e-certificate prices post 2021 were too low to attract enough institutional investor resulting in lower sales.
  • Permits for projects were delayed and/or not granted at all which created holes in the pipeline as happened with the Kölvallen-project in 2017.
  • EBITDA Bear Case Scenario: 120 MSEK. If this happens two years out I think the effect on share price will be limited to a downside of approximately 15 SEK per share as debt repayment until then will have decreased the overall risk.

3+ years out:

  • Grid connections are being planned to continential Europe and the UK. This will likely lead to Sweden being able to export electricity generated from wind and solar at higher prices.
  • Arise may divest some or all of their own windfarms down the road. This would bring down debt dramatically and likely result in a repricing as I believe the debt level is the primary drag on the share price. While this is likely to boost the share price short term I am unsure whether it is the optimal move long term as these assets, especially those in the southern part of Sweden, are becoming increasingly valuable in the current pricing environment. Arise CEO have recently stated they believe their wind farms are likely to have a longer lifespan than the 25 years that are reported in the books.

Never time frame forecasts again!

And by the way let me end this post by apologizing for that 50% year-end target I made in March even though it panned out.

I believe all we can comment on is our estimate of fair value and not what the markets will do, especially short term like within nine months, and for that reason I will refrain from commenting on that going forward. I never do this in written form but on video it slipped out in a moment of uncertainty and regretably I didn’t bother with the editing.

Disclaimer: I do not accept responsibility for losses that are a result of buy/sell recommendations I make. I encourage you to do your own reserarch before making an investment decision. I own shares in Arise.

Let the Uranium Bull Market Begin

“The most exciting returns are to be had from an asset class where those who know it best, love it least, because they have been hurt the most.” – Done Cox

Major supply destruction

Sector analysts in the uranium space have been saying that the world’s largest uranium mine, McArthur River, would likely reopen after a 10-month temporary shutdown that started in February and their overly conservative supply/demand forecast models have reflected this. Meanwhile, the owner, Cameco, had repeatedly said they would not bring it back unless uranium prices were meaningfully higher as it would make no sense economically.

Last night a decision was made to put the mine on hold indefinitely until nuclear utilities are willing to sign long-term contracts at a price that reflect their true costs plus a reasonable return – probably north of 45 USD/lb – the spot price is now at 24 USD/lb and the latest long-term contract price was around 29 USD/lb. This shutdown equates to supply destruction of 12% of the global production that nuclear power plant utilities thought would come back online as they have relied on paid analysts and consultants filling their ears with the sweet words that it would.

A domino effect is likely

I believe this marks the beginning of a new bull market for a few reasons.

  1. The nuclear power plant utilities will have to wake up from their dream state to a new reality in which cheap uranium below the cost of production is no longer available in quantities they had been hoping for.
  2. Cameco will have to buy significant amounts of uranium in the spot market to fulfill their contracts to customers. This will inevitably push prices higher.
  3. Kazatomprom plans to IPO in a few months time. It would make sense for them to delay any action that will result in higher uranium prices (such as further production curtailments) until after Cameco has made the decision to put McArthur River on hold indefinitely. This game of chicken has now been won and they can now pull whatever levers they please without shooting themselves in the foot.

There are many other reasons that I have already covered in previous posts but the above three are linked directly to the news release from last night.

The final de-risking of the case for uranium

I cannot imagine the risk/reward will get any better than it is at this moment. My opinion is that the McArthur River decision is the straw that will break the camel’s back and if one prefers to wait for further de-risking it will almost certainly come at the cost of more expensive stock prices, thus reducing the risk/reward. In my opinion the way to handle risk is in how one sizes a position, not wait for all the stars to align because all opportunities will be gone when the skies are completely clear and everybody can see it. One wants to be positioned before the price of uranium moves because now it is pretty much inevitable that it will.

My current uranium positions

For the record and for transparancy, my bets are primarily with US producer Energy Fuels and London-listed Yellow Cake. The latter being the safer “in case I am wrong on the time horizon”-type of bet – like Uranium Participation, that I have highlighted previously in a video, but YCA trades at a larger discount. I also have smaller positions in Paladin Energy and GoviEx as well as a tiny position in the optionality play Virginia Resources.

Disclaimer: Note that this may change at any time and while I intend for all of these positions to be longer term I may enter and exit positions without notification of this on my blog. I do not accept responsibility for any loss that may occur as a result of any recommendation I make and urge readers to perform their own research and due diligence. My posts are intended to be treated as a starting point only.

Arise Q2 – Higher Electricity Prices Appear Sustainable

Although the reported numbers were in the red (due to factors that were known and expected) the quarter was an exceptional one nonetheless as reflected by a 40% increase in the share price.

Electricity prices are booming both on the short and on the long end of the curve. On the short end due to water reservoir levels being low, and on the longer end, which is perhaps more significant, due to rising demand and carbon emission quotas increasing steeply because of an increasing focus on the environment from governments.

The impact of carbon emission quotas on electricity prices

To give an idea of the impact carbon emission quotas have had: Quotas have risen from 7 to 16 EUR since January 1st. For every 1 EUR in quotas the impact on the price of electricity is 90 cent. On a SEK/MWh basis this translates to about 85 SEK of sustained improvement. Given that the forward curve for 2020 indicated a price of 280 SEK/MWh one year ago (when large impairments were taken by Arise!), this now sits at 360 SEK/MWh – a significant boost upwards that is mostly the result of the carbon emission quotas move. The two electricity analysts I’ve been speaking to recently both expect the quotas to go higher still.

The impact on rising e-certificate prices on cash flow

On top of that we have had a boom in the forward prices of e-certificates for 2018-2020 since the start of the year.  I’ve created a spread sheet to calculate how much this means in terms of the net present value of the increased cash flows to equity holders when comparing to the outlook at the beginning of the year.

Given that my assumptions on their current hedging percentages are correct (and their slides today indicate it is in the right neighborhood) I estimate the value to be 80 MSEK. To put this in relation to equity and market cap those are 800 MSEK and 580 MSEK.

See the spread sheet here. Admittedly it is a bit messy (did it for myself initially) and so you may need to have looked at the case in some detail for this to make any sense at all.

Why is this important?

Because their debt level at 1,000 MSEK is relatively high in relation to their past cash flows and now that both e-certificate prices AND recently also electricity prices look to contribute much more cash the debt can be reduced at a much faster pace than previously believed which means the stock has started to reprice. This effect is what makes highly levered stocks go bananas, as has been the case for Arise these last few months. Note that the 80 MSEK number is for e-certificates only. Add to that the impact of the rising electricity prices as well as the increased capacity (and increased willingness of potential buyers) for project sales.

The pipeline is more robust than ever

On top of that the pipeline is looking more robust than ever. With projects of 180 MW, 150 MW, 45 MW and 35 MW ready or close to ready to be sold from now and until the end 2019 (potentially providing 1 MSEK/MW on the bottom line). The Kölvallen project, which initially failed to get environmental permissions, is another 150 MW that could potentially be brought online by 2020/2021.

One of few downsides that I see is that the market could get ahead of itself believing that current electricity prices are likely to stay as high as they are now. While I do think we will see much higher prices than we’ve seen in the last 3-4 years the current 550 SEK/MWh (excl e-cert) in the warmest months of the year is perhaps at an extreme – and if not shareholders will have very nice ride going forward!

Another downside is that the forward prices for e-certificate prices are very low from 2021 and onwards due to the construction of the current system. There is some expectation from industry players that this will be fixed to ensure that the long term build out goals will be reached but this is in no way a certain outcome. There is also some chance that institutional players will invest even without the subsidy from e-certificates if the current electricity pricing environment trends continue via support from carbon emission quotas.

Take profits or  hold for the longer term?

I am personally retaining a core position for the longer term but I have been reducing my holding by about half this past week. I still see the stock as under valued but not by the same extreme amount as when I last wrote about it in my post of April 30th when the price was 12,30 SEK.  I tend to be quite aggressive in my sizing when opportunities like that come along and the risk appear low but the flip side is I am forced to reduce earlier than I would have had my position size been a more standard one.

So I think much of the upside has been realized but that there is still some way to go when having a two year+ time horizon. Given current fundamentals my estimate of fair value two years out is 22-24 SEK per share, equal to 0,9-1,0 of book value (the price is now 17,30 SEK). I arrive at that number partly because I see potential for a reversal of past impairments now that fundamentals have improved and partly because I think the chance of project sale success in the coming two years is high.

I’d appreciate any feedback on what your current view of the stock is and if I have overlooked anything!

Disclaimer
I do not accept responsibility for losses that are a result of buy/sell recommendations I make. I encourage you to do your own reserarch before making an investment decision.

My #1 Uranium Bet – 5 Catalysts

5 catalysts for company X – in short form:

  1. US Section 232. First steel and aluminum – uranium next?
  2. Modest valuation compared to US peers while having superior near-term production capacity.
  3. Potential other sources of revenue from vanadium and clean up work for the government of old US uranium mines that were never restored.
  4. There has been forced selling of shares from the uranium ETF Ura Global X for the past three months. This will slow down and stop completely by July 31st.
  5. Inclusion in the Russel 3000 index on June 25th = forced buying from institutions and small cap ETFs. News from yesterday.

So company X = Energy Fuels. This is a company which I’ve been accumulating from the end of March till now to a degree where it has now become my largest position in the uranium space so I thought I’d write a few words about why this is my #1 pick currently.

Note that this post will be a company specific post and not about the uranium sector. I made two videos on my view on uranium here: The Case for Uranium Part 1 and The Case for Uranium Part 2 in case you are interested in a deeper dive into that. Both were made before I started accumulating Energy Fuels (EF). My general view on uranium is unchanged since then if not slightly more bullish as hedge funds have started to enter the space buying physical uranium realizing that the industry is now on its knees so severely that supply destruction has become an economic necessity = uranium prices must rise. As always in cyclical industries where demand is certain: After rain comes sun.

A word of warning

Before I elaborate more on the 5 catalysts let me stress that EF (ticker symbol: UUUU) is an aggressive pick that comes with a certain amount of risk. I have personally chosen to size more heavily than I am normally comfortable with in relation to the amount of risk the stock carries with it because I see huge potential within a 1-year time frame. But realize that my uranium outlook is a lot more bullish than that of the general market, and even among uranium bulls. If I am proven wrong on the timeframe there are better uranium stocks available, specifically Uranium Participation where I’d postulate that the risk is almost insignificant and a 2x on one’s money in a three year time span extremely likely.

Note that if U3O8 prices stay below 45 USD/lb for the coming 12-months it is likely EF will need more capital as they have no long-term contracts and would sell at a loss at current prices. This could potentially lead to bankruptcy, but much more likely a dilutive capital raise. Neither option is ideal for investors but that is the price one pays for the significant upside potential.

Now for an elaboration of the above mentioned catalysts.

The 5 catalysts – in elaborated form: 

  1. US Section 232. EF has tremendous upside if the Trump administration decides to help out US producers by forcing US uranium buyers to buy a 25% quota domestically (12 million pounds out of 180 Mlb of global demand = limited impact on the overall market).This could result in a two tier pricing system where US producers receive up to 30 USD per pound of U3O8 more than non-US producers = 55-60 USD/lb. Were that to happen EF would go up at least 3x and probably more.According to my calculations Energy Fuels EBIT at a U3O8 price of 60 USD/lb will be about 90-110 MUSD when ramped up fully (assuming 5 Mlb of production). Current share price of 2,06 USD = market cap of 150 MUSD.This may appear to be a long shot on the surface as it seems to go against the very soul of America. However, it has been in place before and many in the industry believe this to be a very real possibility and judging from that I’d say the chance is at least 30%.

    The reason for all this speculation is that Energy Fuels and Ur-Energy sent a so-called 232 petition to the US Department of Commerce on January 15th claiming unfair competition from state-owned players in Kazakhstan much like the petition that the steel and aluminum industry submitted in the summer of 2017 and which the administration have now acted on in 2018. The argument is that subsidized players can afford to dump prices whereas others cannot and this leads to elimination of competition on unfair grounds.

    Section 232 of the Trade Expansion Act in 1962 focuses on national security and for that reason the administration can act without support from congress. And since uranium is much more of a national security concern than steel and aluminum (20% of US electricity comes from nuclear energy) one might conclude that the administration is likely to act on it.

    However, if national security isn’t the real motivation behind the steel and aluminum tariffs but instead it is jobs for American workers then uranium may not get the same backing as the new jobs it would provide are in states where the republicans are already dominating (Wyoming, Texas) and where they don’t really need the extra votes.

    Note that there is a risk the stock will fall if the administration decides not to act. EF has outperformed the general uranium market the last three months and much of that could be due to investors beginning to price in the possibility of 232. The flip side to that argument is that the petition was submitted on Jan 15th and as can be gleaned from the graph below the response initially was not only muted but even negative.Screen Shot 2018-06-20 at 11.55.29

    And while we’re at it let’s include a graph for the last 5 years to illustrate the suffering that has been going on for shareholders (the general direction is similar for all other uranium producers):

    Screen Shot 2018-06-20 at 14.52.32.png

  2. Modest valuation. EF can bring on more U3O8 in production in a shorter amount of time than the two other main US players, UEC and Ur-Energy, despite being valued significantly lower (close to 0,5x!) on an Enterprise Value to pounds in the ground basis. Because of those factors EF has significantly more upside.Why do I single out UEC and Ur-Energy specifically? Because they will also be affected by petition 232 (if you are in uranium for that specifically and want a US producer) and because all three have similar mining methods and mining costs (which are in the lower 2nd quadrant globally). This means all three can bring on production faster than most global competitors, which is why I believe that in the current environment this is where to look primarily. EF can potentially bring those costs even lower than the others, see catalyst 3.On the flip side, EF has higher overhead costs due to a bigger operation and a dilutive capital raise is likely to hit EF shareholders harder than those of UEC and Ur-Energy. UEC has a nice titanium deposit that potentially is worth a lot of money and Ur-Energy has some long-term contracts that go into 2021 whereas the two others have no existing contracts beyond 2018. In terms of current shareholder base rating EF would come in last of the three. That could change as a new management have been in place since January. My impression is that it is a more alert one.

    Summary: If you believe that crunch time is very close EF is the play of the three imo. If you believe it happens in 1-3 years, Ur-Energy and UEC may be better options. If you don’t believe any of that stay out for now!
     

  3. Unlike most uranium companies, EF has other potential sources of income from vanadium and clean up work of old US uranium mines from the 1950s era when environmental considerations weren’t the same as they are now. Both are new opportunities that did not exist one year ago.The US government has set aside significant amounts of cash in the recent budget for clean up work of these old non-restored mines and it is my understanding that Energy Fuels is in a prime position to receive much of this work because of their White Mesa mill which sits close by.They also have vanadium in the ponds at White Mesa which they are now looking to extract as vanadium has shot up in price this past year. See graph:
    Screen Shot 2018-06-20 at 10.45.28
    On top of that EF can knock off about 10 USD/lb of U3O8 costs per pound from bi-product vanadium on some of their conventional mine production (which is set to come on at U3O8 prices of 60 USD/lb) if vanadium prices stay where they are. That means it could potentially come on sooner, perhaps at 50 USD/lb. UEC also has conventional mines with vanadium but it is my understanding that permits are years away for those.

    Both of these potential revenue streams can turn out to be of extreme importance to shareholders should uranium prices remain subdued for longer as new capital may not be needed. Note that both are in the ”if” category still though. We don’t know for sure if they will make a dime on either.

    And two short term tactical triggers:

  4. The Uranium ETF Ura Global X is transitioning to go from 100% uranium producers to 70% uranium producers and 30% ”nuclear components”. This change started in March and the transition will be complete on July 31st. This means the ETF has had to sell 30% of it’s holdings in many producers.I started tracking their EF holdings from April 6th and the share count was then at 9,3 million. As of today this number is now 6,5 million = 30%. So that means the selling ought to stop if not shortly then at least by the end of July.Interesting to note that the EF share price has held up well in that period rising 35% despite the heavy selling. Ura Global X has been selling about 60,000 shares daily in the last two-three months. Considering the average daily volume in EF is around 500,000 this is a significant amount of downside pressure that is soon to be removed. Will the effect be like that of a bathing ball under water?
  5. Russel 3000 index inclusion. Yesterday EF announced it will be included in the Russel 3000 index from June 25th. This may lead to institutional buying propping up the price. However, there is some chance speculators have already anticipated this and bought ahead of time making the effect of the inclusion less significant. We’ll see.

I’d be interested in your view. All feedback is welcome. (And please excuse the formatting. For some reason spaces and paragraphs are getting messed up in this article even after being corrected).

 

On valuation – some numbers

 

Energy Fuels

Stock ticker: UUUU

Stock Price: 2,06 USD

Enterprise Value: 180 MUSD

U3O8 resources: 130 Mlb (EV/Res = 1,38)

Near-term annual production potential: 5 Mlb annually. (2,5 Mlb at 45 USD/lb + 2,5 Mlb at 60 USD/lb)

Annual Burn Rate: 30 MUSD.

Net Working Capital: 43 MUSD.

Interestingly: According to my calculations U3O8 prices at 45 USD/lb means Energy Fuels EBIT is at 10 MUSD, ie. barely above break even. However, at 60 USD/lb EBIT is around 90 MUSD (110 MUSD if vanadium prices stay where they are at now). This goes to shows the leverage that is at play here.

 

UEC

Stock Ticker: UEC

Stock Price: 1,56 USD

Enterprise Value: 255 MUSD

U3O8 Resources: 112 Mlb (EV/Res = 2,28)

Near-term annual production potential: 4 Mlb annually. (2 Mlb at 45 USD/lb + 2 Mlb at 50 USD/lb but the later cannot be brought into production till at least 2 years out)

Annual Burn Rate: 20 MUSD

 

Ur-Energy

Stock Ticker: URG

Stock Price: 0,70 USD

Enterprise Value: 95 MUSD

U3O8 Resources: 42 Mlb (EV/Resource = 2,26)

Near-term annual production potential: 2 Mlb annually. (1 Mlb at 45 USD/lb + 1 Mlb at 60 USD/lb)

Annual Burn Rate: Doesn’t apply due to long-term contracts.

 

Disclaimer
I do not accept responsibility for losses that are a result of buy/sell recommendations I make. I encourage you to do your own reserarch before making an investment decision.

Wilhelm Wilhelmsen Holding Q1 Update

WWL & Maritime Services

The daughter company, Wallenius Wilhelmsen Logistics, or WWL, were hurt by lowering rates, higher bunker costs and currency headwinds. Surprisingly for me the improvements in the mining segment wasn’t significant enough to offset the negatives and the share price was hammered down 20%. The stock had climbed 200% in less than two years so even slightly deteriorating fundamentals got punished harshly.

For the maritime segment the EBIT-margin improved slightly from 4% to now 6%. Not enough improvement to warrant a rerating of this segment in my Excel valuation.

Discount to NAV has narrowed

The updated excel sheet for Wilhelm Wilhelmsen Holding, WWI, shows the discount to NAV at 35%, which is the lowest it has been for the past 24 months. As a result of that I have scaled down my position somewhat.

Get Paid for Being a Masochist: Concordia Maritime

The product tankers are bleeding and have been since the end of 2015 due to oversupply from the good years when too much capacity was ordered. Some are even reporting negative cash flows. So what is changing now?

  • The supply/demand balance is improving, especially when accounting for increased scrapping of older vessels ahead of 2020 regulations and demand growth of 4%. (2017 was a big scrapping year and 2018 will top that as 66% of 2017 numbers was reached already in April). Screen Shot 2018-04-30 at 12.38.20
  • Global Clean Petroleum Products inventories are coming down to below average levels. This may the most important chart short term indicating the wait for the turnaround could be a short one:Screen Shot 2018-04-30 at 11.26.19
  • As are crude oil inventories (the green line has fallen below the 5-year average in 2018)Screen Shot 2018-04-30 at 13.02.38
  • Prices have been significantly below 5-year averages for almost three yearsScreen Shot 2018-04-30 at 11.44.28
  • The price of vessels are stabilizing (new builds increasing slightly) Screen Shot 2018-04-30 at 12.33.13
  • Shipyard capacity is stretched. Scorpio Tankers 10K: “Shipyard capacity has rapidly and dramatically declined”. I have not been able to find numbers on that though.
  • New financing methods in the shipping sector will lead to increased discipline.

We all know what tends to happen in cyclical industries when these dynamics are at play, right?

Concordia Maritime, Torm, Ardmore Shipping and Scorpio Tankers, to name a few in the product tanker space, are all struggling, naturally. Torm and Scorpio both took in new capital in recent months. But despite being the cheapest of the bunch on a Price-to-Book level, Concordia Maritime (Swedish) is in a very comfortable position when it comes to the cash position, meaning they can weather the storm for longer than their competitors before needing addittional capital. On top of that they are achieving market beating pricing rates quarter after quarter.

On a peer-to-peer basis the stock has underperformed peers in the last three months despite a similar environment, and despite the Swedish currency performing terribly. (STNG = Scorpio Tankers. ASC = Ardmore Shipping. TRMD = Torm)Screen Shot 2018-04-30 at 12.01.36

The price is currently 10,40 SEK and the market cap 450 MSEK. It currently trades at 0,4 to NAV, which is lower than peers… A major impairment was taken six months ago when the pricing environment was at the bottom. I believe there is potential for a multiplying effect here: 1) The discount to NAV narrows, and 2) Vessel pricing rise = higher book value = potentially creating a nice multiplying effect on the share price.

Added to this the Swedish currency has been absolutely demolished the last three months. It is down 8-12% against the USD, EUR, NOK and DKK, to name a few related currencies. This means an added cheapness (the price of the stock + some of their costs are in SEK).

Patience and the importance of cultivating a tolerance for pain

The question, as is often the case with these deep value cyclical situations where future demand is certain is not if the market comes back, but when

This is why patience is the mother of all edges in cyclical industries. A curious Chinese proverb states that patience is only possible from a place of strength, which from an investor’s point of view can be interpreted as not depending on near-term gains and refraining from using leverage in cyclical stocks. There is a tremendous advantage to be had in never being forced to sell.

The second magic ingredient is cultivating a tolerance for pain. This is essential because the troughs are often outdrawn and longer than expected and the upturn often short and violent, so while the net result may be overperformance in the end deep value investors experience more defeats on a daily basis than momentum investors, which is why it is harder. This is also why the opportunity exists: One gets paid for being a masochist 😉

And just to be clear: In my opinion this is not a “buy and hold forever” type of stock. Instead it is a “get in when the market is depressed and get out when normalization has occured”. If you are a splendid market timer you may even want to wait till euphoria has been reached. Personally, I am usually off to other hunting grounds before that happens.

Concordia Maritime is controlled by a major shareholder, Stena Sphere, which holds 52%. Some have pointed to corporate governance issues with a majority shareholder being in control while at the same time providing customers to Concordia Maritime for a fee. I personally am undecided whether this is a good or a bad thing for Concordia Maritime’s shareholders. Better debt terms are possible when you have a financially strong player backing you. On the other hand there is the possibility of overcharging for their services. But if that were the case, EBITDA-margins would be worse than competitors and that isn’t the case. Either way, this is more of an issue if you hold for the long haul, rather than taking an opportunistic approach to cyclicality, which is the game that I would recommend playing in this particular case.

Disclaimer: I do not accept responsibility for losses that are a result of buy/sell recommendations I make. I encourage you to do your own reserarch before making an investment decision.

Arise: Price Heads South, Fundamentals Head North – A Few Charts

The share price of the Swedish windpower company Arise indicates a struggling company. arise kurs

However, the balance sheet is solid after the recent refinancing and the pricing fundamentals have improved significantly this last year, especially since the start of the year. The combination of electricity prices (first graph below) + e-certificate prices (next two graphs) are now consistently above the 500 SEK/MWh range. A level we haven’t seen for the last three years. Finally “in the money”-territory on an allin basis, not just on a cash flow basis as has been the case in recent years. I believe break-even (e-spot + e-certificates) is now around 400 SEK/MWh if we include the recent impairments.

elsek

March was particularly cold and was probably an outlier. The price has come down and settled at 400 SEK/MWh for April (still way above previous years: April 2017: 280 SEK/MWh, April 2016: 200 SEK/MWh, April 2015: 240 SEK/MWh).

E-certificate prices have risen sharply in the last few weeks:

e-certificates

Screen Shot 2018-04-30 at 10.46.54

Much of this has to do with rising coal prices (and CO2 emission pricing has an impact on this which is why I include a graph of that as well).

coal

co2

The story has changed but the price hasn’t reflected this change, yet!

The Case for Uranium

Presentation slides: The Case for Uranium.pdf

Cliff notes:

  • Unsustainble gap between production costs and prices
  • The number of miners are down 90% since 2011
  • Both sides of the supply/demand balance is shifting in a favorable direction and the longer term outlook is fantastic
  • Adding new supply is a lengthier process than in other sectors
  • Game changing events are taking place in Kazakhstan – OPEC-like structure in the near future?
  • Investors hate uranium after a 7-year long bear market
  • Upside potential is explosive while downside is well-protected

 

Wind Power: The Fundamentals in Arise Have Improved

Cliff notes:

  • Arise has refinanced their bond = less risk.
  • Demand for wind power projects among institutional investors has risen.
  • Valuation gap. Trades at half book value while competitor Eolus trades at book value. The size of their pipelines is the same.
  • The forward price curve for electricity has improved. Probably a function of the price of coal and carbon emission quotas rising throughout 2017 and continuing in 2018 laying a floor under the price of electricity.

Summary: The fundamentals have improved while the price of the stock has fallen to 12,50 SEK. I expect a rerating to occur and see fair value in the 18-19 SEK range.

Wilhelm Wilhelmsen Holding Q4 Update

Sorry for the delay in updating the excel sheet following Q4, which was released on the 15th, but here it is: wwhq4-2017.

I have the discount to NAV at 38,3% currently and the total NAV at 396 NOK. Nordea has the same NAV at 522 NOK… Not sure why we get such different numbers, as they don’t specify how they arrived at them but I suspect they value WMS more ”aggressively” than I do. I’d like to see a few more quarters of stable results before I revisit that valuation.

Either way, there seems to be plenty of room for the share price of Wilhelm Wilhelmsen Holding to grow just on the basis of the discount gap shrinking. On the business side there are promising signs as well. I expect mining related commodities to do well in the coming years and the group is well positioned to take advantage of that.

Q4 – Holding

As for the report, it was pretty much in line with expectations at the holding level. Wilhelmsen Maritime Services, WMS, improved both the topline and the EBIT-margin (after M&A costs) which is now at 10%, which is about where it should be longer term. Apart from that there was no big news.

Q4 – WWL

The daugther company WWL was hit by a 140 MUSD provision on top of the 300 MUSD that had already been set aside. This was a surprise to the downside that I had not seen coming and the market cap effect is -4%, which equates to 2% for Holding.

The operating results of the daugther company continued the postitive trend from Q3 and High & Heavy volumes have started to kick in, which is evident in the cargo mix when adjusting for seasonal effects. Volumes grew both quarter-on-quarter and year-on-year. The company has raised the expected synergies from the merger another 20 MUSD annually and they also benefit by 6 MUSD per year from the US tax cuts (which are absolutely madness if I am allowed to have an opinion on the subject!).

Coming up

I am currently digging into the energy space and I expect some of that research will find its way into this blog. So if this is an area that interests you please stay tuned for an update within the coming weeks 🙂

God damnit, I missed the boat!

Every investor knows the feeling of having followed a stock for a while and having considered buying it when all of a sudden the thing takes off and you are left on the dock viewing the boat and its cheerful passengers from afar as it disappears into the sunny horizon while you are beating yourself over the head for missing out on yet another opportunity!

You know that feeling, right?

If so here is why you MUST silence that voice in your head and overcome what could otherwise end up eating away at your life savings:

  1.  That voice is a liar. You would have bought the stock if you had thought it sufficiently attractive. There always is a reason why you didn’t act – most often a very good one. Perhaps you hadn’t put in enough work to understand the company sufficiently, which again is a reason why you could not and should not buy it.
  2. Remember all the bombs and mines you avoided over time due to craving large enough margins of safety. Don’t give in – stay on the path!
  3. If the stock went up based on positive unexpected news flow then it isn’t the same stock any more and therefore it is irrational to have any attachment to what once was. It’s simply a different situation from the one you considered before the news broke. Analyze anew, carefully and deliberately and without haste. Mistrust any bodily reaction compelling you to jump onboard. Detach!
  4. Recognize the danger of hunting the next hot thing that has left people disconnected from their rational selves in a blind hunt for quick profits. One word: Refrain. Fundamentals are what drives prices over the long haul – and they usually come down after the time of exuberance is over. Remember Warren Buffett’s quote: “The market is a device for transferring money from the impatient to the patient.”
  5. You want to always be in a calm state of mind when considering financial actions. Fear of missing out (FOMO) takes you out of that state and into caveman territory where the amygdala and fear and greed rules. When fear or greed has become rampant in the market you want to be an observer as opposed to a participant – and generally opt for the opposite side.
  6. In the history of the markets FOMO is the single biggest contributing factor to bubbles. If you can manage to stay away from those you probably won’t get rich quick but you will live to fight another day when drowning is taking place all around you. In the markets not losing is more important than winning – unlike in life! You won’t die if your neighbour gets the prize and you don’t. Deal with it!
  7. Recognize FOMO as the biggest monster in the market and as a crusher of souls. It may not have devoured your savings yet – your gambles may even have paid off handsomely a few times and lured you into thinking it is a viable strategy – but if you don’t actively keep FOMO a bay, one day the odds are it will devour you cold-bloodedly. Therefore: A day without FOMO in our lives is a day worth celebrating!
  8. Finally, and most importantly: There are tons of boats in the ocean arriving at our shores every year (and by the way, having enough dry powder is also such a boat: the optionality of cash). The best counter to FOMO is to put in the work and dig up enough cases with enough margin of safety so that you can wave goodbye to all of those boats that you will miss with no feelings of regret – and to do so with a smile knowing that yet again you conquered the mighty enemy that is FOMO!

Much of this is easier said than done. And no, I don’t have it down completely myself. But in the words of JFK:

We choose to go to the moon. Not because it is easy but because it is hard!

 

Are You a Cowboy or Are You a Chicken?

Do you swing for the fences or is your main focus on not getting killed? And is your assessment of that question even accurate?

Say Hello to a Chicken (I Think)

Personally, I like to think I’m a chicken as my focus is almost always downside oriented first and foremost. However, when discussing position sizing with friends more often than not I get labeled a cowboy as few and large positions is usually my game.

Charlie and I disagree with that! (Hm, for some reason that line felt good. I wonder if Warren gets the same pleasure from it when he says it – which is often…).

A few bets are all you need, but when you find the few, act aggressively. Diversification is for people who don’t know anything. – Charlie Munger

The point of the above quote is that with knowledge comes risk protection. And in my world big bets are reserved for especially safe situations where as many angles as possible are covered through relentless investigation. For me that tends to be investment companies and conglomerates as these are already quite diversified through their holdings in multiple companies and where there is an added layer of safety through an unusually large discount. I rarely take super large positions outside of those types of companies. So in spite of having massive positions percentagewise I would argue that this is in fact a chicken approach to investing, one in which it is hard to get hurt in a big way.

A hypothetical example

Take an example. Which is more diversified: five promising growth stocks or one investment company with an unusually large discount to NAV? More often than not I’d bet on the latter, but a more accurate answer is, of course, that it depends. If you have deep expert knowledge and an intimate feel for the industries in which the five growth stocks operate, preferably through working or having worked in the field, then you may have yourself a near perfect match between diversification and a high expected value situation, supposing the fields are non-correlated. But few of us have this much expert knowledge and on top of that it would require a lot of work.

 Laziness can be riskier than big bets

So risk comes more from laziness than the sizing and the amount of companies in one’s portfolio. And risk can be materially decreased from understanding and being able to identify the type of situations where one can size up with a large degree of safety. More on that in a recent post: https://hammerinvesting.wordpress.com/2016/12/18/the-sizing-of-a-bet-the-art-of-not-blowing-up-while-getting-the-best-of-it/

Bonus: The title of this post was inspired by a recent Howard Marks interview on Bloomberg Radio : https://www.bloomberg.com/news/audio/2017-02-17/interview-with-howard-marks-masters-in-business-audio To Marks devotees, such as myself, it may not contain anything new in terms of substance but ohhh the pleasure of this man’s eloquence! Poetry blended with the sharpness of a Japanese knife…

Macro Risks & Arise Sold

Macro view

A disclaimer is in order:

  1. A broad macro view of the world in all of its beautiful complexity is a really, really dangerous and risky thing to have. Most people are best off simply buying whenever they have spare cash – as long as it doesn’t threaten their personal situation. Never taking chips off the table at anytime in one’s life except when needing it to buy something is almost always the most prudent thing to do in order to secure buying power as we get older and to fight the fact that inflation eats into the real value of our savings.
  2. Whenever you or someone you listen to is having a negative and bearish macro view you should be particularly sceptical of that view. Being bearish is more interesting and intellectually stimulating so in that respect it can be rather seducing. The question is whether it is beneficial to the wallet because over the long haul being positive has won in the market by a huge margin historically. It does seem that humanity has a tendency to always overcome hardships. Many would argue though that recent decades have been aided artificially by mountains of debt, and that this is now a major source of our current problems.

The optionality of cash and equivalents in a high-risk setting

The markets seem very sure that 1) giant stimulus packages will be approved by the US congress, and 2) that they will work where everything else has failed. That may happen but it is very far from a sure thing and it won’t happen tomorrow, more like 2+ years down the road. In the meantime we are entering into dangerous territory and the risks are mounting on multiple fronts in the coming years. I realize it is unfashionable to make macro calls – and perhaps rightly so – but I do think prudence is called for considering the following factors, many of which have reached proportions unseen for decades:

List of macro risks:

  1. The geopolitical power balance is out of whack which has led to instability not seen since the late 70’s/early 80’s. Could turn out explosive.
  2. Rapidly growing tensions within all developed societies. Is this strictly limited to the immigrant situation or is it also rooted in the enormous inequality divide which is stifling consumption and thereby economic growth?
  3. Poor underlying demographics in the developed world, which may be a deeper and more fundamental cause for the slow growth of the last 10 years.
  4. A possible bubble in the bond market. This is way more dangerous to the world economy than a stock market crash due to the sheer size of the debt market (this could actually be bullish for stocks if money from bonds retreat into stocks). Will haircuts be needed for bondholders? And if so, what happens to the balance sheets that are heavily exposed to that debt?
  5. 0% interest rate for 10 years ought to lead to poor capital allocation, which in turn usually leads to recessions or outright depressions.
  6. How will the steep mountains of sovereign debt all over the world be paid back? Will central banks continue to stimulate and thereby increase risks of a giant blow-off and/or runaway inflation somewhere down the line?
  7. A global trade war seems increasingly likely (given administration picks). This could lead to a global recession.
  8. Low capex globally and high share buyback (which is typically a late-cycle phenomenon) means there isn’t much belief in the future. If companies aren’t investing where will future growth come from?
  9. Historically high margins. Is mean reversion inevitable or is it a sign of the IT economy being less capital intensive? If the former turns out to be true we are in for a multiple contraction.
  10. US jobless claims has fallen to a 43-year low. This is often an early indicator of a downturn and a late-cycle phenomenon since it suggests the potential for further growth is low as there isn’t much slack left. On top of that, even now when unemployment is this low the economy is struggling, which is not exactly a sign of underlying strength.
  11. AI could be here much sooner than expected. Some experts talk about a couple of years rather than 10 years. While this will provide opportunities in the long run – is our system adequately prepared for it in the short term?
  12. How will the stimulus package get financed? More debt or will Trump find a way to let Chinese money invest in roads, airports, etc.? Perhaps in exchange for not imposing trade tariffs on Chinese goods? Win-win if possible but is strong-arm tactics viable in the longer run…?
  13. High valuations among so-called ”safe” dividend stocks due to “reach for yield” desperation. Shiller PE of 28 and the non-manipulative Price/Sales ratio is through the roof at 2,6 (1,6 being the average). Warren Buffett’s favorite indicator Total market cap/GDP is also blinking red. This is currently at 127%. Based on historical averages a fair valued market would be at around 85-90%.
  14. Trump being Trump.

The bullish arguments that I see:

  1. A giant stimulus plan corresponding to 2,5% of GDP over a 10-year period in the US ought to move the needle IF it indeed is approved. And if Germany picks up the mantle and does the same if could have a big effect. It is also a huge gamble because if it doesn’t do much the debt situation will be even more dire as a result.
  2. Deregulation and tax cuts may also add some umpph. However, the latter could have a negative effect on long-term growth if much of it is given to the top, which would not do much for consumption.
  3. Bond weakness could transform into stock strength as the money leaving the bond market has to go somewhere. If I had to choose, I’d feel safer in the stock market than in the debt (bond) market right now.
  4. The possibility of a Trump impeachment would reduce many of the outlier risks. I suspect there will be a huge number of Republicans that will leap at the opportunity to get rid of him if it arises now that they have secured power. And I suspect there will be ample opportunities as the guy is likely to confuse his own financial interests with those of the state at some point.
  5. In general I think it is more prudent to move to the emerging world where there is growth potential due to low debt levels as well as lower valuations.

Conclusion

One can argue whether the risk/reward points to a bullish or a bearish view, but one cannot argue against the fact that the risks are high. As a consequence of my own cautious view I have set out to increase the cash position to at least 30% and I am currently looking into gold miners as a potential currency and market hedge. I will probably post something about my findings further down the line.

For Those About to Trump etc.

In my last post I had said I’d write in depth about the US election situation but decided I cannot do it without it quickly becoming a private issue, which isn’t of interest to anyone. So I’ll just quickly say it makes me boil with anger that people chose untruth and unchecked aggression and that they were willing to put on a big gamble that will undoubtedly cause a great deal of harm to living beings all over the globe. But one either gets this or one doesn’t and my words won’t make dent of difference.

I hate what happened with uncontrollable anger. So this is my mistake for the year: In order to preserve mental health I will resort to shielding myself from the words of Trump and his lunatics to prevent that anger from taking over, preferring instead to read commentator’s analyses of the situation. As an investor you always want the naked source not other’s interpretations of it so this is a step backwards for me. Hopefully something will come in the way of this presidency so we can move on.

For the record: I was for Bush being elected in 2000 (and against in 2004) so this is not automated knee-jerk lefty speak. I have listened to tons of past interviews with Trump and figure I have a grasp of what the man is made of and it isn’t the material of a man with a grand and carefully thought out vision. His path is fraught with bankruptcies and court battles and there isn’t much else there except the ego’s will to express itself.

Portfolio update – Arise sold

I decided to sell my remaining stake in Arise. I took some chips off following the September spike and now I let go of the rest. The reason being the combination of 1) a collapse in e-certificate prices lately (143 SEK/MWh in October to 69 now) as well as what I regard as a surprising weakness in the electricity spot price (below 300 SEK/MWh for a full week). A combined price below 370 SEK/MWh in wintertime despite extremely low water reservoir levels (low capacity in the system ought to lead to higher electricity prices) while the share price is approaching a three-year high has made me decide to move to the sidelines.

In addition to this there is a bit of uncertainty about the fact that the Kölvallen-project (150-200 MW) has still not received the final permit. It was scheduled to happen in the fall of 2016 and now the decision is expected in Q1.

To be clear it was a close decision to sell and my cautious macro view and my wish to increase the cash position played a part. I still think the share price is a bit lower than fair value even given current circumstances but on the other hand it isn’t as much of a no-brainer proposition for me currently so I elected to monitor the situation from the sidelines and perhaps re-enter at a later time should the outlook as well as the margin of safety become more attractive again.

When I started writing about the stock in October 2014 the stock price was 17,10 (https://hammerinvesting.wordpress.com/2014/10/09/arise-windpower-traded-at-a-historically-large-discount-part-1/). Now it sits at 21,50 for a gain of 26%, which isn’t great for a two and a half year time frame but market beating nonetheless.

The #1 Error I Committed in 2016

An interesting, a tumultuous and an utterly horrifying year for the developed world has come to an end and even though I am thankful the year was extremely kind to me personally I find it difficult to shake off the nasty feeling that something terrible could be about to unfold in the world. More on that in my follow-up post. In it I will outline an investment mistake that I will make in 2017 and there is nothing I can do to prevent it due to a flaw in my mental constitution…

For now though I’d like to focus on the one giant mistake that I know for sure that I committed in 2016 because I think it is one many of us make and I think it is very much avoidable. At the end of my post I will also get into my current top positions.

Preparation, damn it!

Trump wins and I sit and sweat like an idiot researching military defense companies and pharmaceuticals after the fact instead of putting in the work ahead of time. This isn’t merely one of those excusable mistakes we all make during a year. Instead this is one that cannot be brushed off lightly because it is one of few areas where there is a significant edge to be had by individual investors who are free to ignore the day-to-day noise as opposed to many money managers who get measured on quarterly performance.

Frantic research leads to fuzzy thinking, which again tends to lead to rushed, subpar decisions. (I bought one company, Invisio Communications, after only a few hours of research only to sell it the next day after further research. Great company, stretched valuation in the near term.)

So the lesson is: Plan ahead or prepare for getting pushed around by the market and expect mediocre results.

Definitely easier said than done as many events will be of the ”thief in the dark”-variety, i.e. completely unknowable ahead of time. But there are others that are dimly available to our eyes out there in the distance.

Think ahead – examples

Suppose, for example, that China is forced to devalue their currency by a massive amount, say 25%. This would send violent shock waves through the global markets but it would probably also cause many Chinese stocks to become extremely attractive right after the devaluation (as opposed to before!). And I imagine in the first few hours of the panic one may be able to pick up some nice bargains while the markets are searching for their footings. This presupposes that one has done the work on the potential individual companies and that money can be moved to those markets quickly.

For individual companies there will often be ”trigger events” where one can calculate the value of each outcome ahead of time. This road is perhaps a better one to take, especially with regards to smaller companies, than trying to get ahead on the macro front.

Time is of the essence

You will notice that I am preoccupied by time and tactics here. The reason being that I have a lot of respect for the market’s ability to correct mispricings quite quickly and so often they will only appear for short periods of time before the gap is closed.

Many value investors will not bother with such tactical maneuverings preferring instead to search for compounders and worry less about hitting them at the point of maximum pessimism. This strategy relies on superior analytical ability and patience (the mother of all edges) and it is a fine one.

It isn’t one that is ideally suited to my personality though as I tend to look more in the deep value and ”special situations” space where mispricings are more temporary in nature and where my superior tolerance for pain (if I may say so myself!) can create potential edges in the market. A more opportunistic mindset.

For those wondering about my tolerance for pain… Yes, your suspicions are correct: This skill was carefully crafted over years as a slave in a sadomasochistic relationship giving in to the needs of the wife! That plus a side career playing cards characterized by violent volatility on a daily basis helped as well.

Strategic focus

If I had to put percentages on my general strategic focus I’d say somewhere in the range of 60% deep value, 25% tactical/special situations, 15% buy-and-hold compounding and 0% momentum. So compared to many buy-and-hold value investors I usually turn over my portfolio more than most, often in the 100-200% range.

Unusually low portfolio turnover for me in 2016

In 2016 my big positions in Wilhelmsen Holding and Arise Windpower (which at one point constituted 80% of my overall portfolio, unfortunately I sold off 1/3 in WWIB following Trump) called for lots of waiting, so I did almost no buying and selling until mid-September – 11% of my portfolio was turned over altogether, unusually low for me. By the end of the year that had climbed to 40% due to rearrangements in the portfolio following the US election, which I believe to be a game changer event.

My top 6 positions going into 2017

As of this moment my top 6 positions and their weightings are:

Wilhelm Wilhelmsen Holding (WWIB, NO) – 32% weighting

Cash and equivalents – 18% (including time arbitrage positions)

Mylan (MYL, US) – 13%

Arise Windpower (ARISE, SE) – 11%

Protector Forsikring (PROTCT, NO) – 8%

AO Johansen (AOJ, DK) – 7%

(Smaller positions – 11%)

Cash = optionality

The plan is to increase cash to about 30% in the following month or two as I am becoming more and more fearful of the mounting risks on multiple fronts and want the optionality that cash provides.

It won’t be fun to watch the market likely go higher while sitting on cash but there are meditative ego lessons to be learned in the process of sitting on one’s hands…

My next post

In my next post I will get into the risks that I see as well as go into the mistake I am inevitably going to make in 2017.If you are in the mood for some gloom and some doom stay tuned for For Those About to Trump – I Salute You!

The Sizing of a Bet – or the Art of Not Blowing Up While Getting the Best of It

In many areas of life size is overrated in my opinion. The wife thinks otherwise – which is always a cause for concern as evening approaches… Now when it comes to investing you cannot afford to close your eyes to uncomfortable facts. And one such fact is that if your strategy to outperform the market relies on high concentration on a relatively small number of high conviction ideas you will blow up at some point in time if your understanding of the mechanics of bet sizing is flawed.

The better the odds, the bigger the sizing – then readjust for risk

The main idea is very intuitive to most. We size each bet according to the expected value of it. EV being the difference between the stock price and what we perceive to be fair value after careful calculation, which is the difficult part. Only then do we readjust for risk by scaling down when the risk is high and conversely scale up when it is not.

(Two notes: 1) EV in this context should not be confused with Enterprise Value, and 2) The time horizon is unimportant. A ”bet” could easily be a 20 year long position. I use the term ”bet” in the title for two reasons. The more important one is the wife thinks ”position” is better used in other contexts. And so being sensitive to risk I opted for ”bet”. The secondary and less important reason is that on a musical level ”bet” is more pleasing to the ear!)

Why the highest EV idea should not always be our biggest position

Assume that we are magically confronted with two bets that both have a 3x expectation and the outcome of both will be decided tomorrow. Bet both our own house and that of our grandma, right? You know the answer: Not so fast – it depends on the risk involved. So let’s quantify:

In example A there is a 30% chance the company gets bought tomorrow at 10x our investment and a 70% chance the deal fails and as a result that the company goes belly up and our investment is worth 0.

In example B the numbers are 4x 75% of the time, and the remaining 25% of the time it goes bust and we get 0.

The Expected Value of each is the same:

EV in example A: (10 x 0,3) + (0 x 0,7) = 3x

EV in example B: (4 x 0,75) + (0 x 0,25) = 3x

Let’s ignore the fact that both of these very hypothetical bets rank in the ”72 virgins in the sky”-sphere, ie. not gonna happen, but really, really nice to think about nonetheless and let’s instead agree that bet A is way riskier than bet B though the average expectation for each is the same. Neither proposition are in the ”bet grandma’s house”-range, but for some very risk tolerant dudes or gals bet B may actually be within the ”bet our own house”-range.

Size really is everything!

The EV is massive for both bets and therefore no-brainers that are criminal not to make. But since we ruled out betting grandmas house on the grounds it was too risky (though plenty of people had no problem taking risks at the expense of others in the years leading up to 2008!) the question then becomes one of sizing.

The Kelly criterion not suitable for everyone

How much then? Some use the so-called Kelly criterion, which is a mathmatical formula that provides the theoretically optimal way to size one’s bets to maximize long-term growth of capital. I would caution against it, however, since it does not take your own personal situation into account, such as cash flows from your job, risk preference, age, mental constitution and last but not least errors in judgement. To add a margin of safety some will use fractional Kelly (mentioned in the link above).

What I do

I don’t use Kelly myself but I do factor in both my personal cash flow situation, the number of opportunities I currently am aware of, my conviction level in each as well as the risk inherent in each – all to best of my ability.

The gold standard: many non-correlated high EV bets

The gold standard is to have a ton of non-correlated high conviction bets. For that to be the case one of two things need to happen.

One is you need to first narrow the field of ideas intelligently and then do a huge amount of work on all of the most promising ones. Only a rare few possess both the intelligence and the inclination for constant hard work such as a Warren Buffett, a Peter Lynch or a Mike Burry (think The Big Short), so many high EV ideas will be hard to come by for most.

Investment ideas from people you know to have the right process in place can be a source but remember you will need to have a thorough understanding of the drivers and the details of the business in order to know when to sell so work is always necessary unless you take to index investing, which is probably preferable for most people – though I will provide another solution that almost certainly will beat the market over time at the end of this post without too much work. It probably won’t be by a huge amount but it will beat indexing.

Absent that you may need to wait for the market to take a big dive and suddenly the waters may be ripe with opportunity.

A history of three 50%+ positions – and a gut wrenching loser

In the past five years I have had three 50%+ positions. Most people I know would never even consider this a possibility and it certainly isn’t the gold standard you want to aim for most of the time. However, I would argue there are times and situations when huge bets are very rational and not especially risky.

The first of those three times was in early 2012 in a Danish company called United International Enterprises, or UIE. This is a holding company where the discount to net asset value (NAV) had risen irrationally to 46% while the historical average was in the 20-30% range. The assets were stable in nature and on top of that the brothers who held the reins had recently bought shares for 1.5 million USD in the company. To me this seemed like a situation with both significant upside and a lot of safety on the downside attached to it, which is what you want out of a big bet. It worked out well and after 7-8 months the discount had narrowed to more normal levels and so I sold.

The second situation was a Swedish company called East Capital Explorer in late september 2013. The situation is similar in many respects, except the assets were more diversified and it required some work to ascertain the NAV as the holdings consisted of 40+ companies in 10 different countries listed on obscure exchanges. The company would issue a quarterly update of the NAV in 8 days time and due to heavy insider buying (8 million USD) I thought there was a good chance the NAV would increase significantly and that I could front run the update by doing the work myself and know the result ahead of time. I concluded it was at 42% while the historical average was at around 25% so I took a large position and sold it 2 months later when the discount went below 25% and received a 30% gain in exchange for a little effort.

The third case is Wilhelmsen Holding. I’ve written extensively about that so no need to go into detail here except to say that since it is also a conglomerate with a huge discount to NAV as the other two cases the risk is greatly reduced when comparing to a one trick pony type of company that sells products within one sector only. Leverage at the holding level is also very limited in this case.

Huge insider buying adds to safety as well. Also fraud becomes less of a concern in conglomerates and investment companies with many holdings, especially when insider buying has been prevalent.

Greed gave rise to this post 

Back in October 2014 I got greedy and loosened up on my bet sizing requirements (read: I screwed up on them). A Norwegian company in the oil service sector, Polarcus, had essentially been reduced to an option because of declining revenue coming from the big oil companies. The upside was huge but so was the downside risk due to high leverage. Still I thought the EV was attractive enough that it warranted a bet, especially since pension funds were selling out desperately in what seemed to me to be a forced fashion.

My thinking was that these are not the sharpest knives in the industry and that the reason for their selling might be due to institutional market cap constraints following the decline in price or managers simply trying to protect their job by not having a loser in their books. Seeing this I got greedy and violated my own rules and put 20% in it.

The oil price declined further in the weeks to come following an OPEC meeting in which the Saudis decided they would go for market share rather than cut production. The oil companies cut their capital expenditures more and more as time passed and it started to seem likely that Polarcus would need a cash injection to stay afloat which would probably wipe out the existing shareholders given the size of the loan in comparison to the market cap.

I got out ahead of that, luckily, and took a tough 25% loss on the position. It turned out to be the right decision but still I was taught a painful lesson about sizing. I’d bet on the situation again but hopefully I can control my greed the next time a similar one presents itself and size these option-like situations more appropriately.

Summary

The big bets should be reserved for cases where the downside is extremely well protected along with significant upside to protect the opportunity cost. The gold standard is to have many non-correlated high EV bets because then downside risk suddenly becomes much less relevant. This is difficult to obtain at any specific point in time due to both time restraints and due to the market seldom cooperating in providing you with tons of non-correlated high EV bets. And non-correlation is genereally hard to come by in the interconnected world we live in.

So how can someone who isn’t well versed in the markets use the above info and expect to outperform the market? By zooming in on investment companies in particular (and perhaps also conglomerates) and buy when the discount to NAV is above the historical average, preferably by a significant amount, and sell when it goes below. This is an easy way to buy a significant portion of the market while doing it at a discount, which ought to lead to outperformance. Seems almost too easy but it really does work.

Here is a list of Swedish investment companies you might want to look into so you can strike when the discount is out of whack.

Next post

Stay tuned for my next post around New Year. It will be about the mistakes I committed in 2016 as well as the composition of my portfolio going into 2017. Having made almost no changes all year I made some significant ones following the insane Trump victory.

Takeaways from the Wilhelmsen Capital Markets Day

I attended the Wilhelmsen Capital Markets Day in Oslo last week and it turned out to be fruitful in many respects. More than 100 people showed up and it was great to have the chance to exchange ideas with other investors and to meet management for the first time in a format that allowed plenty of time.

While there weren’t any ”breaking news” (plenty of those leading up to the event) Wilhelmsen’s investor day turned out to be a smörgåsbord of relevant information, and not exactly of the blue sky scenario garbage variety that is often dumped on investors at similar events. Those following the Wilhelmsen companies may have already seen the slide presentations but I will just add my 2 cents in a note-to-self format as things were said that weren’t in the slides.

Notes from Wilhelmsen CMD

The holding company, WWH (stock ticker WWIB):

  • The merger will add ”at least” 50-100 MUSD to the bottom line of WWL, primarily due to the utilization rate of the vessels improving. “At least” was new information to me.
  • Major reasons for the merger: Quicker decisions, less stalling = more manuverability in a market where margins are under pressure.
  • Share buybacks is not on the table currently. The overarching goal is ensuring long term value creation and survival by keeping the holding company net debt free as it is now (no bond debt to use for share buybacks in other words). Subsiduairies can potentially assume more risk in the form of debt – all at an arm’s length away from the mother.
  • Aquisitions targets need to be close to debt free (I like the sound of that!), dominant in their field and have an underlying positive cash flow. No experimentation that will endanger equity in WWH.

WMS:

  • Margin pressure. Outlook in the near term is cloudy.
  • Low customer credit default risk despite shipping customers hurting perhaps more than ever. Partly due to WMS being able to withhold vessels until payment has been obtained, meaning bills from WMS are not the ones you want to stall.
  • Interesting Survitec deal. 20% in a company that is a dominant market leader in all segments they enter into. High margins and nice pricing power. IPO potential in 2-3 years.

WWASA:

  • Margin pressure going forward. Merger to offset some of that.
  • Supply/demand under pressure as there is very little scrapping potential for the next 10 years world wide and the world fleet is younger than ever (Chinese boom 5-10 years ago to blame for that). Scrapping/new building-ratio does not look favorable many years out unless new building cancellations start to take place.
  • WWASA best in class? Utilization rate of 85-90% is above industry average of 80% and EBIT-margins seem to be better than their biggest competitors, though it is difficult to measure as the competitors are not pure RoRo players only and do not specify their margins by segments in their financial reports.
  • Mining is finally showing signs of improvement (Rio Tinto capex expanding again) and big opportunity for growth particularly in Australia where WWL has a strong inland logistics network.
  • WWL’s land based logistics business is asset light and has grown rapidly. Revenue now about the same as ocean transportation (although most of it comes from the low-margin distribution business). Margins from Terminals and Tech Services, which currently accounts for 40% of inland logistics revenue) are handsome in the 10-15% range. Long term contracts and cash flow is stable. In my opinion this change in revenue stream will lead to a repricing of WWASA further down the road.
  • The inland and ocean based businesses are separate financially, meaning should one experience difficulties it will not drag down the other.

Conclusion – what has changed?

Wilhelmsen Holding’s prudent capital allocation strategy means one can view an investment in the company as a storage of value with almost bond like safety while also getting the benefit of a lot of upside potential due to the generous discount-on-discount effect, which I find to be counterintuitive. A simple sum of the parts-valuation (based on mark-to-market pricing of WWASA, Treasure and Qube, book value of NorSea and EBITDA*6 for WMS) gives an upside of about 100% from the current market price. Added to that both the holdings in WWASA and Treasure appear undervalued (hence the discount-on-discount). Both of those companies probably have sharper upside potential in the near term but at greater risk, in my opinion, particularly WWASA.

Adding monetary experimentation and mindboggling politics into the equation

The current non-tested central bank experimentation, the weird political scenes around the world and high valuations in general leads me to believe that one ought to focus on safety rather than going for that extra percentage point here and there while exposing oneself to the enormous risks lurking out there. So in general I think defense is the play right now. In life the mindset of not losing is often equal to losing. But in investing there are times when not losing is a way to set the stage for winning…

Wilhelmsen: On Today’s Merger

A quick update on my opinion on today’s proposed merger. You can read the press release from the company here: http://www.newsweb.no/newsweb/search.do?messageId=408785

Expected gain for the holding company (WWIB): 30 MUSD per year (250 MNOK)

First the hard numbers. The synergies – a larger and more robust company will be able to achieve better financing terms, will need to employ fewer people as well as being able to direct their combined vessels more efficiently – are expected to result in a gain on the bottom line of between 50-100 MUSD for the new merged company, Wallenius Wilhelmsen Logistics.

Wilhelm Wilhelmsen Holding (WWIB) will own 40% of this company, which means the bottom line will improve by 75 MUSD (average estimate) * 40% = 30 MUSD per year = 250 MNOK per year. There are 46,5 million outstanding shares which means earnings will improve by 5 NOK per share. If we assign a conservative PE of 5-6 that would mean 25-30 NOK/per share. The market’s verdict today: 7 NOK.

Now that I got my scorn for the market’s ability to do simple math out of the way let’s focus on the broader picture because there is more to this merger than the gain from synergies.

The name itself indicates a gradual move which has been underway for the last couple of years away from shipping and towards inland logistics, where margins are better – and where stock valuations are much higher. WWASA is valued at a gigantic discount to book value, while inland players such as Hyundai Glovis (p/b 2) and Qube Holding (p/b 1,5) – both of which Wilhelmsen Holding hold a minority share in – are valued much higher.

There is also the fact that the Wilhelmsen’s have once again demonstrated a willingness to let go of majority control and instead focus more on releasing shareholder value. I think this trend is very clearly going to continue. Once a tightly controlled company starts to open up like this the odds of it reversing course are low. The selling off of the Hyundai Glovis shares may now have come closer and perhaps there is more streamlining to come from the Wilhelmsen Maritime Systems division in the near future as well.

Just my two cents on the meaning of today’s development. I’m curious about your view…

Wilhelm Wilhelmsen – Glovis Shares to be Spun Off

Just a very brief update on Wilhelm Wilhelmsen ASA & Holding after restructuring announcement and Q4 results yesterday. I will go into more detail on my estimates of normalized earnings when I come back from a two month vacation to the beautiful country of New Zealand.

The market price of Wilhelm Wilhelmsen Holding’s main asset, WWASA, has been very suppressed in relation to current earnings for quite some time – and even more so in relation to my estimate of normalized earnings. When I checked last week it has gone from very underpriced to comically underpriced considering the following simple math:

Market value of WWASA: 6900 MNOK.

Market value of share in Hyundai Glovis: 6600 MNOK

Market value of WWASA excluding Glovis: 6900-6600 = 300 MNOK

WWASA profits after tax for the last two challenging years: around 1000 MNOK per year excluding contributions from Glovis and after one-off provision for the antitrust case.

A first step toward a more market friendly direction?

Yesterday management took a step that surprised both the market and myself – namely to prioritize transparency in relation to the company structure by spinning off the shares in Hyundai Glovis in a different listing. The company has for many years been more focused on creating long term real shareholder value (as can be seen by the constant increase in shareholder equity over the years) than caressing the market with cosmetics moves such as simplifying the company structure but apparently the mispricing became too much even for them (being a publicly traded company and all) and the market has reacted with long overdue hoorays, especially for WWASA. I personally think this move is mainly a cosmetic one as no real value was added equity wise by today’s announcement but still important in that it could signal a first step in a more market friendly direction which could lead to repricing faster than otherwise might have been the case.

2016 will most likely be another challenging year for High & Heavy

Q4 saw an expected decline on the top line while profit margins improved. Considering that major customers such as Caterpillar and John Deere are having the fourth straight down year for the first time in their history I believe better times are to come in the years ahead for the High & Heavy (mining & agriculture) segment, which is the most profitable segment and one that WWASA is particularly exposed to. Business has always proven cyclical in nature while many analysts tend to extrapolate recent trends into the future leading to faulty expectations. It may still take some time for the segment to turn around – most industry players (WWASA, Caterpillar & John Deere among others) expect 2016 to be another tough year – but profitability is still good for WWASA currently and investments into new vessels by competitors have been at stable levels so no reason to suspect a substantially tougher playing field in the years to come, in my view.

Disclaimer: I am heavily exposed to WWIB and may unconciously be biased in my views. Always advisable to do one’s own research…

It’s That Time of year – Window Dressing and Tax Selling

A Danish poet wrote a poem many years ago saying that the year contains sixteen months and five of those are November! A not so subtle hint that darkness and cloudy weather is becoming the norm at this time of year and that time tends to become more of a drag.

My mother and I are less pessimistic. In fact it is a month where we indulge in our disorders and celebrate them. For her Christmas comes early. And those 107 Santa Claus characters populating every shelf in the house? Well, they are just not enough. And so as soon as the stores make new ones available she acts swiftly and decisively. With skills carefully crafted and perfected over many years she picks out the most spectacular ones before anyone else can get to them – and thus fulfills her cravings.

I’m also like that at this time of year except my disorder is more related to stock purchases. I load up on stocks I have had my eyes set on and I even buy on margin (4% currently and I will most likely boost it to 10% as I have done in previous years). Doing so makes me tense but I simply refuse to let those crumbs lie on the floor without picking them up when they are thrown around so carelessly by money managers clinging on to their jobs. You might say I have a mean streak in me because I don’t believe in leaving money on the table for my fellow man but when I see mispricings before my eyes without acting on them, I become physically ill. The stomach ache from buying on margin I can handle but not that other pain. Also, stomach ache is the constant companion of the bargain hunter so I get a bit of extra practise at the same time!

So what makes some money managers become so generous all of a sudden? Why do they act like amateurs and let small investors eat their lunch?

Window dressing

Some investment funds mislead their clients by selling badly performing securities before the end of a reporting period – month, quarter or year – and use the money to buy a rising security instead or to hold cash to buy back the securities they sold when the new period begins. By listing the stocks they hold at the end of the period the fund wants to appear to have performed better than it actually has. It is a despicable practise but it is a well-known fact within the industry that it occurs and it is most prevalent during the months of November and December.

Here is another window dressing technique that I witnessed in real time as I had an interest in buying a related stock at the time: Check out Wilhelmsen Holding’s A stock movement, ticker WWI, on October 30th, the last day of the month. In the last half hour of trading that day the price jumped 10% from 154 to 170,5 on low volume ochestrated by one buyer, CSB, who had been buying heavily in the previous weeks. The related B share hardly moved and in the following days the price came down by the same amount. This maneuvre is not legal but nonetheless it can often be witnessed in several illiquid stocks, especially on Dec 31st. The purpose is to inflate performance numbers at a relatively small price. It seems silly and if you or I did that it would be akin to pissing in our pants to keep warm for a few seconds. But perhaps you would also be tempted by sub par investment decisions if you had clients or bosses to report to?

Tax selling

In an overall rising year selling losing stocks to cancel out part of the wins can lessen the tax burden. For this reason you will often see stocks that have underperformed reach their lows in November/early December.

Be on the other side of the trade

You could call both of the above light forms of ”forced selling”. Any time you can be on the other side of a trade that isn’t driven by company fundamentals you want to be in that position – supposing of course that you want to own the particular stock in the first place. Note that what I am talking about here is the general odds of the above happening – you never know with absolute certainty who you buy from or what their motives are.

The January effect and small cap losers

Part of the reason January is often particularly good to small cap stocks that performed badly the year before can be attributed to the above practises. The market tends to correct itself and smooth out ineffeciencies but strangely this one has persisted and I will continue the uncomfortable practise of buying on margin for three months of the year and then gradually become non-leveraged come February/March until evidence says the market has erradicated it.

This bet doesn’t always turn out favorably, of course. In fact as late as 2014 I was not treated with any respect whatsoever by Mr. Market when I went for a leveraged oil play that turned sour as the oil price decline worsened. I won’t know for sure whether my bet was sound but I believe it was and therefore I would do it again. Investing is at heart a mathmatical undertaking where you attempt to estimate the likelihood of different scenarios happening:

Expected value = (Intrinsic value of the company in Scenario A * likelihood percentage) + (Scenario B * likelihood) + (Scenario C * likelihood) etc…

Dance like a butterfly sting like a bee

The above is a quote by Muhammad Ali to describe his boxing style: Non-dogmatic and opportunistic. When you see an opening: Pounce. I think this flexible attitude can also be applied by the enterprising investor even though check lists and hard rules are also a fine way to guard oneself against permanent loss. But to completely shut oneself off from action when circumstances are especially favorable is also a mistake in my book – mistakes can also be ones of omission as Charlie Munger puts it.

There is only principle I will not bend ever and that is the idea of a large Margin of Safety. The gap between what I perceive the value to be and the market price needs to be large for me to consider an investment no matter the circumstances.

The Cat is Out of the Bag – Part 2 (Arise Windpower)

The electricity market in Sweden has been very soft in 2015 due to a number of factors. The biggest contributing factor has been an abnormally wet year increasing the hydropower supply. Other factors: more wind capacity added to the system, a rather slow overall economic recovery, warmer than average temperatures and more than average wind conditions (reflected in the good operating results). In other words, when it comes to electricity prices 2015 has been hit by a perfect storm in almost all respects. In a normalized setting, power prices ought to increase – especially given the fact that four nuclear reactors – 13% of the overall supply – is in the process of being taken out of the system from now until 2020.

As a result Arise Windpower decided to write down their assets by about 10%. In my opinion a bit on the cautious side to do so given that they still have nice hedges in place until mid next year and thus plenty of time to see how the price situation plays out but it is after all a technicality and the market has already discounted the depressed conditions in the price of the Arise shares, which even after the write-down trades at 50% of book value despite a flow of high margin project sales.

Important to note also that about 70% of the production from their co-owned windfarms in Jädraås (about 40% of their overall production) have hedges in the 630-640 SEK/MWh range until the end of 2017 (compared to market prices, including e-certificates, of around 400 SEK currently) thus providing a nice cushion should electricity prices continue to be depressed.

Eolus Wind had written down their assets on Oct. 16th – their write-down was 15%, but I believe their assets are also older on average and thus bought at a time when wind turbine prices were higher. Other wind farm operators have chosen not to write down their assets but they may be forced to do so in the future.

I recently wrote a longer post about the e-certificate situation, thoughts on the future for ocean-based wind farms and possible project sales in the coming years for subscribers on inrater.com and I plan to write a more in-depth post on the overall situation on there soon.

Meanwhile, let’s hope El Nino brings wrath to the Scandinavian winter… May we all suffer a cold and painful winter and may the winds blaze through our lands at violent speeds!

The Cat is Out of the Bag – Part 1 (Wilhelmsen)

Wilhelm Wilhelmsen and Arise Windpower both presented investors with shocks in their Q3 reports. The underlying results were solid as expected but provisions and write-downs shaved off significant amounts of their equity from their balance sheets.

In the case of Wilhelmsen, WWASA made provisions of 200 million USD for the anti-trust case, and the holding company, WWI & WWIB, another 50 million USD in impairment. It was known the company would be fined, but based on the settlements in Japan and South Africa I had estimated the global fines to amount to approximately 100 million USD, so it is fair to say I was surprised by the amount. Even though it isn’t the final verdict, it must be in that neighborhood since the company has been silent on a specific amount until now. The cases surfaced about 4 years ago so it has been a long wait that has contributed to uncertainty among investors.

It is important to note that the fine does not threaten the survival of the company at all. Their cash position and their easily liquidated share position in Hyundai Glovis (worth about USD 800 million, WWI owns 73% of this) insures that the liquitidy position is very solid. The decision to keep paying the biannual dividend also indicates that the company views their financial position as solid. What the provision means is that 13% of their equity was shaved off, compared to the 5% that I had estimated.

No market reaction

The market reaction has been non-existent. In fact, the stock trades 5% higher compared to one month ago (it is down 5% today, but this is set off by the 5% increase yesterday ahead of the report). That begs the question if the market, unlike me, expected the size of the fine to be as large as the company made provisions for today. That could be the case. It could also be the case that the market judges the provisions to be overly pessimistic.

But there is also a third option, which is embodied in the following quote by Franklin D. Roosevelt:

”We have nothing to fear but fear itself”

He said this in a famous speech in 1933 following the crash in 1929 and the subsequent uptake in the economy which had started to play out. It was true then and it is also true as a general concept for investing. Whenever there is uncertainty about a specific outcome investors tend to overreact. And for private investors with no bosses to report to (and therefore no way to get fired!), this provides a road to overperformance in a ”low hanging fruit” sort of way – provided, of course, the survival of the ongoing business of the particular company is not in question.

Historically cheap valuation

The long term potential in the case is very much intact. In fact it seems to me almost mindblowingly cheap considering that the company’s earnings power is strong compared to the market cap (P/E 4-5, excluding today’s one-off provisions) and has been for many years in spite of tough conditions with increased competition and the fact that the high margin high & heavy market (agriculture, mining equipment) is experiencing hardships, evidenced by reports by Caterpillar and John Deere (25% downturn). One ought to ask oneself what happens to the already healthy profit margins once that segment turns around… The other major segment – transportation of cars by sea – is almost certainly bright considering the growing middle class in China and India (and Africe further down the line) as well as the future replacement of gasoline driven cars towards more electricity/hybrid driven ones.

On a price-to-book valuation WWIB is priced at 0,49 and WWASA at 0,60. There is no reason why a dividend paying healthy business is priced at these levels and I continue to believe the price is based on irrational fear. If you think otherwise, please give me a holler!

Reaction to Arise Windpower’s write-downs

On Friday I will take a look at another company, Arise Windpower, where an almost identical scenario has played out following their report on Nov. 6th. Since I am writing about this company to subscribers at inrater.com (I write about Swedish and Danish companies on there) I cannot go into too much detail, but I will lay out my general outlook.

Update on Wilhelm Wilhelmsen Holding

It’s been a long while since my last post, so I thought I’d give a short update on developments in Wilhelm Wilhelmsen Holding (listed in Norway) since my last post. Please excuse me if this post is a bit more hurried and less thorough than I normally aim for (fewer concrete numbers), but it is vacation time 😉

Wilhelm Wilhelmsen Holding

Bearish developments:

  • The Big Negative: Their shares in Hyundai Glovis have come down by more than 30% since my first post on WWH on March 18th. As this is WWH’s most important asset, accounting for NOK 4,1 billion (NOK 5,8 billion on March 18). This is a significant portion of the market cap, which is currently NOK 8,1 billion. The share price in WWH has increased 16% in the same period.
  • Hyundai and Kia have recorded declining car sales. I expect this to have a negative effect on Q2 as these two companies are major customers of the coowned company EUKOR. It is, by the way, the major reason why the Glovis shares have come down.

Bullish developments:

  • The Big Positive: The dollar is has recently come back to its highs from March and the oil prices have gone down once again meaning revenue is worth more and operating cost are coming down. Clearly favorable for WWH.
  • Much as I expected Q1 was a great quarter, primarily due to a strong dollar, a low oil price and cost cutting effects from 2014 that have started to have an impact.
  • The ClarkSea index is up.

Conclusion:

In my opinion, the combo of Glovis being worth less while the WWH stock being priced higher makes WWH less of a no-brainer than it was four months ago. I still believe it to be a sound investment long term, but I think it is odd for the market not to react more negatively to such a sudden and heavy decline by their major asset and I fear that this could take place any time so I have decided to reduce my position by two thirds and put that money in more consumer related investments where I see more tailwind both short and long term. The discount to NAV is still favorable, which is why I am keeping one third and ready to increase again if circumstances dictate doing so.

Note: The price was 149,50 when I recommended the stock and it now sits at 171, an increase of 16% (when including 3 kr in dividend received in May).

Stay tuned for my next post on a subject I think is particularly important for investors having stocks in troubled industries, which is my favorite hunting grounds. The title is going to be Becoming Comfortable with Uncertainty.

Wilhelm Wilhelmsen Holding, the Bull Case

My last post on Wilhelm Wilhelmsen Holding, WWI, focused on the Bear Case, https://hammerinvesting.wordpress.com/2015/03/19/wilhelm-wilhelmsen-the-bear-case/. In this post I will present some bullish arguments. It will be shorter than my first two posts as some bullish arguments have already been discussed in those:

The Bull Case

  • Bottom of High & Heavy cycle?
  • High barriers to entry
  • Strong balance sheet
  • Strong dollar, cheap oil, opex cuts
  • Cheap share price, possibly based on irrational reasoning (see Bear Case)

As with the Bear Case, let’s look at each of the above.

Bottom of High & Heavy cycle?
For the last two years there has been a recurring theme in every quarterly report: ”Unfavorable cargo mix.” What that means is that the company would like a larger percentage of their cargo to be in the High & Heavy-segment, which is more profitable than the car carrier segment.

The reason for this unfavorable mix is that mining and agriculture companies have been holding back on capex spending, ie. upgrading old equipment or buying new due to depressed prices in those sectors. The good news is this cannot continue for much longer. At some point in the not to distant future they will have to make these investments. A good indicator of when this shift occurs is to keep track of reports of manufacturers of that type of equipment: Caterpillar and John Deere.

I list this as bullish since we want to be investing in cyclical companies when they are near the bottom of their cycle instead of near the top. When High & Heavy starts to improve we can expect better margins. Since the stock is already cheap based on current earnings, I expect this to have a strong impact on the share price once it kicks in.

The car carrier segment seems poised for continued growth as former poor countries lift a larger portion of their citizens into the middle class.

High barriers to entry
Investments into the car carrier sector is capital intensive and it takes years from purchasing a vessel till it is delivered. In other words, the economic moat around the sector is quite wide. This makes increased competition less likely in the foreseeable future and profitability more likely to be durable.

Strong balance sheet
When investing in depressed markets, a strong balance sheet is essential in making sure that companies can weather potential storms for longer than their competitors. An additional benefit of having cash on hand is potential opportunities to buy competitors in trouble or their assets. Having an equity ratio of 48% for the holding company, WWI, and 51% for the daughter company, WWASA, Wilhelm Wilhelmsen is in a strong position. Also noteworthy is the interest WWASA is paying on their bonds: 2-3,5%. In other words, they have access to cheap money and are not bogged down by large interest payments.

Strong dollar, cheap oil, opex cuts
In the near term there are a number of external factors that WWI will benefit from.

The strong dollar contributes to stronger earnings as revenue is mainly in dollars and only to a lesser extent on the expense side.

Cheap oil reduces transportation costs – although some of those savings are likely to land in the pockets of customers in the form of cheaper prices. At least that has been the case in some of the shipping and transportation companies that I follow.

During 2014 Wilhelm Wilhelmsen undertook operating expenditures cuts that will start to have a positive impact in 2015.

Cheap share price based on irrational reasoning (see Bear Case)
All of the above bull arguments mean very little if the share price is overly expensive. In my post on March 19th, the Bear Case, I noted some possible reasons for the cheap price, some of which are clearly irrational.

Future posts on WWI
My three posts on WWI have focused mainly on qualitative aspects. I will probably revisit the case and post one that is more numbers driven (free cash flow) in the coming months.

Let me know if you have any questions or additional thoughts that can shed more light on the case.

Wilhelm Wilhelmsen Holding, the Bear Case

In my first post on W. Wilhelmsen Holding published yesterday, https://hammerinvesting.wordpress.com/2015/03/18/wilhelm-wilhelmsen-holding-quality-at-bargain-prices/, it was established that the stock is exceptionally cheap right now, based on both Price/Book and Price/Earnings.

Why is it cheap? The Bear Case
This question ought to be the main focus when we dig into the fundamentals of a company, which on the surface appears to be especially cheap. There is always the risk that it is a value trap and that the market knows about things that we don’t. As we slowly peel the onion that is the company and get closer to the core of it, reasons will start to appear. The main question is if those reasons are rational or not.

So far I have spotted the following possible reasons:

  • Antitrust investigations
  • Uncertainty about contract renewal
  • Fear of increase in local car production?
  • Conglomerate discount
  • Shipping market discount
  • Norwegian market discount (following the current oil crash)
  • The founding family controls more than 50%
  • Dividend payout ratio is low (12%)
  • No share buyback
  • Cyclical, low liquidity, boring

Let’s look at those one by one.

Antitrust investigations
WWASA and three Japanese competitors are all being investigated for price fixing from 2008-2012. The investigation started in the fall of 2013 and has already led to fines from Japanese authorities. Two Japanese competitors have also been fined by US authorities and it is expected that WWASA will be fined as well. It is also expected that the EU, Canada, Mexico and Chile will seek to fine the major of players in the industry. This creates uncertainty in the market. But it can also be a source of opportunity and lead to mispricings if that fear is irrationally overblown. WWASA expects a clearer overall picture on this issue during 2015.

Having spoken to analysts who have followed the process more closely, the expectation is that the total fines for WWASA will be in the USD 100-120 million range, and USD 200 million being a worst case scenario, in their opinion. Translating those numbers to the balance sheet of the holding company means a reduction of between USD 70-140 million in equity. If that turns out to be the case the effect will be in the 0,02-0,03 range in terms of Price/Book, ie. it will jump from 0,49 to 0,51/0,52 – still a far cry from P/B 0,84 of 2013 and 2012. In other words, while a serious matter, this alone cannot be the reason for the heavy discount – if we suppose investors are rational.

The liquidity position of WWASA is solid enough to counter fines of this size. On top of that WWASA has a 12,5% share in the logistics company Hyundai Glovis, and that share is currently worth approximately USD 1 billion. So if things get tough, they can sell a portion of that.

Uncertainty about contract renewal
Eukor, which is 40% owned by WWASA, has a contract renegotiation with Hyundai and Kia coming up in 2016. Eukor currently transports 60% of Hyundai’s and Kia’s exports and there is uncertainty whether this will continue or whether it will drop into the 50% or 40% range. WWASA has stated that they expect volumes to remain the same. Perhaps the market views this as overly optimistic.

Fear of increase in local car production?
I have not been able to find information on whether there is a trend in this direction currently. But if it is indeed the case, or if it happened in the future, it would result in a smaller market, so it is a potential threat to keep in mind and to look out for.

Conglomerate discount
There has always been a discount compared to a sum-of-parts valuation in WWI. As I wrote in the first part of this analysis, I don’t completely agree with it, but it will probably stay that way in the foreseeable future. Should the company decide to spin off some of their holdings, this will come down and the share price will go up.

Another reason for the discount might be a very simple one. Both WWI and WWASA consist of a myriad of companies and joint ventures, which makes it harder and more time consuming to analyze. Perhaps many potential investors stay away for that reason. However, none of those two reasons address the increasing discount gap.

The general shipping industry has been hit hard
The Baltic Dry index, which measures the transport activity of commodities by sea, is at an all time low – due to a combination of overcapacity and declining demand. As a result of that many players in the shipping industry are struggling. However, WWI’s main operations are in the car carrier and high & heavy markets, which are both unrelated to Baltic Dry. The revenues for the Ship Service part of the group has declined slightly – but profits are up and EBIT-margin a healthy 10%. However, these numbers are relatively small compared to the overall numbers for the group.

You could argue that if the market is viewed to be in a slump now and the current P/E is at 3,4 what happens to the share price once profits start to really take off?

Norwegian market discount
Norway is to a very large extent synonymous with the oil and shipping industries. As both have witnessed brutal declines recently some investors in the region may have withdrawn funds from the overall stock market out of fear regardless of the industry that the individual companies are in. A lot of stocks on the Oslo stock Exchange are traded at historically cheap prices. For some the fear is warranted, for other much less so. I believe the latter to be the case for WWI.

The founding family controls more than 50%
Some investors don’t like to be at the mercy of one group controlling 50%+ of the outstanding shares. However, it is very well documented that founding families tend to be more focused on long term value creation than your average CEO. And generally speaking, you get rewarded handsomely for owning shares in family owned businesses. However, there is also another side to this story and that is that the company (Tallyman), which controls the majority of shares in WWI, is owned by about 15 family members, I am told (as a side note, many of those are on this list of Norway’s richest people, among them the group CEO, Thomas Wilhelmsen: http://www.dn.no/nyheter/naringsliv/2013/10/18/her-er-norges-1000-rikeste). What happens if there are disagreements with regards to the overall strategy within that group. Can it hamper decisive action?

Low dividend payout ratio
WWI is expected to pay out NOK 3 to shareholders in May and NOK 2 in November, this equates to only 12% of earnings (3,3% dividend yield). Compare that to the more normal 50% payout ratio of other companies. I think this is one reason why WWI is usually cheap compared to its earnings power. In the current low interest environment the market is hungry for dividend yield so I have no doubt the share price would explode if the company suddenly decided to payout 50% of its profits. Very unlikely to happen though. The company does not strike me as one that changes its strategies to satisfy the market.

No share buybacks
If the primary aim of a company is to increase shareholder value one expects that company to invest its profits in ways that maximizes the return. New capex investments might be expected to produce a return on investment in the 10-15% range. However, there is another low hanging fruit waiting to be grapped now that the company’s asset are for sale at only 49 cents on the dollar and that is to buy back its own stocks. If Price/Book were to increase to the more normal (but still cheap) levels of 2012 and 2013 the stock would increase by about 70% in value. That seems like a no brainer investment to make. And personally, I would much rather see this happen than increased dividends.

I don’t believe it will happen though. The company has no history of doing so and it may prefer an organic growth strategy. If that is the case, perhaps the stock market is punishing the company for preferring empire building rather than shareholder maximizing initiatives.

Cyclical, low liquidity, boring
I don’t care in what shape or form they present themselves but I like value propositions. Paying much less than the expected value of an asset is all that interests me. But many investor groups need an investment to fit into a certain box in order for them to invest and in many ways WWI doesn’t fit the bill.

Dividend investors tend to be defensive and shy away from businesses that are cyclical in nature, which WWI certainly is.

Institutional investors want a minimum of liquidity otherwise their very buying and selling will move the price too much to be worth it for them. On many days the volume in WWI is less NOK 1 million, which is surprising for a company of this size.

Gamblers want bigger day-to-day movement than WWI provides, being in a mature business segment and with a low gearing ratio and solid balance sheet. The later also scares away growth oriented investors.

Personally, I am indifferent to those reasons. I just want the gap between price and value to be huge. I also don’t mind volatility from year to year as long as value is created and compounded over time.

Bear Case conclusions
Of the above mentioned 10 possible reasons for the discount, I believe the first three are somewhat rational. I am the most uncomfortable with the second and third reasons as I find those the hardest to assess both in terms of the likelihood of them occurring as well as the possible impact they can have. The rest are not really rational in my book.

I hope there are skeptical investors out there  who would like to share their thoughts if they have found holes in my analysis or have additional information or questions/thoughts to bring to the table.

You can read the third and final part, the Bull Case, here: https://hammerinvesting.wordpress.com/2015/03/23/wilhelm-wilhelmsen-holding-the-bull-case/

Wilhelm Wilhelmsen Holding – Quality at Bargain Prices?

Everyone and their neighbor has been participating in a mad rush to buy quality companies (earnings wise) for the past year or so. This has led to bloated, pumped up prices and I want no part in that race even though the participants have been rewarded nicely – so far. Value investors typically look a little dumb in the latter stages of bull markets, but Seth Klarman and the like often remain with their clothes on unlike many others investors a couple of years later. As I have said repeatedly in my blog: Quality is not a safe haven. Price is king when it comes to evaluating risk, not quality. But, if I can have it both ways, I am open to suggestions!

I might just have stumbled upon such a company: Wilhelm Wilhelmsen Holding, listed on the Oslo Stock Exchange, stock ticker WWI. It has in fact been on my radar for some time I just hadn’t gone down and dirty with analyzing it due to its complexity which meant it would be a time consuming exercise if nothing came up. Below is a diagram of its structure:

WWI overview

The 25% drop in share price since July has triggered my curiosity and I thought it would be an excellent time to take a closer look and dig into whether the drop was warranted or whether it has provided an opportunity for investors. Especially since the share prices of the three main competitors have gone up in the same period of time, indicating a low probability that it is the future prospects of the market they are in that is at fault.

Wilhelm Wilhelmsen Holding, WWI, has an immaculate value creation record since 1861. In the last 15 years WWI has returned 12% annually (semi-annual dividends + increase in share price) to their shareholders, which equates to 4,5x their money, beating the general market by a wide margin.

The company’s biggest asset is the daughter company WWASA (to the left in the diagram above), of which it owns 72,73%. The company’s primary market is transportation of cars and so called “high & heavy” equipment (mainly mining and agricultural machinery) by sea. They also have a lot of subsidiaries and joint ventures in related markets. In other words, it is a conglomerate, and investors typically crave discounts for those. However, unlike many other conglomerates WWI’s businesses intertwine creating synergies, so perhaps it would be more appropriate to award a premium to the share price instead. This probably won’t happen any time soon. However, it is my belief that the current discount will come down as it is rather large.

Key valuation figures, WWI (holding company)

Today 2014 2013 2012
Price/Earnings 3,4 4,2 5,9 4,1
Price/Book 0,49 0,55 0,84 0,83
Solvency ratio 48% 48% 46% 42%

Key valuation figures, WWASA (daughter company)

Today 2014 2013 2012
Price/Earnings 7,3 8,2 7,6 4,9
Price/Book 0,80 0,79 1,22 0,77
Solvency ratio 51% 51% 48% 45%

At the time of this analysis the price for WWI was NOK 149,50 (for the B share, the A share was slightly higher at 150,50 – if I was buying, I’d buy whichever is cheaper on the day). Price/Earnings is extremely low at 3,43 based on 2014 numbers and the company guides for 2015 to be similar to 2014. Price-to-Book is at 0,49, down considerably from 0,84 in 2013. Curiously, in the heyday year of 2007 Price/Book was at 2,2 (4,5 times higher than today).

These first two numbers generally don’t go together. Either you have excellent earnings and pay a high price-to-book for it, or you have poor or negative earnings prospects and are compensated by getting what is on the balance sheet at a discount.

What’s the catch?
Why both? What are the dangers lingering out there in the horizon? Well, according to my analysis there are a few but in my opinion they are relatively minor in proportion to the heavy discounts the market is providing.

  • Antitrust investigations
  • Uncertainty about contract renewal
  • Fear of increase in local car production?
  • Conglomerate discount
  • Shipping market discount
  • Norwegian market discount (following the current oil crash)
  • The founding family controls more than 50%
  • Dividend payout ratio is low (12%)
  • No share buyback
  • Cyclical, low liquidity, boring

Follow-up post
In my next post, I will take a closer look at each of those bear case arguments and following that I will then proceed to the bull case arguments: https://hammerinvesting.wordpress.com/2015/03/19/wilhelm-wilhelmsen-the-bear-case/

Polarcus – the Story has Darkened

Since I posted my analysis on Polarcus on Nov 18th and a follow-up on Dec 8th the price of oil has come down dramatically to reach USD 45 (Brent) at its low point. Judging from the number of tenders and the current day rates in the seismic industry, Big Oil has essentially freezed their seismic capex spending. During December oil companies reported they would reduce capex by 20% on average. Since seismic players CGG and WesternGeco were quick to reduce their seismic fleet my thinking has been that the balance between supply and demand would not take as large a hit as was reflected in the seismic share prices. However, the tender activity in January was down 50%, and in the North Sea there has been 5 tenders while there is usually 20-25 this time of year. This development is especially unfortunate for Polarcus because of their strained balance sheet and poor backlog for Q2 (45%) and Q3 (55%). Since January 7th there was no new orders until March 4th. And PGS CEO has recently said that there is still 15% overcapacity in the industry and as long as this gap exists this will naturally have an adverse effect on day rates.

Two problems in the horizon
There are two problems in the horizons. The immediate (but less serious) one is loan covenants. In order not to be in breach of those Polarcus needs USD 150 million EBIDTA on a 12-month rolling basis for Q2 (they need USD 50 million in total for Q1 and Q2). I believe they will reach that but it isn’t a certainty if the backlog for Q2 doesn’t build up very soon. A bigger issue is Q4 2015 where the total EBIDTA needs to reach USD 172 million on a 12-month rolling basis and where the equity issue in Q3 2014 does not count in the equation any more. In light of developments the last couple of months I don’t see that happening. But this has happened before and has only led to insignificant fines so it may not be a big issue after all. Then again, it might…

The overshadowing issue, though, is the refinancing of the bond that is maturing in April 2016 where they need to pay USD 104 million. Free cash flow will not cover this amount and given the current yield-to-maturity of their bonds (in the 40-50% range) a new bond issuance seems extremely unlikely unless the market turns sharply upwards in less than a year’s time. So that leaves four other options: The sale of a vessel, new cash injection through equity placement, debt restructuring or liquidation – the latter I think is very unlikely unless oil collapses completely, I assign less than 5% to the likelihood of that scenario. Shareholders will root for the first option as the other three options will almost wipe them out. Sovcomflot has an option to buy the V. Tikhonov vessel, which is currently on bareboat charter. If this happens the share price will almost certainly shoot dramatically upwards (except in the case of a fire sale price). I don’t see this as particularly likely though. My guess is that Sovcomflot is as capex spending focused as the rest of the industry, and if they decide to buy they have a lot of leverage when it comes to pricing given Polarcus’ situation.

The need for cash
That leaves us with cash injection from a new equity issue and debt restructuring. The low share price has made the first of those options less likely. The market cap is now around USD 40 million and Plcs needs at least USD 100 million. In other words, we are looking at a dilution of current shareholders by at least 70%. On top of that, it might only be a shortterm solution as it doesn’t address the bigger issue, which is that there will still be a large amount of debt left which is difficult to service in the current environment. For that reason, I think a debt restructuring is the most likely scenario and one that bond holders will be pressured to go along with. For shareholders this will be bad news as debt restructurings usually wipe out 90%+ of their value.

Sold Polarcus shares, bought Dolphin
For the above reasons I decided to sell my Polarcus shares and buy Dolphin instead. I believe in the longerterm outlook for the industry but right now I believe the risk/reward has become less attractive in Polarcus, even though the stock has gone down significantly in the last two weeks.

Polarcus – lessons learned
I took a loss of 22% (average buy price 0,76, average sell price 0,59) and even though this isn’t the first time that has happened this one has been particularly painful due to the size of my position. I have no problem with the buy and sell decisions themselves. Macro events are impossible to forecast and I would do the same again every day of the week given the situation as it was, and especially once the pension funds started selling out. However, I will probably think twice about the sizing of my bet in a risky proposition such as Polarcus in the future. I am not ready to admit that there may have been an element of hybris involved due to large bets having paid off very well in the past since I previously have only made big bets when the downside was very well protected. The mental anguish involved, however, has been an eye opener. I have followed the developments of the stock price too closely which has led to less research on other possible investments. That has been the main lesson and I cannot allow that to happen again. Overall, the experience has reinforced my belief in taking contrarian positions.

Next article
In the near future I will post an article called “The Sizing of a Bet” where I will go into this subject in more detail as it is one I am fascinated with.

Arise Windpower – a Quantitative Analysis (Part 2)

Back in October I wrote a qualitative analysis on Arise Windpower (https://hammerinvesting.wordpress.com/2014/10/09/arise-windpower-traded-at-a-historically-large-discount-part-1/) – before reading this quantitative follow-up I recommend that you read part 1 first.

I have been hesitant making calls on future electricity prices due to political uncertainty regarding a possible re-election. Since it has now been cleared up that there will be no re-election I feel somewhat more comfortable making these estimates. However, it is important to realize that there still is a lot of uncertainty in the assumptions below.

Since October, there has been some interesting developments:
1) A project with a capacity of 46 MW was sold to BlackRock, one of the largest money managers in the world. The company will receive a healthy profit of SEK 46 million as well as management fees going forward.
2) Due to the current low electricity prices the company has decided to reduce risk by selling three wind parks with a total capacity of 25 MW (total portfolio is 266 MW). They expect to sell these wind parks at prices above book value. On December 3rd the first of those were sold at a price that was 15% above book value. It was the small Stjärnarp wind park with a capacity of 5,4 MW which was sold for SEK 83 million and which had a book value of SEK 72 million (cost 75 million, depreciation 3 million).

Projects sold above book value, while the stock is traded at a 48% discount
The above sales show that even in the current challenging environment where electricity prices are at historically low levels, customers are willing to buy at prices that are above book value. This is not reflected in the current stock price, which is selling at a 48% discount to book value. After these sales the risk in the stock has been reduced significantly and the upside ought to be apparent for investors.

Let’s now take a closer look at the net present value of future cash flows and convert the number to price per share. Below are my assumptions.

Discounted cash flow analysis – assumptions:
– The previous expansion strategy has been put on hold due to lower electricity prices and therefore I will assume no building of new farms. This means Arise will rely on the cash flows generated from existing wind farms as well as projects sold to external parties. Should total energy prices rise to above 700 SEK/MWh it can be expected Arise will again look into expansion. This is an added upside but also one that is impossible to quantify, and so for this analysis I will focus on the current strategy only.
– Arise has sold 5,4 MW recently and aims to sell 20 MW more at a price above book value. This will lower debt from SEK 1,6 billion to around SEK 1,2 billion. Whether or not these sales will materialize, it will not affect the intrinsic value of Arise Windpower by much. It might be slightly higher if these sales do not materialize, however, the investment will also be somewhat riskier.
– Yearly average production: 715 GWh (current) – 87 GWh (sale of 25 MW) = 628 GWh after sale of 25 MW.
– Life span of a wind farm is 25 years. E-certificates are received for 15 of those years. On average Arise’s total wind farm capacity has been in operation for 3 years. That means on average they have 12 years left to receive E-certificates. For the remaining 10 years only elspot prices will be collected.
– For 2015 we already know Arise will receive around 600 MSEK/MWh due to forward price hedging. Very little is hedged after 2015.

– From 2016 and onwards I make the following assumptions as to prices and the likelihood of them occurring:
Scenario 1: Total elspot + E-certificate prices from 2016 and onwards: 450 MSEK/MWh. 2% price increase per year. Probability: 15% (No e-certificate hike + prolonged lower e-spot prices)
Scenario 2: Total elspot + E-certificate prices from 2016 and onwards: 650 MSEK/MWh. 2% price increase per year. Probability: 60% (normalized e-certificate prices + slightly higher e-spot prices but still below historical average)
Scenario 3: Total elspot + E-certificate prices from 2016 and onwards: 800 MSEK/MWh. 2% price increase per year. Probability: 25% (global recovery above expectations)

In terms of free cash flows my estimates for a normal year are as follows – based on previous years and based on a price of 650 SEK/MWh:
Screen Shot 2014-12-28 at 23.03.22

– On top of revenue from own wind farms Arise expects project sales of 75 MW on average per year. After the BlackRock deal this seems a reasonable assumption. Total profit after tax for those sales is estimated to be SEK 35 million. Added to that approximately SEK 5 million in management fees per year per project. We don’t know for sure whether Arise will succeed in making these project sales, but due to the recent sales I estimate there is a 75% chance of this happening – so for the numbers I have discounted with this factor.

Given an 8% discount rate, I have calculated the intrinsic value per share to be as follows:

Scenario 1: 13,60
Scenario 2: 31,50
Scenario 3: 44,20

Weighing the different outcomes I arrive at the following numbers:
Intrinsic value: 13,6 x 0,15 + 31,5 x 0,60 + 44,2 x 0,25 = SEK 32,00 per share

The current share price is 16,90. And the current book value per share is 34,90. In other words, the above estimate is still below book value. Considering what recent customers have been willing to pay for Arise’s wind farms it is possible my guesstimates are too conservative. I’d be interested in hearing yours.

Note that when it comes to discounted cash flows it is a case of garbage in, garbage out. And since there is a lot of uncertainty in almost all of these numbers, take it for what it is: Lots of guesses as to possible future outcomes.