When There’s Lemons …

This week’s missive will get back to some of the basic block and tackling we face at times as investors.  Not to downplay the market madness, it seems everyone and their brother now has a view on the pandemic. Certainly not immune to the downdraft, in hindsight my decision to sell my taxable Canadian stocks on February 28th makes me look like a genius.  The reality is essentially sheer dumb luck. It did, however, provide the cash to nibble on subsequent down days.

The Canadian IRA Taxability Answer

I did receive my first dividend from TMX Group a couple of weeks ago and to my chagrin saw Canadian tax withheld even though it’s in my IRA.  Obviously one of the outliers I previously referenced. While my appeal failed, my broker did confirm two of my companies reside in this category, the other being Hydro One.   I did gain some insight which I figured I’d share.  

1. To be processed as compliant with the tax treaty, companies have to use the DTC – which comes with a cost.  Most Canadian companies trading in the US absorb this fee as a cost of doing business.
2. Canada has their own version of the DTC – CDS which is owned by none other than the TMX group, which uses (at least for US based stockholders) Citi for disbursement without treaty compliance review.
3. Brokers have no recourse but to withhold Canadian taxes in IRAs for CDS processed dividends.  Meaning there is no tax benefit for US citizens holding non-DTC processed securities.

These two will be sold from the IRA when the markets recover a little.  Meanwhile both are also held in my taxable account where I can claim a tax deduction when taxes are filed.

De-risking Process

With the heightened level of uncertainty, more than a few bloggers have shared their approach towards increased safety.  Dividend Diplomats ran a piece on Debt to Equity Ratios and Chuck Carnavale reviewed a Debt to Capital analysis. While both metrics are fundamentally sound – and I’ll likely add to existing holdings that are on these lists – both share a flaw that is highlighted by the current black swan event.  Companies in unprecedented numbers are drawing down their credit lines or issuing new paper, both of which have an impact on the ratios. I mean, is Disney any less of an investment with $6B additional debt offset by $6B cash? Other than a slight increase in carrying expense, I would argue no but they do have other issues with the magnitude currently unknown.  My take is this is where the ratings agencies theoretically should be earning their keep.

My process is to essentially begin the process of reducing the speculative portion of the portfolio.  Eliminating my one BDC (MAIN – smaller business exposure), Entertainment Properties (high social distance exposure), Newell (a recipient of an SEC subpoena).  This is one time a dividend cut or suspension doesn’t necessarily mean a sell if the purpose is cash preservation. I did reduce – but not fully sell – Cracker Barrel on their delay and suspension.

Additionally, I keep abreast of the news to identify potential opportunities.  You’ve heard the mantra, Don’t Fight The Fed?  How about profiting from the economic stimulus they’re embarking on?  Blackrock is a (partial) proxy for this angle. I say partial as I doubt the fees will generate a meaningful profit to them.

In Parting

As no one knows when and how this will end and I doubt I have the time on my side to play the long game, the better part of valor is to strengthen the hand I have.  Someone younger can carry more risk but caution is warranted in my opinion. Either way, try to make some lemonade from these lemons.

Oh, Hell

… the U.S. could see a 20% unemployment rate if the coronavirus pandemic is not properly dealt with.

reportedly, Treasury Secretary Steven Mnuchin, March 17, 2020

Perhaps it was hyperbole in performing some old-fashioned arm twisting with GOP senators, but it sure was a market mover with the DOW dropping 6.73% the following day. It was down 1,000 points when the double whammy hit:

Hell is coming.

Bill Ackman, CNBC interview March 18, 2020

Bill’s context was in urging companies to conserve cash by pausing buybacks, the warning was apparently heard as the markets promptly dropped further, triggering a circuit breaker. Fast forward two days …

Hell is here.

Robert Herjavec, CNBC interview March 20, 2020

The difference obviously being big companies versus small. Then there are the minis. The mom and pop shops – sole proprietors. The ones that operate on a shoestring budget to begin with.

Assuming Mnuchin is the face of the organization – at least in regards to negotiations with Congress – it would appear to be a tacit acknowledgement that the president has been blowing smoke – albeit perhaps for tactical reasons. Realizing a 20% unemployment rate is not a foregone conclusion, as this is a level not seen since the Great Depression, I doubt many investors have come to grips with the current bear market. Time In The Market recently published a view that is rational and insightful.

Yet, if we are on the verge of Hell, it may be useful to understand some of the conditions present when it last arrived:

• Unequal distribution of wealth
• High Tariffs
• Slowing Economy
• Market Speculation (notably margin use)

While similarities exist, differences include Federal deficit spending and an external catalyst (rather than implosion).

What is stunning is the general lack of foresight now on display. Granted, some industries (airlines) had any contingency plans blown away with various governments forcing their hands. The line being formed by corporations and trade associations less than a month into the crisis is downright obscene. Some requests on behalf of workers are understandable, but it is becoming increasingly apparent that the Trump corporate tax cuts did little to shore up the vitality (or viability) of many companies. At the very least, retained earnings (in theory) should sustain companies for longer periods. History may reflect that this opportunity squandered was a result of greed.

There are some foundational cracks forming as well. Ronin LLC, a clearing firm was dissolved last week and some banks acted to shore up money market funds after significant outflows.

It will be one thing to pass a relief bill. As always, the devil is in the details – specifically the delivery mechanisms. Various ideas have been floated – using existing SBA, ADP, PAYX or US Treasury infrastructure but each has inherent flaws. Meanwhile of the small businesses I’m familiar with; a pizza parlor is now delivery only, an after market auto custom shop is sidelined pending a restart of production lines, and another is working through order backlogs. One – a caterer – has evolved from banquets and corporate events to Non-contact Delivery Foodservice. Various approaches from hunkering down to minimizing losses to retooling the business model. Whether Hell is coming or here already, at least ingenuity remains in full swing!

The Bull Is Dead

Another brutal week in the markets at large as the long running bull market officially died.  It is perhaps fitting it came to an end under the watch of the only president that I can recall that used the stock market as a barometer of his economic prowess.  Perhaps had his team treated the outbreak seriously a little sooner he could have been viewed as managing the outbreak’s severity on the economy as opposed to now being managed by the situation.

The world as we knew it has – at least temporarily – come to an end.  Sports, leisure activities, schools and large gatherings are suspended and working from home is back in vogue.  While the House passed a bill for an initial stop gap measure, Trump finally did declare a national emergency – perhaps bruised by the bad press.  Not helping matters was the meme tweeted by his own staff.

The pace of news related to local and corporate responses to the virus  has been fast moving, one example being the NCAA tournament being changed to an event without fans to outright cancellation.  My initial thought for this week’s topic was how the economic impact of this one event’s lack of fans would impact local economies.  Scratch that research line – but I will share that the play-in game had an average impact to the Dayton economy of roughly $4.7 million, including ticket sales, lodging, restaurants and air travel.  Concession sales benefited Pepsi (PEP), Kroger (KR) and Anheuser-Busch (BUD) as well as a local charity. Airlines serving Dayton are Allegiant Air (ALGT), American (AA), Delta (DAL) and United (UAL).  Arena sponsors (priceless advertising) include Fifth Third Bank (FITB) and Cincinnati Bell (CBB).  Extrapolate that across the other thirteen, larger, multi-day sites and the picture becomes uglier.  Extrapolate further across the overall US economy and all of the events, services and venues potentially impacted and one can easily see why recession worries are on the rise.

One aspect I find troubling in this evolving situation is the confirmation by Treasury Secretary Steven Mnuchin that the administration was considering emergency assistance for affected industries. “This is not a bailout. This is considering providing certain things for certain industries. Airlines, hotels, cruise lines”.  Ignoring the semantics over the ‘bailout’ definition, airlines are perhaps understandable. Hotels, less so due to their existing leverage. But taxpayer money going to cruise lines? Methinks the administration has yet another unforced error looming on the horizon.  

Consider the optics:Royal Caribbean (RCL), Norwegian (NCLH) and MSC are incorporated in Liberia, Bermuda and Switzerland respectively, making them foriegn companies.  Even Carnival (CCL) is not immune having a dual US and UK corporate structure. Adding insult to injury: Only one ship (Norwegian’s MS Pride of America) is US flagged.  All others are flagged Bahamas, Panama or Malta.  While the Jones Act can be cited as the cause – thereby itself needing revisions, my belief, perhaps unfounded, is that these companies use this as an excuse to lawfully circumvent US Labor laws.  Cha-ching!

Another item easily overlooked last week was the Fed’s injection of liquidity into the system.  The rumor mill has been working overtime on this one but the general consensus is that hedge funds and private equity firms have been urging their portfolio companies to draw down their lines of credit – proving once again that cash is king especially in uncertain times.  In the event that the epidemic is little more than an economic blip, this could be considered prudent – essentially, no harm, no foul while generating some income for the banks. The problem I see is if the perception of a bungled operation is allowed to become a reality resulting in greater harm to the economy.

The general investing blogging community has finally awakened to the fact that there’s more than just noise as I’m seeing more posts on the Coronavirus topic.  Other than the drop in portfolio value all else is normal on this front. The dividends keep coming. Overall they are growing with only one cut to report. I was watching with unusual attention the results from my two Hong Kong companies as the virus is literally on their doorstep.  Both cited Coronavirus and the protests as headwinds being dealt with. One (Swire Pacific – SWRAY) maintained last year’s dividend rate while the other (MTR Corp – MTCPY) surprised me with a 2.5% increase. The common denominator being both had retained earnings and lines of credit as a backstop.  Over the next quarter, I believe the number of US companies drawing down their LOCs could be a leading indicator of the direction that this is going, i.e., is the worst behind us or yet to come? Meanwhile, I am selectively averaging down – last week was Australia’s Computershare (CMSQY) and Canada’s Toronto-Dominion Bank (TD).

As always, thoughts/comments are welcome!

Coronavirus – Pt 3

Another week has elapsed with the coronavirus headlines still front and center.  Politically in the US little has changed with the President doing his utmost to slant the narrative, including leaving an infected cruise liner offshore stating, “I like the numbers being where they are,” … (appearing) to be explicitly acknowledging his political concerns about the outbreak: “I don’t need to have the numbers double because of one ship that wasn’t our fault.”

On the state of the markets, as anticipated there was volatility this past week – despite an emergency Fed rate cut – and the DOW eked out a slight gain.  The one piece of good news at the end of the week was the announcement on test kits for the virus. Many details have yet to be released but will initially benefit two companies – Labcorp (LH) and Quest Diagnostics (DGX).  I suspect it will be provided on a minimal cost-plus basis due to the optics and several insurers already stating existing policies will cover said tests.

 It’s becoming increasingly clear that pundits (probably including yours truly) have disparate ideas as to what’s next.   What is known is travel is being disrupted – Amtrak, airlines and ships. Conventions, including the iconic SXSW, have been cancelled or postponed with a direct economic impact already exceeding $1B – with more to come.  Many companies are issuing earnings warnings, enacting travel restrictions and enabling work from home regimens. Schools in some areas – including the US – are temporarily closing.  Each of these comes with a yet to be identified economic cost, both direct and indirect.  As the US is primarily a service economy, much of this output will not be recovered in future quarter GDP numbers.

Playing on this theme, Jim Cramer began touting his “stay-at-home economy index”.  While (hopefully) being a thought stimulus for his followers, the most blatant issue I have is how well these companies can profit from this paradigm shift.  For example, will new subscribers flock to Netflix? Will companies continue their unfettered advertising on Facebook? How many buildings does Prologis have vacant to accommodate Amazon?  Does Amazon have spare robots up their sleeve to ramp up? This ‘index’ might have legs if the virus is more than a one or two quarter blip.  

Besides the test kits, my inclination is to look at the perceived necessities – the stuff flying off the shelves – even though demand may be based in fear rather than reality – and determine if the stock price reflects a value proposition.  These would include (public companies only):

• N95 Face Masks (CDC approved) 
  • Honeywell (HON)
  • 3M (MMM)
  • Kimberly-Clark (KMB)
  • Alpha Pro Tech (APT)
• Disinfectant Products (EPA approved)
  • Ecolab Inc (ECL)
  • Stepan Company (SCL)
  • Lonza Group AG (LZAGY – caution – possible spinoff)
  • Clorox (CLX)
  • Reckitt Benckiser (RBGLY)

In store for the week ahead will probably be a battle for the headlines between Coronavirus and oil.  No deal in Vienna is good news for US consumers other than the Texans dependent on the oil industry. Prudence dictates I review my oil patch banks’ relative exposure in a declining price environment.
Long: DGX, NVDA, AAPL, PLD, PEP, MKC, MMM, KMB, CLX

February 2019 Update

Given the Coronavirus impact on the market, my monthly review will be abbreviated with a planned return to normalcy next month.  That said, the portfolio was essentially flat with the S&P, both down – -9.18% for the index and -9.43% for me. The difference is an increased cash position which if I included would put me down 8.78%.  Dividends rose 26.71% year on year but this is misleading as I timed the moves (actually buy/sell transactions) of my Canadian stocks to my IRA post ex-dividend date as best I could to duplicate several of the dividends.  

Positions sold: TD Ameritrade (pending merger), Nutrien (a little leery of China’s ability to buy ag products per trade deal) and Invesco’s Timber ETF (is a slowdown looming?).

Positions Added: Vonage (a free one, so I’ll probably hold for a year) and Coca-Cola Japan (hoping the Olympics aren’t cancelled).

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Now that we have a correction, what next?   First and foremost, ensure your investing plan accommodates this type of black swan event.  Next listen to multiple news sources to separate the hype from the reality. For instance, the World Health Organization upgraded the risk of spread on Friday.  Also on Friday, a somewhat flippant Mick Mulvaney said, “what I might do today [to] calm the markets is tell people turn their televisions off for 24 hours”. The President held a Saturday press conference where he “called for calm … and tried to reassure the nation that the threat was under control”.  Are you reassured?

I take my cues from warnings and conference calls.  On Friday I was presented with my first dividend cut of 2020 – AMC Theatres.  This is one I won’t sell on the cut for three reasons.

1. I had suspected this when I bought my most recent tranche and I bought enough to pretty much offset the cut
2. They are on the front lines of any potential virus impact
3. They are doing it the ‘Warren Buffett’ way

The December drop (when I last bought), I did check the debt maturities first.  In their call they stated, “when there is real uncertainty in the world, we’re going to be conservative and keeping cash in our pockets to make sure that — what I think might be somewhat irrational fears the market has had over the past few days don’t turn out to be rational fears.”  In addition to the dividend cut, management is taking a pay cut replaced with out of the money options.  Their priorities have become deleveraging first and rewarding owners via buybacks – which are paid out of retained earnings.  

Frankly, I would not be surprised if others follow in AMC’s footsteps.  Many foreign companies currently pay dividends at rates fixed to an earnings range.  Should these times persist, perhaps earnings take a hit. How many US companies have retained earnings sufficient to weather more than a few quarters and still fund working capital, capital expenditures, acquisitions, research and development, marketing or debt reduction?  If not, do they have the financial strength to sustain accumulated deficits? (Consider the energy sector in this regard).

Another interesting tidbit from the call was the comment, “we do not have business interruption insurance for the coronavirus”.  It turns out that many insurance companies exclude viruses in a post-SARS world.  Those that did not modify their policies or underwriting may have an impact in today’s world. This aspect was not analyzed for purposes of this post.

If the President is correct in asserting the threat (is) under control, we probably don’t need to be concerned with the financial stability of other public facing companies, such as restaurants, travel and leisure or retail.  But that position, while projecting strength, belies the fact that supply chains are being stretched, production lines are at reduced capacity and the consumer’s capacity to spend is turning cautious.

While the WHO is urging calm, perhaps as a counter to Jim Cramer’s posturing, respected analysts, such as Mohamed El-Erian are weighing in on potential rate cuts being unable to stabilize the markets, arguing a medical solution is the only weapon.  I suspect he’s correct and perhaps a solution is available sooner rather than later.

I don’t pretend to know which way the will markets react – only that increased volatility is probably here for a while.  What I do is gather information and attempt to find flaws or weaknesses in possible outcomes to determine scenarios that might be profitable. Do your own due diligence, but my guess is medical solutions are priced into the stock price already.

Long: VG, AMC, CCOJY

The Ongoing Virus Saga

In the markets this week, concerns over Coronavirus continued to be front and center. Not surprisingly caution (finally) took hold amid varying views on the longevity and severity of the impact, including reports of cases in South Korea and Iran.  In a counter programming attempt, the White House, through Larry Kudlow, indicated it was “not an American story” subsequent to the Saint Louis Fed comments stating there is a “high probability” that the outbreak will be a temporary shock.  While it’s become commonplace for the government to talk from both sides of its mouth, the issues I find in the actual data indicate caution is warranted.  

While the slowing manufacturing output is likely a result of supplier delays with the virus, more concerning to me is that for the first time in the Trump presidency the key economic driver of the US economy – the services sector – fell into contraction territory, albeit fractionally.  For good measure, don’t ignore the corporate warnings due to the virus led by the likes of Apple. One contrarian surprise being Caterpillar – although this could be strictly relief that the perceived end of the trade war is nigh.

Complicating any analysis is oil pricing and whether any strength is the result of production cuts, increased demand or refinery maintenance – or some combination.  There remains an ongoing debate among traders as to whether the market is tilting bullish or bearish. So no raging indicators one way or the other are visible.

Reinforcing my concerns are two measures being implemented by China.  The first subsidized loans to key companies that are helping prevent and fight the epidemic.  These rates are as low as 1.32% of which foreign companies, such as 3M are eligible. The second could be the shock that does make this an American story.  China has issued more than 1,600 force majeure certificates to shield companies from legal damages arising from the coronavirus outbreak. The riddle then potentially becomes, “When is a contract not a contract …?”  Keep in mind that next week’s economic data is mostly pre-virus.

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In the midst of tax season the initial results look promising.  As many remember, I groused last year (quite a bit) over Trump’s tax cuts actually being an increase.  We decided to accelerate taxable RMDs in 2018 to lower our 2019 tax bracket. To ensure my calculations were correct, I did not modify any withholding rates.  The strategy worked as a refund for 2019 is forthcoming. I’m still a few weeks away from reporting my final tax percentage rate but do know it’s lower year on year.  And yes – unlike candidate Bloomberg I can and do use Turbo Tax, a product of Intuit which is one of my portfolio companies. I did have to smile from the priceless, national advertising they received.

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Another element of my consolidation strategy is taking form.  I have decided to eliminate ETFs from the equation. Although there are things to like about them, the downside (for me) is fluctuating payout rates with regression to the mean, partly a result of changes to the underlying components.  Basically, I see minimal upside potential while conceding there is associated risk mitigation I’m giving up. The upside (hopefully) is a slightly higher return in pure equities. I expect to be fully divested by mid-year distributions.

Here’s hoping February is shaping up as a good month for us all!

DVK System Review

I’ve been noodling over a post published by FerdiS over at DivGro for awhile now, essentially weighing the pros and cons against my biases to figure the most appropriate rebuttal.  In a nutshell, the post first grabbing my attention was his Recent Sells.  Within this piece was the comment, “I … rank my … stocks by quality score and by CDN” and on this basis eliminated two holdings.  

I am a proponent of every investor having a defined methodology within their comfort zone to determine the quality of their portfolio and various bloggers regularly publish their screening mechanisms and processes.  Conversely, I don’t shy away from highlighting perceived frailties in these. A combination of Yield, Rising Payout Streak, PE Ratio and Payout Ratio are the most common attributes used by several bloggers while adding others to customize to their tastes.  One example being the Dividend Discount Model.  

Back in 2013, I’m not sure Simply Investing anticipated the record bull market coupled with inordinately low interest rates.  Using KO as an example, his method would have classified it as overvalued. A changing business – while looking backwards (bottler spinoff) – doesn’t neatly fit this model.  On the other hand, forward looking views, such as the DDM, have a basis in a series of assumptions. Even the Diplomat’s approach – which is arguably the most straightforward – has an assumption set within the metric, Dividend Growth Rate greater than the rate of inflation, allowing for management discretion (not a major issue in a low inflation environment).

FerdiS method – while thoughtful and elegant – has some limitations and could be viewed as an advertisement for premium services.  Value Line, S&P, Morningstar and Simply Safe Dividends are the source data. S&P data can be obtained free and Morningstar through some brokers (otherwise $199/year).  Simply Safe Dividends runs $399/year and Value Line $598/year.

Beyond the fees, the results are only as good as the dataset can generate.  Mindful that I only performed a spot check against my portfolio, it appears Morningstar applies no moat to financials and narrow to utilities.  As to the other providers – your stock has to be within the universe they cover. My assumption is the 80/20 rule applies here with limitations to small caps and foreign issues as these are not widely held by US investors.  

As my preference is to get the investing view from the rear view mirror (ala, what have you done for me lately), all the metrics this model uses are forward focused based on analysis by an individual or algorithm.  The final note being the use of the CDN (Chowder Rule) as Sure Dividend makes a compelling case of its unreliability.  

A comparison would be incomplete without peer review.  KO scores 23 of 25 on the modified DVK scale whereas the Diplomats and Dividends Diversify consider it overvalued.  For my part, KO is a small (<1%) position that I’m not adding to other than dividend reinvestment. Kind of makes me wonder …

Bottom line: I’m not sure of the value of this – at least to me.  But in my spare time I’ll continue plugging my portfolio into the model to ascertain whether this assessment is correct.  I do, however, like the jigsaw puzzle of his methodology but can’t help but wonder if this is a prelude to even further premium offerings being rolled out …

Disclosure: Long MORN, VALU, KO