August 14, 2019 - Yield curve inverted today. This has preceded a recession every time since 1980 so Mr. Market got more worried than usual and was selling the biggest 500 businesses in the U.S. for almost 3% less on average than he was yesterday. Last time the yield curve inverted was 2007 and although it has been a good indicator of predicting a recession, the timing hasn't been perfect. The difference between yields on the 2 and 10 year went negative in December 2005 and in May 1998 but the recessions didn't follow in both instances for around 2 years later. Predicting the exact timing of a recession is too difficult.

Germany's economy contracted .1% in the 2nd quarter. Another quarter of contraction would signal a recession.

Argentina's stock market dropped 50 something percent on Monday. I think that is the 2nd largest one day drop in history and is absurd. A 10% or 20% drop in a day is a lot yet alone 50%. Argentina was just able to issue a 100-year bond a little more than 2 years ago. That was issued in 2007 a year after a default.

6 month - 1.92%
1 year - 1.79%
2 year - 1.58%
5 year - 1.51%
7 year - 1.55%
10 year - 1.59%

Source: Treasury.gov 

Tencent reported earnings today and cited a poor advertising market in China. This doesn't bode well for Baidu. Tencent still reported an increase of I believe 20 something percent in operating profit due to cutting expenses and due to revenue from wechat and social gaming. Seems like they aren't as vulnerable to the advertising market as Baidu and Weibo are and this shows in their stock price which has held up more compared to Sina, Weibo, and Baidu.

All of this news is negative which gives you a gauge of the sentiment in the markets today - pessimistic.

Below is a passage written by Howard Marks in his letter "On the Other Hand" discussing the most recent decision from the Fed to cut rates by 25 basis points. Is it good for the markets because a lower Fed Funds rate can mean lower interest rates to discount future cash flows by or despite good economics data, did the Fed lower the rate because they see trouble ahead?

"My point is that a rate cut’s implications aren’t always as simple a matter as they may appear to be.  Assuming the Fed is a good diagnostician, a decision to cut rates isn’t necessarily good news.  You can argue that, if there’s trouble ahead, we’re better off with a rate cut than without one.  But that still doesn’t make it good news.  First, it means the Fed thinks trouble is looming.  And second, it certainly doesn’t guarantee the problem will be solved.  (It’s worth noting that 18 months after that first rate cut in September 2007 – during which time ten more cuts followed, eventually taking the fed funds rate to nearly zero – the S&P 500 finally bottomed out, down more than 50% from where it stood on the day of the first cut.)"

Negative yielding bonds from Charlie Bilello on August 5, 2019: https://twitter.com/charliebilello/status/1158394284917383168

*****

August 7, 2019 - I need to reiterate an obvious investment principle/rule that is obvious in theory to adhere to but is much harder in practice to follow due to my laziness and greed. One must do his own work and own research and never buy on tips. Tips in the old days used to be a recommendation from a friend or an associate and although these obviously still happen today, with the development of the internet there are other ways to get tips such as from investment managers who publish research on a company and submit the research on a website. These ideas can be found in investment letters, 13F filings, websites, blogs, etc. I was recently tempted to buy a stock in a company called Burford capital and put in a very small order to buy 3 days ago. The company is now being accused of being an accounting fraud and the stock has gone from around $17 a share to $6 in only a day. Although it would have only been a small loss for you on paper that wouldn't have had a material affect, it's still important that you must do your own research no matter how good the investor is. Developing bad habits will cause harm for you in the future as it will make you more lazy. You also need to understand the business you're buying. Although you have a broad idea of what the business does, you don't truly understand it and you know this after reading the short report put out today by Muddy Waters as you are reading the way Burford does its accounting you can tell you're still in the researching and learning phrase on this idea. 

Burford Capital:

What does it do: Exchanges litigation financing in lawsuits for a fee and/or a percentage of the winnings in the lawsuits.  Most of business is done in the U.S. and there are a lot of lawsuits in the U.S. 80-90% of lawsuits settle before going to court making it easier for Burford who finances the lawsuits to get performance fees since going to trial takes time.

Bull thesis: Lawsuit financing is a growing market without much competition at the moment. CEO is owner operator. Owns between 10-20% of the shares and has experience in the business and seems like he has a passion to be there for the long term. 

 

Bear Thesis: Accounting can be hard to understand. Business involves lots of accounting estimates which can make earnings unreliable. High turnover at the CFO position and the current CEO is the CEO's wife. 


Conclusion: it gets put in the too hard pile for now and you do nothing unless you can understand the company better.

As an aside, you bought more Wells Fargo in the mid $45's today. Your thesis from your previous journal entry in July is still intact but the market offered you an opportunity to add to your position today because of the drop in the 10 yr treasury yield. The curve got more inverted and banks are in the business of borrowing short-term and lending long-term so when rates are higher in the short term and lower in the long term (inverted yield curve), this makes for worse business for a bank. No business wants to borrow money at a higher rate and earn money at a rate that is lower than the rate at which they borrowed at. 

*****

August 6, 2019 - Added to Fairfax position today between 455-460 a share. Fairfax has a business set up very similar to Berkshire where they own insurance firms and use the premiums and underwriting gains to invest in other companies. In the past, they have made some macro bets on the market but a couple years ago said they won't anymore.

Prem Watsa has compounded capital and grown book value in the mid to high teens since the company was started in the 1980's. He was making bearish macro bets on the market between 2014-2016 that didn't work out. It cost the firm and its shareholders at least a billion dollars of misallocated capital. Prem Watsa then admitted it was a mistake and that the company will only stick to buying good businesses at good or fair prices. He is the chairman and CEO and is honest and upfront with shareholders.  He has the talent for compounding capital but it's important to understand the difficulty of going short and making macro bets on the market. Timing plays too important of a factor in this regard and who in the world could have predicted that this business cycle would have broke the record of the business cycle leading up to 2000. You for sure were wrong in this regard. You didn't for a second think this would be the longest bull market in history. Anyway, mistakes happen and Prem Watsa being a good capital compounder who is aligned with shareholders and admits mistakes and going forward will stick to picking good businesses is my main reason for investing in this company. In other words, I'm betting on the jockey.

Currently the stock price hasn't done much over the last 5 years. It stayed in between $430 and as high as $586. I think some of this is due to the macro bets that Prem made that didn't work out. Now Mr. Market lost some faith in him but I think he will continue to compound capital at rates in the mid to high teens. His company has been looking a lot at India lately which I think will be one of the fastest growing economies for the next 20-30 years. Fairfax set up a holding company called Fairfax India Holdings Corp. to invest in India and the parent company, Fairfax Financial, gets a hedge fund type fee and performance fee on the gains. 

Right now, it trades at a fair valuation that I am happy to own at and would be even more happy to buy more if the price were to drop:

Prices to Sales: 0.7 

Price to TTM Earnings: 15

Price to 5 yr Average Earnings: 16.5

Price to Forward Earnings: 7 (Morningstar)

Price to Book: 1.0

*****

August 1, 2019 - I've been invested in Kraft Heinz for about a year to two years now and have added a lot to my position through all the negative events - dividend cut, large write down of intangibles and goodwill relating to Oscar Meyers and Kraft, SEC investigation, filing delay of financials, stepping down of CEO, large 4Q 2019 loss, and debt concerns. I think the company has a capital compounder underneath all of this which is Heinz. I still see a lot of Heinz ketchup bottles and some of their other sauces at restaurants, diners, food courts, delis, etc and I still see a strong economic brand there.

 

Without the Heinz brand this company is more of a value trap. Warren has said that he didn't overpay for Heinz at $25b so if I take his word and believe that Heinz could compound capital enough to double its value over the next 10 years (7% minimum cagr) then that would put the value at $50B minimum which exceeds the market price today by $10B. That is one margin of safety that can protect me from permanent loss of capital. And with a current market cap of $40B for KHC I think there is still at least $10B-15B of value today in all of the other brands even though some for sure have lost economic goodwill. Some of the ones I do like are Planters, Philadelphia Cream Cheese, A1, Oscar Meyers bacon, Kraft cheese, and Kraft dressing. (There is bias in that last statement.) Orea Idea and Maxwell house might have some value but I would rather see them sold to reduce debt. I don't think Oscar Meyer cold cuts and bologna has much value. 

 

I believe it's concerning that the company is struggling to find a buyer to buy the Orea Idea and Maxwell brands at the price they're looking for. Good news is slowly coming in now that there is a new CEO, the company filed its restated financials for the last 3 years, and on August 8th they will report results for the first 6 months of 2019 before the market opens. Doing it before the market opens is a sign of confidence from the company in my opinion since the price will fluctuate throughout the day based on the results. I think time will help this company clean up the mess they made (note per just-food.com: chairman of 3G, Jorge, acknowledged they screwed up Kraft/Heinz, said he has $10B commitment from investors at the time of writing of the article for a new fund but abandoned plans for a new acquisition to merge with KHC, and will fix the mess they made).

 

If this was a retail company I wouldn't be in it but packaged foods is a solvable problem. Has the industry changed so much where it has become unsolvable? (Ex. e-commerce grocery shopping, processed foods transition, lower barriers to entry) I don't think so and I am betting on it but time will see if I'm correct.

 

So the major concern I have is the debt. Debt due in 2019 is $355M, 2020 is $3B, 2021 is $990M, and 2022 is $3.5B. 2019 is ok but 2020 will be an issue. I'm expecting about 5B-5.5B in ebit and 1.2B-1.5B in int exp so with taxes it can be net income of about $3B and after dividends of $2B there could be a surplus of $1B in cash. They have around $1B in cash and just got about $1B from the sale of their Canadian Cheese unit. If it ends up not being enough to meet 2020's debt obligation, I see options to get around this such as cut dividend, sell assets (brands), refinance with banks, or raise capital. I think they will meet their debt obligation in 2020 even if they have to get a high cost loan from Buffett and 2021 debt isn't too high at 900M.

 

So, it's a time arbitrage bet, 3G/Buffett not giving up, positive ebit generating (4th quarter was accounting write down which is noncash but I acknowledge poor capital allocation), financials are being reported finally after delays, procurement issue is getting solved, SEC issue still under investigation but my guess is it ends in a fine that doesn't cripple KHC, and debt is biggest issue but is solvable. I think fund managers are frightened to be involved partially to career risk and fears their brands are done but I disagree and as good news starts to show up they will slowly begin buying and the stock price can reach low 40's in 2-3 years.

 

Overall, it's undervalued right now at $32 a share with a lot of negative priced in and some good news already trickling in. 

Market Cap - $39,700M

Minority Interest - $118M

Debt - $31,100M

Cash - $1,130

Total E/V - $69,788

EBIT (est.) - $5,000M

EV/EBIT - 14 (Balance Sheet #'s as of Dec. 2018)

*****

July 24, 2019 - Tweedy Brown released their 13F filing today for the 2nd quarter with additions to Baidu, Alcon, and Sina. This catches my attention because Baidu is one of my larger positions and Tweedy increased their position by 40%. Also, Alcon is a company I'm interested in buying but have been waiting for a better entry price. I missed the entry price when it first IPO'd and dropped to mid 50's because I wasn't prepared. 13Fs are filed for each calendar year and the fund has 45 days following the end of the quarter to submit their 13F form. That means somewhere between 4/1/19 and 6/30/19 Tweedy bought shares of Baidu between the price range of $110 and $180, bought Alcon between the price range of $54 and $63, and bought Sina between $40 and $64. Sina was only increased by 1.2% and I didn't really know anything about it before seeing this 13F filing today but have researched it since this afternoon and it is cheap in my opinion. Sina has a net cash position of $1 billion, owns around 47% of Chinese Twitter (Weibo) which has a market cap of around $9B, so their ownership stake in Weibo is worth close to $4.5B meanwhile the market cap of Sina is only $2.9B. Weibo looks to be a good asset but with the trade war and fears over a possible slowing down of China's economy, there is a risk that Weibo's advertising revenues go down. Sina doesn't appear to have as much value besides Weibo since their media assets have been compared more to Yahoo.  I don't think Yahoo is that bad but regardless, the valuation here is so cheap. Weibo has about 300M users and is profitable. Sina is profitable as well but I didn't figure out yet how much of that is due to Weibo or if they are profitable as a standalone company. I will continue to research but not buy yet as I don't feel like I know enough about the company since I just started researching today.​

*****

July 23, 2019 -  Alcon is a great business that provides eye care services. The business came to my attention because they were just spun off and I use their contacts lens solution called Opti Free. Warren Buffett had a quote about Juicy Fruit gum where he mentioned the power of the brand name by alloting to the notion that the mouth is a very sensitive place and you're just not going to pick up another piece of gum from a company you're not familiar with and put it in your mouth.

 

This quote reminds me of Alcon because the eye to me is a lot more sensitive of a place than the mouth and I'm going to be very cautious of what I put there. Alcon has some other business segments as well besides just contacts solution like equipment used for lasik surgery and contacts lenses. Now although I use the contacts lense solution from Alcon,  I don't use the contacts. I use the contacts from Johnson and Johnson instead so that is notable for competition and moat purposes. The price is around $60 per share as I write this and I looked at the stock price a couple weeks ago and it was around the same price then also. I think it's a little overpriced at the moment. I like it at low 50's but I will revisit it in the mid 50's to possibly think about initiating a position.

From Alcon's form 20F:

1.2B operating income 


29.2B market cap (7/23/19 close of market)
- 500M cash
+  3.5B debt
32.2B EV

32.2B ÷ 1.2B = 26.83 EV/EBIT Multiple

Operating income before depreciation last year and the year before was $1.3B while being mismanaged under Novartis. Core operating margin as per prospectus was 17% in 2018, 16% in 2017, and 17% in 2016. Revenues averaged at $7b so assuming a 20% operating margin that would be $1.4B. At $1.4B operating income and a 20x EV/EBIT multiple that is an EV of $28B or market value of $25B or $51.22 a share. With $1.2B operating income (more conservative estimate) and a 20x EV/EBIT multiple and $3B net debt that is a $21B market cap or $43 a share. In summary, don't buy yet. Wait for hopefully low $50's to initiate a position or maybe mid $50's depending on how it is trading. 

*****

July 16, 2019 -  Wells Fargo dropped to the mid 45's today so I initiated my position this afternoon. Wells beat on both eps and revenue so I was surprised it went down so much (3%) today although Wells did open higher at .7% pre-trading. It seems the market was more concerned about Wells' net interest income declining which beget concerns over the low interest environment we are in. Net interest margin fell due to higher deposit costs. Management also said that expenses will be in the high end for 2019 which is usually the case after a scandal. Chipotle had higher expenses after their ebola scandal also in order to clean up the issue then the stock price eventually recovered. Despite headwinds of higher expenses, lower interest rates, inverted yield curve signaling recession, scandal, and no CEO, I will continue to monitor Wells to add to my position at lower prices and average my cost basis down.

*****

July 15, 2019 -  Why I think Wells Fargo is a good risk/reward investment now.  Wells Fargo has been one of the best managed banks for the last 100 years but it recently had an issue where they were incentivizing employees to open up new accounts for customers without their consent. These fraudulent accounts were discovered partly by customers who noticed new credit or debit cards for their accounts that they were unfamiliar with and by customers who noticed account fees that they didn't understand what they were for. Following the scandal, the CEO was removed and was replaced by a new CEO that later departed in early 2019. They are still looking for a replacement CEO since I believe March 2019.

 

This looks like a solvable problem to me. I believe they did the correct first step in replacing management and changing the bad incentives which caused employees to open up fraudulent accounts. Their deposits have also been pretty stable despite the scandal because of their switching-cost moat. It's not so easy to change banks. Following this scandal, the stock is down about 30% from its high. It is capitalized very well and was just approved by the Fed to return $23.1B in capital to shareholders through a share buyback and increase the dividend following the Feds annual compliance review and analysis. This gives investors a 10% return of capital via share buyback ($23b buyback/$200b market cap) and a 4.3% dividend yield (new divided is .51 a quarter). Average net income over the last 5 years of $21B to $23B gives Wells a P/E ratio of 9 to 10 (undervalued) but important to keep in mind that there is no growth since the Fed capped the amount of assets they can have. They can't increase current asset base (take in deposits) until they get approval.

What got me looking closer at Wells Fargo was an idea written by John Huber from Saber Capital on Sum Zero. I agreed with his research and thoughts, so I have been watching this stock since he wrote the report on July 6th. It's undervalued now but I've been cheap. It's been mostly trading between $47.00 and the low $48's until today. Luckily for me it traded down into the high 46's today. WFC reports earnings tomorrow. Is the market saying today that it doesn't expect Wells to report good earnings tomorrow? Am I violating a principle that Jessie Livermore in Reminisces of a Stock Operator talked about: "Don't quiver over 1/5's, 1/4's, 1/2's of a point." Despite this concern of being cheap, I'm still going to wait for a wider margin of safety and hope this company gets into the 45's before I initiate my position. There has been a floor at $44 and if it breaks through that floor I will look to add more between $40 and $43.

*****

July 10, 2019 - Why I think Baidu shares will appreciate: Wide-moat (intangible assets & network effect) with 73% market share in search. A search engine is a high-demand service to be supplied to a country in the digital world that we all live in. (In other words, Baidu services a purpose) “Google of China” and Google has been one of, if not the most successful company in the U.S so it’s the idea of finding what works in one of the best developed markets (U.S.) and applying it to one of the best developing markets (China). Robin Li is owner-operator with large ownership % (16% of shares) so aligns his interest well with me as a shareholder. After deducting iQIYI, Ctrip, and net cash position, I am getting core search at a great price (probably 10-20x net profit) and then getting AI (Apollo, DuerOS) and cloud for free. China has only a 57% internet penetration ratio so has more room to grow which should mean more eyeballs for desktop/mobile advertising dollars. P/E, P/S, P/FCF ratios are all trading at bottoms so puts the risk/reward in my favor. Opportunity is available because the market is way too short-term focused on Baidu’s Q1 results of investing for the future and the cyclical nature of the advertising market due to a slowing down of China’s economy which brought down operating and net earnings. Sell side mostly agrees it is short-term and not long term.

What can go wrong that comes to mind: Politics of China, VIE in Cayman Islands, competition (BABA, Tencent), Debt Bubble in China bursts making China’s recession comparable to Japan in late 80’s, and/or poor management where too much capital is burned on high growth investments and marketing.

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