Amazon takes a bite out of Costco & Home Depot shares, time to buy?

Both Costco and Home Depot have been regarded by money managers as “Amazon proof” until recently. Historically, these two retailing stocks have traded at very high valuations compared to other retailers.

Last month, news that Amazon was buying Whole Foods sent grocery stocks reeling. Costco, along with Kroger, Supervalu, Target and Walmart all tumbled in value. Even some European grocers like Sainsbury and Tesco sank on the announcement of the takeover deal.

Last week, Amazon said it would sell Sear’s Kenmore brand appliances. Shares of Home Depot, along with Lowe’s, Best Buy and Whirlpool were slammed. The loss of value for these stocks was about $12.5 billion. Keep in mind, with the Sears deal, Amazon will now be selling a product line that is not available at Home Depot or Lowe’s stores.

“Analysts at Robert W. Baird said the selloff in Home Depot and Lowe’s was an overreaction. The nearly $7.5 billion market cap loss in Home Depot stock equals slightly more than the amount of its annual appliance sales. Lowe’s stock loss was a little more than 50 percent of its $7 billion in annual appliance sales.”

Buying premium value stocks like Costco and Home Depot when they fall is very difficult. Sometimes looking at their charts can indicate when the bleeding has stop and all the panicky investors have sold their shares.

Looking at the one year chart of Costco, you can see that buyers are coming in near the $150 price range. The 52 week low for Costco is around $142 so the downside risk is relatively small. This could be a buying opportunity if you believe that the Amazon threat has been blown out of portion.

Looking at the one year chart of Home Depot, there seems to be investor support at the $145 level but the stock could fall to the next support level which is around $135 per share. It could be too early to buy because it has only been a week since the Amazon / Sears news announcement. You could take a part position now and average down if the shares continue to fall or you could wait another couple of weeks to see if the $145 level holds.

What do you think? Are Costco and Home Depot still Amazon proof?

 

 

 

 

Share buyback binge is going strong, investors beware!

Is there anything wrong with this? Yes, it means that companies are spending more money on “financial engineering” than on capital spending. It certainly does indicate that companies are at a loss on how to improve their top line, which is what will ultimately improve the bottom line. It leads to frequent complaints by analysts about the “quality” of earnings.

It’s a very important point. Apple is part of an elite group I call “buyback monsters,” companies that have been aggressively buying back stock for years. Apple’s shares outstanding topped out in 2013 at roughly 6.6 billion shares. Since then it has been down every year and now stands at 5.2 billion.

That is a reduction of 21 percent in shares outstanding since 2013. What’s that mean? It means all other things being equal, the company’s earnings per share are 21 percent higher than they would have been had it not done the buybacks.

But that’s only since 2013 … there are companies that have been doing this much longer. IBM shares outstanding topped out at 2.3 billion way back in 1995, it’s been going down almost every year since then, and now stands at 939 million shares. Think about that. That’s a 60 percent reduction in shares outstanding in a little more than 20 years.

Same with Exxon Mobil, after the Mobil acquisition in 1999, shares outstanding topped out at just shy of 7 billion in 2000 and have been going almost steadily downhill since. There’s now 4.2 billion shares outstanding, a reduction of 40 percent since 2000.

Here are just a few more buyback monsters:

  • Northrup Grumman: 50 percent since 2003
  • Gap: 55 percent since 2005
  • Bed Bath & Beyond: 50 percent since 2005
  • McDonald’s: 36 percent since 2000
  • Microsoft: 30 percent since 2004
  • Intel: 30 percent since 2001
  • Cisco: 32 percent since 2001

Why are there buybacks at all? They were originally used to support the issuance of stock options. The options increased the share count outstanding, so to keep the countdown the company bought back shares. But as the opportunity for significant top-line growth waned, buybacks to reduce share counts became a separate strategy to prop up earnings growth.

What is my beef with buybacks? Part of management’s compensation packages include stock options. Buying back company shares ensures that their stock options don’t expire worthless.  It not only fools investors that the earnings are growing but it rewards poor management.

Take IBM for example, despite being one of the most aggressive buyback monsters on the Street, you can’t say IBM’s stock price has soared in the last decade. In 2014, the company eased off a bit on its buybacks, and the stock headed south. It headed south because IBM was beset by fundamental growth issues: Its revenues from its old line businesses were shrinking and there was not revenue from emerging  businesses (like Watson and artificial intelligence) replacing it.

The lesson: No amount of financial engineering like buying back shares can replace management’s inability to grow the business.

 

 

Opportunities for option traders on the takeover of Time Warner

Back in late October, I wrote that AT & T had reached an agreement in principle to buy Time Warner for about $85.4 billion, Time Warner shareholders would get a combination of cash and AT & T stock. The total purchase price would be around $107.50 and the whole process could take around a year to complete.

Click here to read “Looking for option trades on the Time Warner takeover by AT&T”

The stock price of Time Warner was trading at around $86.75 at that time which was way below the takeover price. I suggested two option trades with April expiry dates and one that didn’t expiry until Jan 2018. All three trades turned out profitable.

  1. Buy 300 shares of Time Warner at $86.75 and sell 3 April $90 call options for $3.00 each. This reduces the adjusted cost base to $83.75 and I am hoping that these call options will expire worthless.

Results: Time Warner stock was called away at $90.00 in April for a $6.25 profit or 7.46% in 6 months.

  1. Buy 100 shares of Time Warner at $86.75, sell 1 April $90.00 call option for $3.00 and 1 April $85.00 put option for $3.80 reducing the purchase price to $79.95 a share. ($86.73-$3.00-$3.80 = $79.95)

Results: Time Warner stock was called away at $90.00 in April and the put option expired worthless. Profit of $90.00 – $79.95 = $10.05 or 12.5%

  1. Buy 10 Jan $97.50 call options for $3.50 that expire in 2018. If the deal goes through, these options could be sold for $10 each.

Results: Time Warner stock closed at $99.18 on Friday, I still have 8 more months to take profits. I could sell the Jan $97.50 call options for $6.05 on Monday for a profit of $6.05 – $3.50 =$2.55 or 73%

Being a senior, I totally forgot about this post, I have to apologize for not providing an update sooner. However, I repeated option strategy number 2 by buying 500 shares of Time Warner at $97.50, selling 5 May 97.50 call options for $1.95 and 5 May 97.50 puts for $1.45 (which reduced my purchased price to $94.10) and made $3.40 or 3.6% in one month.

Unfortunately, the VIX which is the ticker symbol for the Chicago Board Option Exchange volatility index has been falling. It measures the market’s expectations of 30 day implied volatility. (Referred to as the fear index) A falling VIX means a reduced amount of fear and cheap option premiums.

Despise the lower possibility of profit, I repeated option strategy number 2 and bought 500 shares of Time Warner at $98.96, sold 5 June 30 100 call options for $1.00 and 5 June 98 put options for $1.00 reducing my overall cost to $96.96 per share. I could potentially make $3.04 if TWX is above $100 by June 30th or 3.14.%

A falling VIX tends to widen the bid / ask price spread on most options. It makes it harder to get your order filled. I had to change my limit order a couple of times during the day to get this Time Warner trade completed.

There is always a risk that this deal will not be approved by regulators. However the takeover price gap has narrow from $86.75 / $107.50 in October to $99.18 / 107.50 in June. A good sign that investors believe that this deal will go through.

Disclaimer: This post is for educational purposes only.

Is Basic Income the answer to a new AI world?

I am so glad that I am a retired senior. I don’t have to worry about a robot taking my job. Since I have lots of time on my hands to think, I wonder what a new AI world would look like. For example; will my 2 year old granddaughter even need to get a driver’s licence? Will the Uber or cab that she orders even come with a driver?

Now I have always been a big fan of science fiction movies. There is a scene in the movie “Logan” where Wolverine has to dodge driver-less trucks to cross the highway to help some people. Installing AI in 16 wheeler trucks could replace the need for a lot of truckers.

Fast food restaurants have been the training ground for teenagers and young adults.  I used to tell my kids that they better get a good education or you will end up using the phrase “would you like fries with that” while working at MacDonald’s. However, even MacDonald’s are installing new self-serve kiosks. Now you can even order your Starbucks coffee using your phone. Where will young people get work experience?

Everywhere I look, jobs are slowing disappearing, the new AI technology seems to have very few limits.

“For example, Australian company Fastbrick Robotics has developed a robot, the Hadrian X, that can lay 1,000 standard bricks in one hour – a task that would take two human bricklayers the better part of a day or longer to complete.”

Japan has the highest percentage of people over the age of 60 and their population is shrinking. As a nation, there is a shortage of workers and they have embraced the use of robots in the work place. This trend could be coming to North America sooner than you think.

As a baby boomer, I worry about the future cost of health care. The world population is aging and health care costs are raising. I hope that science fiction turns into reality and my caregiver looks something like this.

   or this 

Why universal basic income may be necessary

A 2013 study by Oxford University’s Carl Frey and Michael Osborne estimates that 47 percent of U.S. jobs will potentially be replaced by robots and automated technology in the next 10 to 20 years. Those individuals working in transportation, logistics, office management and production are likely to be the first to lose their jobs to robots, according to the report.

For many, basic income sounds like a free ride or welfare. Economist believe that masses of people will not just sit at home but will make a contribution by continuing to work. The basic income would allow recipients to explore other options not available to them if they are struggling just to survive,  such as retraining or to find new job opportunities.

In theory, new opportunities would spring up to replace jobs done by machines. However, there are some practical problems, like where will government get the money if less people are working to pay for a basic income program? The North American education system would require a major overhaul to put more job training skills into the curriculum.

Some additional information to consider

The government of Ontario just announced a three year basic income pilot project to help low income earners in three cities. A single person can apply to receive $16,889 a year and couples will receive $24,027. Recipients who are employed will keep what they made from their jobs but their basic income would be reduced by half their earnings. For example, a single person earning $10,000 per year from a part-time job would receive $11,989 in basic income ($16,989 less 50 per cent of their earned income), for a total income of $21,989.

Is basic income just a pipe dream or a future reality?

 

 

 

 

 

Warning signs that oil prices are range bound for many years

The future price of crude oil is very important to the Canadian economy and to investors in the Toronto stock market (TSX). The Canadian oil patch represents a 25% weighting in the overall index. Over the past few months, we have seen a massive sell-off of oil sands assets by foreigners.

In March, Royal Dutch Shell and Marathon Oil sold stakes in the Alberta oil sands project to Canadian Natural Resources for $12.7 billion. Marathon sold its 20% stake in the project for $2.5 billion. Later in March, Conoco Phillips sold their partnership in the oil sands to Cenovus Energy for $17.7 billion.

Reuters reported last week that BP is considering the sale of its stakes in three Canadian oil sands projects.

“BP’s 50 per cent stake in the Sunrise project near Fort McMurray in Alberta, where Husky Energy Inc owns the rest and is the operator, is the most valuable of the three assets. It also owns a 50 percent stake in Pike, operated by Devon Energy Corp, which is still awaiting a final investment decision, and is majority-owner of the Terre de Grace oil sands pilot project.”

Also in the news is Chevron was exploring the sale of its 20% stake in Canada’s Athabasca oil sands project which could fetch $2.5 billion.

“Faced with a lower oil price environment and challenging economics, which include high cost operations and carbon taxes, global players are increasingly put off by the oil sands.”

Extracting oil from the vast majority of Canada’s oil sands is a very labor and capital intensive process. It requires much higher crude oil prices to justify the more expensive extraction method. Global players exiting their oil sands positions could be a warning sign that the price of oil getting above the $60 level is overly optimistic.

The upcoming IPO of Saudi Arabia’s state own oil company (Saudi Aramco) is another warning sign that the price of oil could be range bound. The company’s oil assets are valued around 2 trillion dollars. It begs the question; why would Saudi Arabia sell part of its state own oil assets to investors?

The simple answer is the Saudi’s need more revenue to pay for their government spending programs. I believe that this is another warning sign that the price of oil will stay lower for much longer. OPEC’s current production cuts are aimed at stabilizing the oil market so that the Saudi Aramco IPO will be successful in raising much need cash for Saudi Arabia.

The key question for the future of the oil market is for how long can a surge in U.S. shale supplies make up for the slow pace of growth elsewhere in the oil sector. The 5 year chart below illustrates the returns on owning two different oil ETFs. You would have lost money owning the Canadian oil ETF (XEG) and you would have broken even on the Spider ETF (XLE). 

In my humble opinion, long term buy and hold investors should avoid oil stocks. I have been bearish on Canadian oil companies for a long time because our oil and gas is land lock. Our only customer is the United States and they have already put a 20% tariff on softwood lumber. There are growing tensions around renegotiating NAFTA which could lead to a tariff on Canadian oil. Oil stocks are still trade-able but you need to be very nibble.

 

Do you agree or disagree? All comments are welcomed.

 

Disclaimer: This post is for discussion purposes only, do your own research before you invest.

 

 

Baby Buffett loses 4 Billion on Valeant shares

Hedge fund manager Bill Ackman first came to my attention when he invested in Canadian Pacific railroad. As an activist investor, Ackman started a lengthy proxy battle with the board of directors to remove Fred Green as CEO and appoint Hunter Harrison in his place. Not only was Ackman successful but it was very profitable for his hedge fund since the value of CP shares more than doubled under Harrison’s leadership.

In early 2015, Bill Ackman invested in Valeant, another Canadian company. His hedge fund purchase shares around $196 and recently sold all of them at $11 a share. He accelerated his losses by buying call options and selling put options.

Hindsight is of course 20-20, are there any investment lessons that we can use?

 Lesson: Intelligent people are capable of doing very dumb things.

Bill Ackman is clearly a smart man otherwise his Pershing Square hedge fund wouldn’t manage pension fund money. But if you asked the average investment professional /your grandmother whether it is a good idea to stick over a quarter of your assets into a highly levered pharma roll up the answer would tend to be a firm “no”.

Lesson: Position sizing is very, very important.

Always be aware of your risk of ruin, no matter how much you are convinced the odds are in your favor. Regardless of how amazingly smart and brilliant you are and how many hundreds of hours of research you have done, it is perfectly possible that you will lose money on any given investment. Pershing Square had too large a position to simply sell its stake and walk away when things started to go wrong.

Lesson: Highly incentivized management teams can still blow themselves up, and take you down with them.

Part of the original appeal of Valeant to the hedge funds that backed it was how the CEO’s stock options had been structured to make him highly incentivized to get the share price as high as possible. Having management teams with “skin in the game” is clearly important but this does not mean they will not do something very stupid.

Lesson: Auctions are not usually very good places to find bargains.

Ackman admits that he now believes Valeant “substantially overpaid” for Salix, its last big acquisition before things fell apart. A big problem with a role up strategy is paying high prices for third rate assets that no one else in the world is willing to buy.

Lesson: Beware of political risk.

Valeant used aggressive drug pricing to help pay for their acquisitions which got the attention of American lawmakers. Bill Ackman had to testify at a hearing held by the U.S. Senate aging committee which was reviewing escalating drug prices. It also became a big issue during the U.S. 2016 presidential election.

Lesson: Take a loss, don’t let your Ego get in your way.

There is no doubt that billionaires tend to have large egos. Being labeled “Baby Buffett” on the cover of Forbes is quite the ego booster. But there is an old saying, “the bigger they are, the harder they fall”. Ackman’s buying call options and selling put options on a losing position is a clear sign that his ego wouldn’t accept taking a loss on Valeant shares.

Postscript: The share price of CSX railroad jumped up 35% on rumors that Hunter Harrison would be the new CEO. Harrison got the job but can he deliver another turnaround? It may be too early to tell. However, I bought some shares of CSX for my investment club.