Events: NRG Energy Idea Initiation 

NRG Energy 

Events

February 18, 2017


SUMMARY INFO

  • NYSE: NRG
  • Recent PPS: $17.10
  • Shares Out: 324.6 million
  • Market Cap: $5,551
  • Recourse Net Debt: $7,236
  • Enterprise: $12,787

DISCUSSION

The day Elliot filed on NRG I happened to be in attendance at a lunch presentation by my good friend, a well-respected Power & Utilities MD. He highlighted what he believed to be a strange discrepancy in Power Generation equities – CPN, DYN, NRG – where they were/are trading at distressed multiples on trough earnings – typically a sign of impending bankruptcy – while the bond market was/is signaling robust and likely improving earnings power. DYN was his top valuation pick; but when questioned about that morning’s NRG filing he noted the compelling near-term set-up:

  1. Recent turmoil in the C-suite created a vacuum in shareholder approval, allowing the activist group to step in opportunistically with little opposition
  2. John Wilder of Bluescape Energy Partners, and former CEO of TXU, has an incredible reputation within the industry
  3. An abundance of NT catalysts: GenOn restructuring + NYLD sale + cost cuts + potential sale of the entire entity
  4. Undervaluation, despite the recent run-up in the stock

The stock receives very little coverage, is highly volatile, and therefore prone to extreme undervaluation…until it’s not. At the current price I believe there is a very low probability of permanent impairment. The non-permanent impairment scenario could be framed as follows: 25% chance of downside volatility of 25-50%; 50% it works its way to $25+ over the course of the next 12-18 months; and 25% it goes north of $20 in very short order.

ANALYSIS

(Source: BAML)

Segments. NRG is comprised of four segments: Core NRG (Retail + Generation), GenOn (bankrupt Generation sub), and NYLD (nat gas and renewable assets yield co).

BAML estimates Core NRG will generate $1.79 billion of EBITDA in 2017, and has recourse net debt of $7.24 billion.

NRG’s stake in NYLD is currently worth approximately $1.4 billion.

And BAML estimates ‘disynergies’ of $97 million once GenOn is officially restructured and separated.

Cost Structure. BAML estimates that Core NRG Generation’s SG&A $/Mwh was approximately $4.64 in 2016 versus an average of $1.20 for CPN and DYN. Their upper end cost cut estimate is $500 million for Core NRG.

With John Wilder on board, I like the $500 million target.

2017 PF FCFE. Core NRG EBITDA of $1,790 + $500 of cost cuts – $97 of disynergies = PF EBITDA of $2,194.

Subtracting $550 of capex and $572 of intex (7% on total debt of $8,177), and applying a 30% tax rate gets you to $750 million of FCF to Equity, or $2.31 per share.

Valuation. Adjusted for the value of NRG’s $4.32 stake in NYLD, NRG currently trades for 5.5x FCFE. Assuming $0 of cost cuts, the stock trades for 10.4x, which is arguably slightly overvalued for a below average business (8.33x FV PE?).

8.33x PF FCFE + $4.32 NYLD = $23.56 FVPS, or 38% upside.

Price Action. Navistar’s post-VW deal price action is instructive, IMO. The stock spiked hard on the announcement, backed off a bit, then proceeded to rise 30%+ in short order. I believe NRG is following a very similar script in the wake of the initial Elliot filing.

But this is simply a piece of the mosaic. If the broad market backs off 1-5% in order to consolidate recent gains, NRG could easily break below pre-Elliot levels. This would be a big buying opportunity, IMO.

DUE DILIGENCE

A deep dive into the situation would entail the following:

  1. Long-term economic structure of the power markets
  2. Asset level comp analysis of NRG cost structure v. CPN and DYN
  3. Detailed background of John Wilder
  4. Industry M&A history
  5. In-depth GenOn restructuring analysis

DISCLOSURES

I own the stock and could sell at any time.

This write-up is for informational purposes only.

S&P 500 Market Outlook

Market Analysis 

S&P 500 Market Outlook 

January 10, 2017


SUMMARY

  • Weight of the evidence suggests further gains in the cyclical bull market advance – SPX 2600 by May/June 2017 (?)
  • Monetary ‘triumvirate’ – inflation + rates + Fed – could lead to mid/late-2017 to early/mid-2018 cyclical bear market
  • Historical measures of market valuation suggest a cyclical bear market ends with the S&P 500 trading for at least 15x earnings, or sub-1,800

DISCUSSION

Some attribute the post-election market rally to Trump’s business-friendly agenda, but the fact of the matter is that the ingredients for the rally were in place months prior to the election. The biggest ‘tell’, as outlined in the November outlook, was the highly bullish advance/decline line, which measures the underlying supply and demand for equities. The AD line, among other supply and demand indicators, has only continued to confirm that there is likely material upside left to this cyclical bull market rally.

And while some sentiment measures indicate short-term consolidation could occur, I cannot emphasize enough how bullish the underlying supply and demand picture is for this market and how careful market ‘bears’ should be. In my opinion, all the bears have going for them right now is very short-term analyses such as this rate-of-change graph.

Risks are looming, however. Rising inflation + rising rates + a hawkish Fed form the monetary ‘triumvirate’ that I believe will ultimately lead to this cyclical bull market’s demise. A ‘black swan’ is always a possibility – by definition – but more often than not, the bull market killer is lurking in plain sight. In a recent lighthearted 2017 Prognostication piece on 17 Mile, I outlined a potential path for the S&P 500 through 2018.

  • 15% rally to 2,614 – or approximately 22.5x earnings – by May/June 2017
  • “Short and May” and go away
  • Fed begins to respond aggressively to rising inflation, tipping US economy into a recession with magnitude somewhere between 1991 and 2000-2002
  • 6-9 month cyclical bear market into early/mid-2018
  • S&P 500 de-rates to 15x earnings, or approximately 1,743 (-33% decline)
Now, of course, managing to such a detailed outlook is nonsense. But the overarching point is, as I will walk through below, how bullish the current market configuration is.

WRITE-UP

Via Seeking Alpha.

DISCLAIMER

The views and information I provide are for informational purposes only; are not meant as investment advice; are subject to change without notice of any kind; do not constitute an offer of products or services with regard to any fund, investment scheme, or pooled investment; nor do they in any way, shape or form represent the views of my employer.

2017 Prognostications

17 Mile

2017 Prognostications

January 7, 2017


On Christmas Eve 2015 I posted a set of ramblings, questions and predictions heading into 2016. With a series of thoughts I have accumulated since early December as a baseline, I will attempt something similar in this post.

* * * * * * * * * * * *

Secular Bull Market?

Among others (Jeff Saut, for one), the great market research firm Ned Davis Research believes we are in an equity secular bull market that will see double digit gains thru the end of the decade, at minimum. As market technicals form the core of their ‘being’, a big driver of the secular bull market thesis is how the market has ‘behaved’ since the March 2009 lows – 15%+ gains per annum with ‘higher highs’ in multiples on the back of improving macro conditions. Valuation is largely ‘backed and filled’ in order to fit the Macro + Technicals ‘weight of the evidence’ conclusion.

GMO and John Hussman best represent the view that the US equity market is severely overvalued based on historical valuation metrics. One additional piece of evidence in their support is the fact that the % of respondents in the monthly BAML “Global Fund Manager Survey” that believes the equity market is overvalued is at record highs. As the BAML “Thundering Word” team likes to say, the equity market is currently dominated by “fully invested bears” (paraphrasing a bit).

Secular bull market believers tend to cite the S&P 500 forward price/operating earnings and/or the spread between equity earnings yields and bond yields. It is semantics, as the burden of proof is on the ‘perma bears’, but I do not agree with these valuation metrics. IMO, the most rational arguments for ‘this time is different’ wrt valuation are tax rates and inflation. As long as the macro backdrop is accomodative to equities, current tax rates remain in place and/or trend lower, and inflation remains tame (sub-3%?), a 17.5-22.5x market PE is likely a fair range.

As a rough gauge, the Value Line median PE closed Friday at 19.6x.

To partially answer the original question, I believe too many global macroeconomic factors must ‘thread the needle’ for the market to see double digits gains thru the end of the decade. So while NDR is more than likely correct that we have been in a secular bull market since March 2009, I believe they are likely wrong in the duration of their call. Sometime in the 2017-2019 period I believe inflation, interest rates, and thus the Fed will become hostile to US economic growth, and the US business cycle will turn south, leading to a de-rating in the US equity market.

This is a relatively lighthearted prognostication piece – so for fun, a rough outline of a possible path for the S&P 500 thru 2018…

S&P 500 Path thru 2018

As I have outlined via multiple mediums – and will do in greater detail in an upcoming post via the 17 Mile Seeking Alpha account – I believe the current market backdrop is very much akin to the early stages of the 2013 bull market. But unlike 2013, valuations, inflation, interest rates and the Fed pose a considerable headwind once the market completes its rally. As such, I believe there is a material probability that the market makes its final peak in the first 6-9 months of 2017 before descending into a cyclical bear market that de-rates the market down to at least 15x earnings (or ‘at most’, depending on the semantics).

The SPX closed Friday at 2276.98. Using the Value Line PE of 19.6x as a rough market proxy, were the S&P 500 to rise to 22.5x earnings it would have to rally by 14.8% to 2613.88. I believe a rally into a “Short in May” season makes sense; but another possibility is that market ‘breadth’ peaks in 1H17 while the index itself doesn’t peak for another 2-3 months (akin to the 1987 peak).

If the Fed begins to aggressively respond to rising inflation – via action and rhetoric – and the US economy heads south in late 2017/early 2018, then the S&P 500 de-rates to 15x, or -33% to 1742.59. Perhaps a recession somewhere between the magnitude of 1990 and 2000-2002, and a 6-9 month equity bear market into early/mid 2018?

Again – all in good fun. This could easily be the exact opposite of how things play out over the next 12-18 months. What I firmly stand by, however, is the current bullish market configuration along the lines of early 2013.

Stocks & Sectors

Media

  • Bit of a rollover prediction from 2016, but Media is a good place to be in 2017.
  • I said on 12/5/16 that the T/TWX deal was a spark, and that once fund managers entered a new year buying would begin…let’s see if there is follow-up to this week’s price action.
  • Broadly, probably want to own everything but VIAB and DIS…but have a feeling I’m simply biased against DIS.
  • The Dolans are not dumb – I think they make a move with MSGN as industry M&A heats up in 2017.
  • Continue to firmly believe that 2017 is the “year of DISH” with the Broadcast auction coming to a close.
  • After a necessary reset in the ‘Malone trade’, LBTYK has been out of the daily spotlight for awhile now (often a necessary condition for a ‘bottom’) and is likely a sneaky-big 2017 winner.

Pharma

  • On 12/5/16 I said: “I want to be more enthusiastic about the potential “Dogs of the Dow” 2017 Spec Pharma trade. For some reason I can’t get there. Perhaps that’s a good thing.” (A ‘good thing’, meaning that I was likely playing my own contrarian indicator.)
  • This week’s Drug stock price action exhibited all the signs of a blown out industry ‘taking off’ in a new year; but I am open to a final round of new lows.
  • TEVA’s puke yesterday was a big buying opportunity, IMO…
  • After seemingly daily attention paid to its declining stock and management’s ‘lack’ of M&A initiative, like LBTYK, GILD is now out of the spotlight and likely set for a big 2017.
  • Is PRGO bought out in 2017, or at least approached?

Reflation/Fins/Bonds

  • BAC/BRK is a great long-term ‘reflation’ combo, but…
  • …Short- to medium-term sentiment is overly extended for the Fins, KRE insider selling is robust, and the bond market has exhibited signs of short- to medium-term selling exhaustion.
  • A BAC/BRK trim/JNJ add trade makes sense into perhaps the end of 1Q17?
  • JNJ is an interesting healthcare/staple combo, so it should benefit from a Pharma + bond market rally.

Other

  • AAPL
    • In December 2015 I asked if we would get a shot at AAPL below $85 in 2016 (it got to $89.47). Let’s roll that forward and ask if we see sub-$80 if AAPL continues to do nothing to diversify its earnings power…
  • AMZN
    • IMHO, the stock is cooked.
    • Everyone and their brothers and sisters are enamored with AMZN’s effectively unlimited growth runway. It’s time for a bout of questioning Bezos.
    • I look forward to considering a long position below $600  🙂
  • MDLZ
    • Does KHC make a move before rates move too far too fast?

Black Swan Required?

It’s always interesting to put together a list of potential ‘black swans’…but more often than not the equity market ‘breaks’ due to market participants not appropriately accounting for a ‘risk’ hiding in plain sight. At present, rising rates, rising inflation, and a more hawkish Fed are viewed positively as signs of accelerating economic growth and thus corporate profitability. I will play the market as it lies, but I believe this monetary triumvirate will more than likely be the source of an equity market ‘break’ later this year.

For fun, my 2017 black swan pick is increased military aggression out of China. #MAGA.


DISCLAIMER: The views and information I provide are for informational purposes only; are not meant as investment advice; are subject to change without notice of any kind; do not constitute an offer of products or services with regard to any fund, investment scheme, or pooled investment; nor do they in any way, shape or form represent the views of my employer.

17 Mile Investment Letter

17 Mile 

Investment Letter 

January 2017


Dear Reader,

As my communication has been sparse of late, an overview/history/update of 17 Mile is in order before a portfolio discussion.

* * * * * * * * * * * *

After 5.5 years of what I viewed to be an investment ‘residency’ of sorts, I launched the 17 Mile blog/project in June 2014 to document the process and performance of my event-driven, value-oriented investment strategy in order to develop a well-documented public – albeit crude and unaudited – performance track record.

From the beginning I have described my investment approach as “Loeb-style ‘events’ + Druckenmiller-style aggressiveness” – one designed for no more than 5% of a total portfolio, not 100% of grannie’s net worth.

From June 2014 thru October 2015 the 17 Mile ‘project’ and strategy went very well. Due to investment performance, yes, but also how that performance was achieved and what I learned about myself along the way. That is…

My core competency is not in deep, on the ground due diligence – that, for better or worse, remains in development – but rather the curation and management of ideas from a wide variety of sources. In other words, portfolio management. (I am fully aware how ‘nails-on-a-chalk-board’ this paragraph will sound to most.)

It turns out that I have a pretty darn good gut feel for the ‘tape’ (and no, when I say ‘tape’ that does not mean staring at price charts). And when I lose the ability to manage according to that ‘feel’, things go very badly.

From November 2015 thru February 8, 2016 the performance of my 17 Mile strategy collapsed. In ascending order of importance:

  1. I misread the broad market environment
  2. Given #1 I was far too aggressively positioned
  3. I broke my portfolio management rules
  4. I allowed market volatility to impair my cognition
  5. Due to a workplace conflict, I boxed myself in from a portfolio/risk management standpoint

At quite literally the worst possible time I simultaneously received a margin call + had a ‘come to Jesus’ investment life moment. Given that I was running the 17 Mile strategy as if it was an actual fund, I decided to shut things down…akin to investors pulling $$$ after a large – even if temporary – drawdown.

That did not last long, and I was quickly back at it, believing I could fight my way back. But given my cognitive impairment from the drawdown, I could not mentally get back into the security that caused the pain in the size needed to recover performance. So in early March I moved on from the forbidden security and on to what I believed to be the next big trade: another leg down for the broad market.

To bring things full circle, the 17 Mile ‘strategy’ evolved as follows:

  • June 14-October 15: Aggressive, yet diversified, event/value
  • November 15-February 16: Aggressive, highly concentrated Energy beta/event/value
  • March-June 16: Aggressive, concentrated macro/market timing
  • July 16 to present: Square 1

As painful and horrifically embarrassing it was to have my original event-driven, value-oriented strategy collapse in public, it was the best thing that could have happened. Truly. With not a shred of false modesty or rationalization.

I have, God willing, 4-5 decades of investing ahead of me. I now have one of the worst investment periods for active managers in the last 2-3 decades under my experience belt + documented in excruciating detail to guide me thru those 4-5 decades. How can I not be anything but ecstatic?

From June 2014 thru today I have learned the following (in no particular order):

  1. Become your own investor
  2. Listen to yourself while listening to others
  3. Do not mess with dangerous market environments
  4. Develop a robust market outlook framework
  5. Live to fight another day
  6. Don’t sacrifice the significant gains to be had on the other side of the abyss for the sake of catching the bottom
  7. Bottoms are pretty darn obvious – WAIT FOR THEM TO HAPPEN
  8. You have to buy ‘distress’ – pick a definition
  9. Get to know everyone’s strengths and weaknesses…particularly the experts
  10. Diversify your concentrations – pick a definition

With these ten lessons in mind I have:

  1. Streamlined the original 17 Mile strategy (17M)
  2. Launched an unlevered event/value strategy called “17 Mile Global” (17MG)
  3. Continue to nurture a fledgling ‘short’ strategy
  4. Developed a third strategy called “17 Mile Distressed” (17MD)
  5. Enhanced my market outlook framework
  6. Cleaned up the blog and Twitter
  7. Developed and launched US equity total return and global asset allocation strategies outside of 17 Mile
  8. Streamlined the management of my total personal investment portfolio

17M. As originally launched, 17M combined long-term oriented value investing with 1-3 year ‘events’, overlaid with portfolio management rules and aggressive trading. Sort of in that loose order of priority.

As demonstrated by the ‘evolution’ outlined earlier, at its core it is really just a highly aggressive trading vehicle with a 6-18 month time horizon and limited portfolio management structure.

With the longer duration investments and strict portfolio management rules now funneled thru 17MG, I can now do whatever I please in 17M. So for example…

As I will get into in later sections, I currently anticipate a fantastic opportunity to “short in May and go away” this year, and I want to be able to take full advantage of that. So rather than not go net short for the sake of strategic purity, I can now confine that bet to 17M where I now allow myself to go aggressively net short.

Lastly – despite the fact that I did a fair amount of opportunistic trading in 17M from June 14 thru October 15, I still kept myself rather constrained. Now, I let it rip. If a ST trade begins to ‘behave’ poorly, it’s gone.

17MG. The 17MG strategy is designed how 17M should have been originally. It is a medium- to long-duration event-driven, value-oriented strategy, with modest amounts of opportunistic trading, and limited market timing. I launched this strategy in May 2016 as a pure-play stock picking vehicle with strict portfolio management rules. It is unlevered; must hold at least 10 securities; has a max initial position size of 10%; and can hold no more than 50% cash.

Within a globally-oriented equity portfolio, I would be comfortable with 17MG comprising upwards of 50% of the US Mid & Large equity allocation (for reference, at present US M&L equities comprise roughly 50% of the global equity benchmark).

Shorting. I really should not even be writing about an extremely rough attempt at developing a short strategy. But FWIW, I am testing it out via a paper model (barred from shorting IRL for compliance purposes). Unfortunately I just do not have the time to devote 110% of my attention to it, so it is really managed from the sidelines with very limited turnover. I do not have position sizing rules, but the short side cannot be more than 100% gross, and I can hedge the market on the long side up to 100% gross. So max total gross is 200%. As I develop my due diligence and universe coverage expertise, I anticipate this ‘model’ ramping significantly over time…

17MD. The “17 Mile Distressed” strategy (anticipated launch sometime in 1Q17) was born out of a personal need + the general streamlining of my total personal investment portfolio. The long-duration portion of my total portfolio is comprised of a 17MG-like buy & hold portfolio (but more concentrated, as money added continually over time acts as a natural hedge/diversifier), index funds and 17M. But I need a portfolio/strategy for savings with a 1-10 year duration – kids’ college, cars, house, vacation, etc, etc. It needs to be a portfolio where I can have my cake and eat it too – above fixed income/cash returns with fixed income/cash-like volatility…i.e. NO drawdowns. This portfolio/strategy construction requires the following:

  1. Zero leverage
  2. Strict position sizing + industry concentration rules
  3. Extraordinarily strict, mechanical portfolio exposure ‘schedule’ tied to broad market conditions + market sentiment

And when I use the term ‘distressed’ I do not necessarily mean the traditional use of the term. A high quality company/stock such as JNJ for example can experience temporary bouts of ‘distress’. I am ecstatic about this strategy, as it takes the best parts of 17M and 17MG and overlays strict portfolio management rules with mechanical market timing. I’m pumped.

Market Outlook. My original ‘Market Mosaic’ framework was: Economic Conditions + Monetary Conditions + Market Technicals + a proprietary Market Model. The Economic Conditions component is by far the most critical, as all sustained 30%+ market declines have historically occurred inside of recessionary economic conditions as defined by the YOY rate of change of Weekly Jobless Claims (4-week moving average) above 20%. And the fact that the May 2015 to early February 2016 cyclical bear market was limited to less than 20% helped confirm this indicator in real time…

…(Unfortunately I failed to heed this indicator by becoming far too bearish from March-June 2016 based on what I believed to be a highly negative set of market ‘technical’ indicators.)

I have since tweaked the Mosaic by removing the ‘Market Model’, revamping the indicator set within the Market Technical component, tweaking how I interpret the Market Technical component, and adding placing greater emphasis on sentiment indicators as a supplement to the Mosaic itself. I am not going to go into great detail, but by far the most important change was the addition of supply & demand indicators.

Clean-Up. If you are in the business of ‘documentation’, then you understand the fact that accumulation of knowledge over time naturally invites a cluttering effect. As such, enormous mental relief is obtained by a semi-regular revamp of the documentation process. For example, I had begun to use the 17 Mile Twitter feed as a market analysis journal of sorts, posting updated thoughts on a weekly basis. But this generated far too much clutter for my Twitter feed, so I created a “Market Analysis” page on the blog in order to simplify and streamline the storage of those thoughts. (That page is now private, as I regularly post content for myself that I am unable to publicly distribute.) Also – I created an alternative Twitter account in order to house more regular intra-day market and stock-specific thoughts, as those too can clutter up the feed (I’m sure someone will happen upon a correct guess over time…).

Two more blog revamps were the de-emphasis of the “Scratch Notes” page and the removal of the “Business & Politics” section. Consistent use of the Scratch Notes page was sucking up far too much precious time that could otherwise be devoted to greater amounts of reading. I love taking notes, as it greatly assists in retaining information; but the pay-off did not exceed the time spent documenting, as I never really used the page to go back and review the notes. I will occasionally post a significant article or two, but activity will be very limited going forward.

The Business & Politics section was born out of my life-long obsession with politics + a riveting campaign season. As I am sure anyone with even a shred of political curiosity found this election cycle, my pre-conceived political notions were questioned – both to the good and bad – on almost every level on virtually a daily basis; and I wanted my thoughts documented in real time. Further, I thought that once the election concluded that my curiosity would naturally subside. But I was wrong – it has only accelerated. As such, I removed the B&P section from the blog and moved my thoughts to the land of political anonymity, far removed from world of “Finance Twitter”.

* * * * * * * * * * * *

While all of the above could perhaps be viewed as highly disparate, that view is wrong. The above is the development of long-term building blocks. The investment business is one of the most scalable operations on earth…once the ‘building blocks’ of process – in all of its forms – are put into place. And at this point in my career, I remain in the building block stage, for better or worse.

Of course MANY are much further ahead than I am from both a process and net worth standpoint. But I do not care. I cannot manage my own investment ‘personality’ according to outside investment personalities. I learn every single day by observing others, learning their strengths and weaknesses. But long-term multi-decade success requires the patient, methodical development of key investment building blocks built upon one’s own investment personality.

Largely by accident I built the 17 Mile project around a single strategy, one that was highly aggressive and not representative of me as an investor in my entirety. As I told a now good investment friend over coffee in Omaha last year, at heart I am actually a very boring, long-term oriented investor that would prefer to buy whole businesses and reinvest excess earnings as I see fit. That is how I manage the bulk of the long-duration portion of my total investment portfolio. As such, the vast majority of my development as an investor/trader over the last 8 or so years has been on the ‘hedge fund’ side of the equation, for lack of a better descriptor. If I spend the next 4-5 decades in a continual state of reinvention, then I will have failed mightily as an investor. But I find this possibility to have a near-ZERO probability of occurrence 🙂

On to the portfolio discussion…

PERFORMANCE

17M. For 2016 the 17M strategy was down -46.9% (gross), versus the DWCFT index return of +12.6%, ending the year with an NAV of $7.18. Since 6/15/14 inception, the 17M strategy is down -28.2%, versus the DWCFT benchmark return of +20.8%.

Clearly horrific, as the commentary above eluded to. However – since the strategy came full circle back to its strategic roots, the process & performance has gained significant momentum. I anticipate that NAV will climb to north of $20 within the next 12-15 months or so.

17MG. From 5/1/16 inception thru 2016 YE, 17MG is up 7.2% (gross) versus the DWCFT index return of +10.9%.

This result is to be expected from an unlevered, relatively low-turnover strategy only eight months into existence. For the first two months the strategy held upwards of 40% cash, as I was bearish on the broad market; and a large long-term weighting in Drug stocks has weighed on ST performance, with ‘ripening’ of those investments not expected until the 2017-2018 time period.

PORTFOLIO CONSTRUCTION

17 Mile

Positions in order of size: DISH, NXST, FOXA, PFE, ADS, DISCK, QVCA, JCI, GDX and ADNT.

Current exposure is largely maxed out, as I believe the short- to medium-term market set-up is highly bullish. But GDX acts as an uncorrelated hedge with gold sentiment bombed out on a short-term sentiment due to a smoking hot USD + the PFE and FOXA positions were initiated as short-term trades into temporary ‘distress’ with the potential to turn into medium- to long-term positions + the out-sized DISH and NXST positions contain large ‘special situation’ components. In other words, exposure can be quickly managed down if needed.

In the event a new opportunity pops up, GDX and PFE would be the first sources of funds. I am currently eyeing SHLD and VRX as potential special situation trades –> medium-duration investments (?), but neither is cooperating at the moment, as I wanted both much lower than current levels.

DISH, ADS, DISCK, QVCA, JCI/ADNT are core medium- to long-term positions, with all but DISH currently sized as such. NXST is not a great long-term business, but the valuation + near-term catalysts are a highly compelling combination for a near- to medium-term trade/investment. FOXA is likely to turn into a core position; PFE is likely to be recycled into a more compelling idea; and GDX is a near-term trade/hedge.

Heading into 2017, DISH possesses the highly compelling troika of: long-term undervaluation + event-potential + high probability near-term special situation. The bear case is that technology will reduce the $3.50 to $4.50 per ‘MHz-POP’ fair value of DISH’s spectrum portfolio to somewhere below $1.50. Perhaps. But I refuse to believe so without a free & clear 6-18 months of industry M&A discussion going by without DISH involved in a transaction of some kind. With the Broadcast Auction coming to a close, the M&A runway is finally clear for DISH to engage with key ‘connectivity’ industry players. As with any position at any time, I am open to the possibility that I am dead friggin wrong. But putting the ‘mosaic’ together, I do not believe now is the time to be bearish on DISH.

We’ll see how the year plays out. If we get a rip-roaring 1H17, I anticipate a serious reduction in portfolio exposure into the May/June time frame, and a likely (large?) net short position. But I will play it where it lies; and if we simply get maybe two or three 5-10% corrections, portfolio exposure may not vary much.

17 Mile Global

17MG is fully invested, and will likely remain so unless we get a hot 1H17 –> “short in May” set-up.

The portfolio is dominated by Media names (>50%) – DISH, FOXA, DISCK, LBTYK, MSGN, NXST – and Drug stocks (20%) – TEVA, MYL, AGN. Other positions include: ADS, WFC, QCOM, HTZ and HRI (in order of size).

INVESTMENTS

Media. Each Media investment has its own catalyst(s) – DISH spectrum, FOXA international investments/SOTP realization/industry consolidation, MSGN Dolan, NXST Media General, LBTYK long-term Comcast take-out (?), DISCK industry consolidation – but the key investment theme is: long-term “OTT” competition is not only further out than market participants believe, but will also not be as negative to long-term earnings power as market participants believe. The worst case scenario is the ‘bundle’ breaks up and the Content Cos are forced to distribute on a standalone basis. But this is irrational, as the cost to reconstruct the bundle ala carte would far exceed the cost of the current ‘bundle’. The market knows this – since if this was a realistic scenario, DISCK would trade for 7x earnings ($14), not 13.5x. IMO, it is likely that as the underemployed ‘Millennials’ cohort comes of age – and assuming they do not descend into socialist hell – the demand for high quality content at scale, distributed in a highly tech-friendly manner will rise. In short, the current ‘bundle’ does not have a demand problem, but rather a structure/tech/usability problem. At minimum this thesis warrants a re-rating to at least 15x earnings for diversified, high quality content. Again, IMO.

A highly catalytic ‘space’ led by top-notch management teams, on top of the fundamental thesis outlined above, is what leads me to an out-sized aggregate position.

Drugs. After Pershing Square kicked off a hedge fund bonanza in the Drug space from April 2014 thru July 2015, the sector has been in a choppy-yet-steady decline. Headlines are ugly – politics, pricing, competition, etc, etc – but valuations are extraordinarily cheap. Unfortunately I am not smart enough to envision much in the way of catalysts; but I do believe we are very close if not at THE bottom, based on classic end-of-year technical selling pressure. As Energy continued to sell off into early 2016 before making its penultimate bottom, Drug stocks could continue to sell off here into the new year. I believe that is unlikely; but if they do, I believe that is the final capitulation moment.

MARKET OUTLOOK 

Macro. The US economy continues to chug along, the global economy ex. US has begun to heal from the 2015 cyclical downturn, and global credit markets remain WIDE open. Without runaway investor sentiment, equity market downside is likely limited to 5-10%.

Technicals. Since Brexit, the amount of demand that has come into the US equity market has been nothing short of explosive. And while there is always room for multi-week/month consolidation, such as what we saw going into the US election, measures of demand continue to point toward further equity market upside.

I will play the market as it lies – so I do not really care about making a ‘big call’ on where the market will go this year…but according to the market demand measures I follow, this market looks eerily similar to the early stages of the 2013 bull market. Reading the ‘tea leaves’ – the market likes to stall in the June-September time frame, and given the extremely elevated absolute valuation of the market, it would not even remotely surprise me to see runaway market sentiment into the May time frame, setting up a wonderful “short in May and go away” opportunity.

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I have already exceeded how much I wanted to write, as one of my New Year resolutions is to write in a more concise, digestible fashion. So I will leave it here for now. I will follow up with a more lighthearted post of various 2017 prognostications I have been accumulating over the past month or so; as well as a more in-depth market outlook for the 17 Mile Seeking Alpha account.

Happy New Year to all.

17M


DISCLAIMER: The views and information I provide are for informational purposes only; are not meant as investment advice; are subject to change without notice of any kind; do not constitute an offer of products or services with regard to any fund, investment scheme, or pooled investment; nor do they in any way, shape or form represent the views of my employer.

Generals: Under Armour Quick Valuation Overview

Under Armour

Generals: Quick Valuation Overview

December 4, 2016


SUMMARY INFO

  • NYSE: UA (formerly UA.C)
  • Recent PPS: $24.77
  • Shares Out: 442.16
  • Market Cap: $10,952
  • Debt: $1,074
  • Enterprise: $12,026

DISCUSSION

I am at the very early stages of my due diligence on Under Armour, but wanted to quickly put some early thoughts down on ‘paper’. In short, it appears Under Armour is a busted growth story with seemingly little in the way of valuation to support the downside. The cloud of uncertainty currently hovering over UA’s stock price is precisely the cloud under which I would like to consider initiating a long-term position in AMZN, as noted in this late September write-up. And in 180 degree opposition to AMZN’s current overly loved stock price, I want to veer materially to the upside vis-a-vis ‘Street’ and market price targets when it comes to my UA valuation work.

The market is disappointed with long-term EBIT margin guidance, and the stock has reacted accordingly. But with UA 2016E sales at $4.9 billion versus $32.4 billion for NKE, UA ‘should’ be targeting almost no operating profit in order to build out its scale sooner rather than later. Though one potential area of long-term concern is how aggressively UA pursues its “Connected Fitness” business. If they are aggressive, it is not a stock to own, IMO.

#1 valuation question: can UA close the 7.56% SG&A margin gap with NKE over the long-term? If so, at what level of sales?

In my rough initial valuation work, I assume UA hits its 2018 sales goal of $7.5 billion, then grows to approximately $14 billion by 2022. I assume UA closes 75% of the SG&A margin gap with NKE by 2022.

If UA trades for 20x 2022 EPS, discounted back at 10% UA is worth approximately $38. (This ignores current debt, as UA more than likely would turn net cash positive by 2022.)

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Again, very early stages of analysis here – but as long as UA does not make an aggressive push into Connected Fitness in 2017 (or guide to it…), from a sentiment/market/trading dynamic perspective my early thought is that this stock could easily clear +50% in 2017.

UA Analysis December 2016