Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST, Thursday, September 27, 2007: There
are two ways of measuring your investment -- the return on your investments
and your net worth. Personally I like net worth. It takes what you started with
at the beginning of the year and measures it against what you have at the end
of the end -- after expenses. It gives you a better measure if you're affording
your lifestyle or it's running you down.
worth measures how you well you did on four critical measures -- your taxes,
your living expenses, returns on your investments and your earned income. Net
worth washes everything out and tells whether you're ahead of the game. Net
worth is the only measure that
friend called yesterday said his growth in net worth had averaged 20% a year
over the last five years. That's pretty extraordinary -- until you know he's
not married, has no kids, and gives cheapness a whole new meaning. He is, however,
endearing in the poverty he feigns. I figure mine will be closer to 7% this
year because it's been a heavy expense year -- what with a wedding, two kids
in graduate school, etc.
figuring net worth, it's legit to include assets you can sell -- like your houses
and your Picassos (I wish). But don't all your other assets -- like cars, furniture,
TVs, cameras -- they're all declining in value. Your upcoming garage sale won't
be worth your time.
days all net worth and rate of return calculations are marred by valuations.
Increasingly, all of us own stuff that isn't valued daily like shares on the
stockmarket. We have "alternative investments," like private equity
funds, which we won't know the real worth of for five years. I wonder how institutions
like Yale do their valuation. Today's papers reports that Yale earned 28% on
its endowment for the fiscal year to June 30, 2007. That's a phenomenal return.
We don't know a lot about how Yale did it, since the Endowment's annual report
isn't out yet. But, from today's New York Times:
endowment continues to be diversified, but Mr. (David) Swensen, Yale's brilliant
manager, declined to say which asset class performed best. His target asset
allocation for fiscal 2008 is fairly similar to the allocation for 2007. The
biggest allocation 28 percent of Yales funds is in real
assets. Last year, those included real estate, oil and gas and timberland,
Yales report showed.
allocation is to what Yale calls absolute return investments, which generally
means hedge funds. Yale is slightly reducing that stake to 23 percent, from
25 percent, according to Mr. Swensen.
is also planning a slight reduction in domestic equities to 11 percent, from
12 percent. Fixed-income and private equity will remain at 4 percent and 15
percent respectively, and private equity is increasing 2 percentage points
to 19 percent, Mr. Swensen said.
There are things
to know about Yale's endowment:
1. It is diversified
-- far more than any single investor (like you or me) could ever hope to be.
2. Yale has probably
the best deal flow in the entire world. There isn't a money manager that doesn't
want to manage money for Yale. Yale is a huge feather in their cap.
3. Yale publicizes
its results for precisely one reason (today's NYTimes, Wall Street Journal,
etc.) -- it wants to attract the deal flow.
of the week:
you don't know what you're doing, it's better not to jump. Evel Knevel
blunders along. Vista sluggishness, Excel bugs (see yesterday) and
now word of bugs in XP -- The trouble occurs when users reinstall XP's system
files using the repair capability found on genuine XP CD-ROMs. (The feature
is not present on "Restore CDs.") The repair option, which is typically
employed when XP for some reason becomes unbootable, rolls many aspects of XP
back to a pristine state. It wipes out many updates and patches and sets Internet
Explorer back to the version that originally shipped with the operating system.
Normally, users who repair XP can easily download and install the latest patches,
using the Automatic Updates control panel or navigating directly to Microsoft's
Windows Update site. However, after using the repair option from an XP CD-ROM,
Windows Update now downloads and installs the new 7.0.600.381 executable files.
Some Windows Updates executables aren't registered with the operating system,
preventing Windows Update from working as intended. This, in turn, prevents
Microsoft's 80 latest patches from installing even if the patches successfully
downloaded to the PC.
Microsoft is working
on this new problem as well and will issue a fix eventually.
To repeat yesterday's
advice: Don't upgrade to Office 2007. Don't use Vista. Turn off automatic upgrades
on XP (too dangerous). If you ever need to repair your Windows XP computer,
Is it time to
short Microsoft? No. (No serious disaster story.) Would I hold Microsoft? No.
(The stock is going nowhere.) If I owned it, would I sell it? Yes. (To repeat,
the stock is going nowhere.)
time you become an airline prisoner: Glenn Deek writes
Harry, I actually
found a strategy that works, I was stuck on the tarmac in Oklahoma city (diverted
from Dallas) because we ran out of gas. They couldn't run the engines and
the air conditioner cart broke so we sat for almost 2 hours baking in the
plane, waiting for a gas truck.
I called the police on my cell phone they sent me to the airport police. I
told them if they didn't get fuel or us off the plane, I was going to call
the fire dept and report an medical emergency.
The guy on the other end said "Oh no, please don't do that, I will take
care of it" and what do you know, five minutes later we had a gas truck
and an air unit.
I also bitched
out the airline once I returned home and received a $400 voucher.
I emailed Deek back:
pulled off this stunt and got away with it? And they didnt threaten
you with arrest and a stay in jail?
I was 2 seats
away from a howling baby. The lady in front of me was ready to pass out. And
I am 6' 5" crammed into those little seats, I'd had enough!
goes Canadian Oil Sands? My
friend and energy guru, Jim Kingsdale writes the excellent Energy
Investment Strategies website. His latest posting concerns Canadian
Oil Sands Trust, a stock I own. This is a long, piece with serious interesting
analysis. Worth reading.
Sands Trust (COS) owns 36.74% of Syncrude, Ltd, one of the largest and most
developed oil sands operations in Canada. Sycrude has a record of profitability
and has already achieved construction of the bulk of its long term capacity
goals, including in July an upgrade that increased output capacity by 40%
to approximately 350,000 barrels per day, or about 129,000 for COS. A de-bottlenecking
upgrade will add another 50,000 b/d to capacity in five years and a final
planned expansion will bring production to 500,000 b/d in about ten years.
There are two
important qualities of Syncrude operations that distinguish it from other
oil sands companies. First, their bitumen deposits are close enough to the
surface that they are mined rather than having to be liquified and then pumped
to the surface, a more expensive and energy-intensive process pursued by Nexen/Opti
and others. Second, Syncrude, in addition to mining bitumen, upgrades its
bitumen into a superior grade of light, sweet synthetic oil that they call
Syncrude Sweet Blend (SSB). SSB sells at a price that
differs from West Texas Intermediate (WTI) crude, the most frequently
quoted oil price. Sometimes SSB is priced at a discount to WTI, as it was
during 2006, but currently SSB enjoys a premium of about $5 per barrel to
the price of WTI.
proposition of an oil sands investment is fairly simple. The company owns
an enormous supply of bitumen, perhaps 50 years worth or more nobody
knows for sure. As the price of crude oil rises, the profitability of mining
and upgrading bitumen is propelled upwards on a leveraged basis, since the
marginal return on an extra dollar of price is 100% less delta taxes. If you
think (as I do) that over the long term the price of oil will increase substantially
as we get closer to and finally pass the onset of Peak Oil, then oil sands
plays are a way to profit from that trend. If you think, as most Wall Street
analysts do, that the longer term price of oil will not move dramatically
above, say, $70, then the value of an oil sands company is much reduced. In
sum, it is all a matter of what the price of oil will be in the out
What are the
risks? If the price of oil does rise past $100 and then past $200 and so on
over the next decade, what might stand in the way of vast riches for the COS
shareholder? First, of course, there is the difficult problem of managing
a huge, sprawling, technologically advanced and advancing enterprise located
in an inhospitable environment with severe endemic labor shortages. Assuming
the company continues to successfully handle these daily challenges, their
task will not be simply a matter of bundling up all the profits and sending
them off to shareholders. The public and their elected representatives
will be increasingly concerned about protecting their environment and
securing their fair share of the rising corporate profits.
all oil sands companies, operates under both provincial and federal environmental
regulations. Both jurisdictions specify requirements and financial penalties
for failing to meet them. COS allocates about $125 million per year to satisfying
the environmental specifications laid out by those governmental requirements.
It estimates that Albertas requirements for continuing reductions in
GHG emissions will add 30 cents per barrel or $7 million to its costs in 2H
07. National environmental standards are under development and the company
estimates that its costs of compliance may be significant. Please
see the web sites of Syncrude and COS, for further discussion of environmental
problems and their remediation. The quarterly reports of COS detail its approach
to environmental issues, including costs.
Issues of taxation
at both the federal and provincial levels are important for oil sands operators.
This year Canada passed a law that impacts trusts, of which COS is one. Recently,
a study commission in Alberta released a report suggesting substantial increases
be made in provincial taxes for all oil and gas operators about which I wrote
last week. Taxes at either the national or provincial level could impact COSs
profitability in the out years.
of trusts is similar to U.S. taxation of REITs. Companies must distribute
90% of earnings but are not taxed at the federal level. Trust taxation was
initiated in part to encourage extractive industries, but eventually the advantages
convinced other types of companies to shift to trust from corporate status.
When such large public companies as Bell Canada contemplated becoming trusts
the Federal government began to see its entire corporate tax receipts begin
to dissolve. Their reaction was to pass a new law taxing dividends of trusts
at 30% starting in 2011.
to this change, COS (which I think has one of the smartest managements going)
has taken a couple of steps to maximize shareholder returns. First it has
decided that from the present time through to the time when the new dividend
tax takes effect, which is estimated to be 2012 or 2013 for COS given their
specific tax credit carryforwards, the company will pay dividends at the maximum
feasible level. It will also, during this period, eliminate debt repayments.
Prior to passage of the new dividend tax law, COS had been making substantial
reductions in its debt.
Secondly , management
is contemplating a change of corporate organization if the new law is not
changed by the time that the new tax begins to be applicable. Management has
indicated that one option is for the company to drop its trust status and
become a corporation. Another option would be for it to sell out, presumably
to a corporation. If COS were to become a corporation, their enormous free
cash flow could be used to buy in shares on a regular basis in lieu of paying
dividends and without incurring a tax. Perhaps there are other actions COS
could take to enhance shareholder value, which I am convinced is a primary
goal of management.
new proposed tax scheme is in its early days of being considered. Currently
oil sands operators pay 25% of operating profit to Alberta after they have
recouped their initial capital investment, which COS has done. If the new
tax proposal simply means that the current tax becomes 20% greater (i.e. a
30% tax) and if that tax were then to be set in stone going forward, it would
not be overly onerous. Nobody likes to see a government change the rules of
the road in taxation after a companys investment has been made based
on the original tax model, particularly when there is no alternative for a
company to change taxing jurisdictions. Nonetheless, the price of oil has
changed very significantly since the original deal was struck and the implications
of the enormous strains on Albertas economy caused by the expansion
of oil sands operations do provide some justification for a re-evaluation
of the fairness of the original tax scheme.
investors must ask is what are the long term intentions of the Alberta governent.
Will they honor whatever new tax scheme eventuates on a long term basis or
will they impose even greater taxes as time goes on, a la Venezuela. Each
investor must make that judgement. Based on my sense of the moral fiber of
Canadians, I am willing to believe at this point that future judgements will
be fair. If the price of oil goes to $200 a barrel will the Alberta government
take no action? For that matter will any government anywhere take no action?
One cannot presume that. There may be some form of oil price controls or new
taxes aimed at mitigating economic damage to the general economy. Such schemes
may not be all bad. But that is a long way from a Venezuelan approach.
In other words,
I believe that life for the oil sands investor is not likely to be perfect.
A never ending increase in the price of oil, which I do believe is in the
cards, will not necessarily translate into COS investors harvesting 100% of
the gains that might be projected based on current regulations and taxation.
On the other hand, the returns are still likely to be pretty good, I suspect.
Let me address
the dividend issue. Personally, I like dividends. I think they are the sincerest
indicator of a companys success. COS pays a substantial and growing
dividend, currently $0.40 per quarter, which is up 33% in 2007. Management
has said it intends to increase the dividend to the maximum extent it deems
prudent over the next six or seven years, as discussed above. The current
dividend is supported by current free cash flow of $0.57/share, which I believe
will increase to about $0.70 in the second half if the price of WTI crude
stays above $70. Another 33% dividend increase for 2008 would bring the dividend
to $0.53 cents. That would not surprise me. Nor would $0.60. One respected
analyst (Kurt Wolff) has predicted $0.80, but I doubt that. In any case a
dividend of $0.53 for 2008 would bring the yield to about 6.4%. If you believe
that the price of oil and therefore the free cash flow of COS
has much further to go in future years, then COS with a 6.4% yield and the
promise of a rising dividend seems attractive to me.
is COS? Warren Buffett once commented that as a general rule a company may
be said to be worth twenty times free cash flow (FCF). The Master might want
to adjust this multiple depending on the outlook for future FCF and prevailing
interest rate levels. Nonetheless, COS is in fact now selling at a 25% discount
to 20 times its first half FCF. If FCF runs at $0.70 for Q3 and Q4 this year
as I project, the 5% cap rate would give the company a buy-out value of $56
per share. Give the public market equities a 25% discount off private market
value and you get $42 a share. That is about 27% more than the current $33
price. Add a 5% dividend and you get a total return of 32% if COS achieves
a $42 value within one year. I think that target has a reasonable likelihood
of being met unless the price of oil declines substantially.
talk about the impacts of the falling U.S. dollar. There are three impacts:
the direct impact on the valuation of COS stock and the COS dividend for an
American investor, the impact on the global price of oil in US dollars, and
the impact on COS earnings. These three impacts work in somewhat complex and
offsetting ways. Given this complexity and the fact that I am not a licensed
foreign exchange expert, this discussion is certainly not intended to be definitive.
Rather, I want to present the bottom line as I understand it for those who
want to consider the issue. Let me address the impacts in the reverse order
as presented above.
Oil Sands Trust, a lower U.S. dollar (Dollar) in relationship
to the Canadian dollar ( Loonie), means that COS revenue from
oil sales is reduced by C$0.04 per share for each penny (roughly 1%) of increased
Loonie value to the Dollar. It is a simple one-to-one cause and effect relationship
because COS revenue is received in Dollars and then translated into Loonies.
While the revenue relationship is direct, the impact on COS operating earnings
is magnified because COS expenses are largely in Loonies. This negative impact
is slightly offset by the fact that COS debt is denominated in Dollars and
therefore is reduced by a falling Dollar.
On the other
hand, a falling Dollar tends to support a rising price for oil. It is impossible
to discern the direct impact of the Dollar/Loonie ratio on the oil price because
supply and demand issues, not foreign exchange, have the primarily impact
on the oil price. But in recent weeks as the Dollar has fallen rather quickly,
it appears to have been an important cause for the rise in oil. A rise of
$C 1.00 (roughly 1.25%) in the price of oil adds C$0.05 cents to the EPS of
the impact of a falling Dollar on the earnings of COS and thereby its ability
to pay dividends, there is a direct and magnified negative impact that is
offset to an indeterminate degree by a positive impact on price of oil. Is
the net effect zero? That may be a reasonable guess, but it is impossible
to know for sure because the precise impact of a falling Dollar on the oil
price of is impossible to know.
investor, however, is advantaged by the falling dollar in a direct one to
one cause and effect relationship. As the US dollar depreciates, assuming
no change in COS share price or dividend as stated in Loonies, the value of
the shares and the dividend are that much greater in Dollars. To be more specific,
COSs $C 0.40 dividend was worth $US 0.364 to me a few months ago when
the Loonie was worth $US 0.91. Now, as the currencies are at par, it is worth
the full $US 0.40 to me. Thats the same as if I had gotten a dividend
increase of 9.9%.
this together, a falling dollar has a net positive impact on the value of
COS shares for the American investor. That is because the impact of the falling
dollar on COSs operating earnings, given its positive impact on the
Dollar price of oil, is some amount that may be close to zero. But the value
of the COS shares and dividend are increased to the American investor by the
full percentage change in the depreciation of the Dollar. Thus, the expectation
of a falling Dollar would be a positive influence on an Americans decision
to buy or sell shares of COS, although it is certainly not the most important
So, to summarize,
heres my take on Canadian Oil Sands Trust:
1. It will be
an operationally leveraged beneficiary of any future increases in the price
of crude oil, regardless of future changes in currency exchange rates.
2. It will benefit
from increasing volume of about 43% over the next ten years.
3. It has enough
bitumen to operate for the next 50 years or longer.
4. It is operated
by an outstanding management team which is shareholder oriented.
5. It is more
subject to the vagaries of governmental regulation and taxation than is the
average company. Moreover, such regulators have a legitimate interest in protecting
their environment, which is inherently harmed by the companys harvesting
of bitumen and conversion into crude oil. Thus, one can assume increasing
costs to the company for environmental mitigation. But the good news is that
the regulators and tax authorities have not yet totally destroyed a reasonable
basis for trust with the investment community. They may yet do so, but it
has not happened so far in my judgement.
6. If the price
of WTI crude averages $71 in the next 12 months, I estimate the FCF of COS
at $0.70. That could support a dividend of $0.53 per quarter and a stock price
wise Navajo lady.
Sally was driving home from one of her business trips in Northern Arizona when
she saw an elderly Navajo woman walking on the side of the road.
As the trip was
a long and quiet one, she stopped the car and asked the Navajo woman if she
would like a lift.
With a silent
nod of thanks, the woman got into the car.
Resuming the journey,
Sally tried in vain to make a bit of small talk with the Navajo woman. The old
woman just sat silently, looking intently at everything she saw, studying every
little deta il, until she noticed a brown bag on the seat next to Sally.
bag?" asked the old woman.
Sally looked down
at the brown bag and said, "It's a bottle of wine. I got it for my husband."
The Navajo woman
was silent for another moment or two.
with the quiet wisdom of an elder, she said: "Good trade."
This column is about my personal search
for the perfect investment. I don't give investment advice. For that you have
to be registered with regulatory authorities, which I am not. I am a reporter
and an investor. I make my daily column -- Monday through Friday -- freely available
for three reasons: Writing is good for sorting things out in my brain. Second,
the column is research for a book I'm writing called "In Search of the
Perfect Investment." Third, I encourage my readers to send me their
ideas, concerns and experiences. That way we can all learn together. My email
address is .
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