Another week of Horrible data (May 4-May 8, 2020)

Risk-on sentiment prevailed in the previous week with all major US indices gaining more than 3% for the week. (SPY/SPX +3.4%, QQQ/NDX +5.7%, IWM/Russell2000 +5.77%, Dow +2.67%)

In the bond world, yield curve steepened with 30 yr Tsy yield +10.8bps WoW vs 10 yr Tsy yield +4bp WoW vs 2yr Tsy yield +3.7bp WoW. US HY OAS tightened by 10bps until Thursday while US IG OAS widened 3bps WoW. Another interesting development here was that Fed Funds Futures for Jan’21 turned negative briefly. So far Fed has been saying they are against the NIRP, let’s see if the bond market forces it’s hand.

If one were to draw an inference from just the above 2 facts (equity markets rising and yield curve steepening), it seems like growth is coming back. Market seems to be looking beyond any bad data point that comes across even if it’s the worst EVER:

  • ISM Non-Manufacturing PMI of 41.8 vs 52.5 last month
  • ADP Employment change of -20.2mm vs -20mm consensus
  • Initial jobless claims of 3.17mm vs consensus 3mm taking overall jobless claims in last 7 weeks to 33mm
  • Continuing Jobless claims of 22.65mm vs consensus 19.9mm
  • Non-farm Payroll of -19.5mm vs consensus -21mm

Why did markets rally with all this bad data? Some say unemployment data are lagging numbers and I agree. But when they say that this is appropriately priced when the S&P is only -9.3% YTD and +1.7% from 1year ago, that is a tough one to agree with.

All risk assets except Banks (KRE +0.6% WoW, KBE +0.6%), Utilities (XLU +0.5%), Staples (XLP +0.9%), Industrials (XLI +1.35%) and Healthcare (+1.6%) rallied hard

  • Semis (SMH +7.2%)
  • Biotech (+6.2%)
  • Consumer Discretionary (+4.5%)
  • Tech Hardware (+6.4%)
  • Homebuilders (+7.3%)
  • Oil & Gas Exploration (+7.2%)

In commodities world, Lumber (+11.6%) and Oil (+24.5%) led the way.

Most market commentators are puzzled by the disconnect between the stock market and reality. Some have started saying, “Stock market is not the economy. The economy is not the stock market”. Other more confident proponents of a solid quick recovery think re-opening will unleash the “pent up demand” bazooka.

We know the situation is not good. I think V-shaped recovery is not possible from my reading of investor calls from 1Q results.

Trump administration re-ignited the optimism for Trade war stuff last week, just before the horrible unemployment numbers. I am not sure how bad the situation really is that they have to again rely on this narrative for markets to keep moving up. How does it gel with US claims of the virus originating in Chinese labs?

From a technicals perspective, S&P is near the 61.8% retracement level again. One trade that has done well is Long Tech/Short S&P and is now probably the most crowded trade. How do we play the current scenario?

  • I would say follow the commodities and design some trades around them as Fed can’t buy commodities or artificially inflate them for long. I am looking at lumber.
  • Traditional stock picking with sector hedges is another way

ELectrosteel Steels: An observation on the disparity in company’s actual value (~Rs. 10) and market price (~Rs 50)

I came across Electrosteel through an article which pointed out disparity in share price of this company on two Indian exchanges – Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) ( ). While the company was trading at 52 on BSE, it was 10 on NSE. It surely looked like a great arbitrage opportunity to buy on NSE and sell on BSE. Only a handful of people would have been able to make use of this opportunity due to very low trading volume on NSE.

Case was basically about a bankruptcy situation for Electrosteel. Trading was suspended on the stock and it resumed after Vedanta bought stake in the company and paid off some debtors. Now that company was seemingly out of the woods, seemed like the stock would reach the highs it was trading at a year ago.

ElectroSteel Steels, value investing, distressed equity

I tried to work out the asset value of this company’s equity based on the notes they published along with 1st quarter P&L statement. Following observations:

  • The company didn’t recreate the balance sheet for Jun 30, 2018 while there was lot going on with the liabilities.
    • Vedanta paid off a chunk of debt and bought out 90% equity stake in the company.
    • A lot of equity transformation was done as part of Vedanta’s deal to buy out the company as will be shown in this article soon.

Back of the envelope calculations suggest that the share price should be around Rs 10 per share. Vedanta paid Rs 53bn to company’s creditors. Of this amount, Vedanta got 90% stake in the company for Rs. 17.6bn worth face value of equity. Which means that approximate equity value of the company will be Rs 19.6bn. Divide this number by the total outstanding shares (1.96bn outstanding shares), it comes to Rs 10. Getting to the 1.96bn outstanding shares is the interesting bit.

Transformation in equity can be seen in the table below.

Electrosteel Steels, Value investing, distressed equity

Here Step 2 and Step 3 are most important steps as these show the reduction in face value and number of shares for existing shareholders. What the table above effectively shows is that if you held 100shs in the company before this equity transformation, you would be left with only 2 shares after the process. And Vedanta owns 18 shares for every 2 shares you hold now.

This can be a perfect example for investors to stay away from over leveraged companies in a cyclical industry. Electrosteel Steels could not repay its debt, hence had to be bought out by Vedanta, in turn creating massive value destruction for existing shareholders.

Greenblatt applied to India stocks, July 2018

Just applied Greenblatt criteria to India listed stocks above USD 50mm of market cap, here are the top 50 ranked by the Return on Invested Capital rank, which is a combination of:

  • Earnings yield: EBIT/ Market cap + Book value of debt
  • Return on capital: EBIT/ Working capital + Net fixed assets

Please do your due diligence before selecting the companies you invest in. This list is only the starting point. All the best!

Greenblatt, value investing, top 50, investingclass
(List of Indian stocks in no particular order)

Greenblatt applied to HK stocks, Jun 2018

Just applied Greenblatt criteria to Hong Kong listed stocks above USD 100mm of market cap, here are the top 50 ranked by the Return on Invested Capital rank, which is a combination of:

  • Earnings yield: EBIT/ Market cap + Book value of debt
  • Return on capital: EBIT/ Working capital + Net fixed assets

Please do your due diligence before selecting the companies you invest in. This list is only the starting point. All the best!

Value Investing, Greenblatt, Hong Kong, Greenblatt applied to Hong Kong, June 2018
List of 50 Hong Kong stocks with market cap > USD 100mm

GILD Sciences – GILD US

  • History of maintaining healthy margins, and hence:
  • Very good return on Invested capital and return on Equity
  • Chance to accumulate at relatively cheap valuation

There has been a lot of discussion on Gilead since the Kite acquisition announcement. So I decided to go and check the performance history of the company and am very pleased to share the results.

Gilead is a specialty pharmaceutical company that makes products targeting diseases like HIV, liver diseases, Hepatitis C etc. Recently they announced takeover of KITE, which is working on a revolutionary cancer cure.

Gilead has been operating at very healthy margins for the last ten years, numbers below for your reference:

Ratios 2007-12 2008-12 2009-12 2010-12 2011-12 2012-12 2013-12 2014-12 2015-12 2016-12 TTM
Gross margin % 81.82 78.88 77.25 76.49 74.67 74.52 74.48 84.78 87.73 85.98 84.94
Operating margin % 51.18 50.21 50.34 49.84 45.20 41.33 40.39 61.33 68.00 58.02 57.84
Net margin % 35.37 36.41 36.86 35.59 32.46 26.91 27.37 48.44 55.00 42.97 41.07
R&D requirement % 13.97 13.53 13.41 13.50 14.66 18.14 18.93 11.47 9.23 16.78 14.56

What the above numbers indicate is that the management has been doing a good job at recognizing opportunities in the market for income generation (eg. Pharmasset acquisition for Hep C drug in 2012).

Below are the numbers for Return on Equity and Return on Capital – impressive, right? The company has been buying back shares since it’s operation, almost 31% reduction in diluted shares in last 10years, hence increasing the value for the shareholders. The net income grew at CAGR of 25% for last 9 years while the EPS grew by 31% during the same period.

Ratios 2007-12 2008-12 2009-12 2010-12 2011-12 2012-12 2013-12 2014-12 2015-12 2016-12 TTM
ROE % 43.24 46.80 40.58 48.24 40.39 28.05 26.97 78.15 96.86 69.15 61.91
ROIC % 31.35 35.24 33.93 29.92 18.97 14.89 17.03 43.32 44.10 28.87 25.85
Diluted shares (mm) 1929.00 1918.00 1868.00 1747.00 1580.00 1583.00 1695.00 1647.00 1521.00 1358.00 1326.00

Gilead at current P/E of ~9 is very attractive and can be accumulated at dips for long-term holding. Seeing the performance above, I believe the management will be able to find opportunities for growth via fruitful acquisitions.

Disclaimer: I wrote the article myself and it expresses my opinion. I am not receiving compensation for it. I am long GILD and do not intend to buy/sell in next 72 hours. I have no relationship with any company whose names are mentioned in this article.