Tuesday, September 19, 2006
whither goest the market?
Damned if I know. A look around shows me that stocks, although off slightly today, have been moving up continuously since July, oil is down well of its highs, gold has started moving down, bonds are up, the economy show signs of weakening (which according to the sadistic bastards in the now imaginary bond pit is a GOOD thing), the dollar is flat, the times predicts strong retail sales ahead, while the journal predicts weak, there is a coup in Thailand, Iraq continues to be the same type of raging success experienced in Indochina while North Korea and Iran make nuclear postures. All this of course is reflected in the VIX which even after a 6%+ move today stands at the ridiculously low level of 12.Having thoroughly tapped out his home equity the consumer seems to be relying on the change found in his couch to drive spending. The SP 500 is only at 16 times earning points out pundit a. Ah-ha retorts pundit B, but profit margins are twice the historical norm. So it we revert to the mean, we are at 32 times actual earnings potential. Unless of course the shift to less capital-intensive technology and service industries away from heavy industry means the profit margin metric is changed forever. Confusing times at best. My best guess is that with signs of the economy slowing and a market that hasn’t had a 10% decline since Maryland had a good football team, there is more risk to the downside that opportunity to the upside in the broad market.I of course don’t trade the broad market but spend most of my time looking for bargain stocks ala Ben graham and his ilk. Ordinarily the only Buffet I pay attention to is Jimmy as I am more in agreement with the concepts of life is just a tire swing and ousters and beer for supper every night of the year than those espoused by the super lefty from Omaha, but cousin Warren was quite correct when he said those running something less than 50 billion could be doing very well with the type of bargain stocks he was seeing but couldn’t buy. The more people buy into indexing, and the semi indexing of the mutual fund industry, the more opportunities are created for vultures and special situation guys like myself. Right now the coal industry for example seems to be stupidly priced. It is true that right at the moment we are producing more coal than we burn but as the drop in prices to a multi year low forces marginal mines to shut down, this situation could change quickly. This along with a more normal northeastern winter and the potential for goal to liquid and coal to gas projects create a more promising long-term picture for coal producers. We re seeing single digit multiples here, cash flow generation that has slowed but not stopped, stock buybacks, insider buying and private equity and activist hedge fund industry in the group. As a falling ship could well sink all boats including my coal barge, I prefer selling slightly out of the money puts a month out on these names. The fact that the current weak outlook from the street has pumped vol in these names helps. I like ICO, JRCC, MEE and CNX in here as candidates for cash secured put writing.Speaking of barges a name that really catches my eye is Aldabra Acquisition. ALBA is a SPAC, a blank check deal. Routinely in these deals management has somewhere around a 20% interest in the form of warrants which are virtually free. Why would insiders be buying shares in the company for cash money? This is real money not options and could be spent on more meaningful stuff like bar tabs, green fees or gas for the boat, important stuff. So when the company showed up my insiders list I got real interested. Heres what I found. They are reverse merging into Great Lakes dredging. There will be about 37 million shares out when the deal is done and ALBA holders will have about 27% of the deal. The rest belongs to PE firm Madison Dearborn. Great Lakes as restructured will have an enterprise value of about 450 million. They will do in the area of 60 million ebidta. The fleet of dredging ships has a replacement value of a billion bucks. They have a40% market share and are the largest dredging firm in the country. While they have overseas work including Bahrain’s enormous projects, US dredging markets are protected from foreign competitors. I come up with at the 500 million mark, a little over enterprise value and about 8.5 times ebidta and 38 million shares outstanding, a value of about 13 bucks. The stock is 5.55 giving me an enormous margin of error. More interesting, the warrants sell for 76 cents, are due in 09 and .55 since in the money with 3 and ½ years to run. There are no guarantees and I may well be missing something but the insider and hedge fund activity in this stock make me think not. There is a pretty good market in the warrants.Two other stocks that are cheap and have strong activist funds pushing for action, including the possible sale of the company are athletic footwear retailer FINL and family restaurant FRN. My guess that both are worth picking up a pullback of any sort. FRN does not have options but FINL does and again, Volatility is up after recent weakness.It was trader extraordinaire and wife lottery winner Jason Thompson who last month firmly declared that being long volatility was the way to go. Given the state of the world, more than a touch of economic uncertainty and very low volatility markets I tend to agree. I have been trying to construct the trade by buying long dated very cheap puts on etfs such as xly, consumer discretionary and xlp, the financials spdr and selling short dated high volatility put premium in the value and special situation stock I like. In addition to the coal stocks I have been using names like SIX, TRN, MIR,CHk,S,WON and NYT to stitch the trade together. We ve been fighting the tape a little bit with the long puts but the premium taken in on the value names keeps us well in the game. The only downside that I see here is being out shares of stocks we don’t min owning in the first palce. Of course the market could keep going up between now and next march with no rise in volatility or significant declines. I ll put that right up there with a Green Bay vs. Houston super bowl in probability.The world turns on. Navy is winning, Notre Dame is more vulnerable than we thought, and the Ravens defense is off the chart again this year. Summer is over and we are headed into fall, that glorious season of football, the world series with the biggest drawback being the women go back to slacks and sweater packing up the halter tops and shorts for another year. Leaves fall, boats come out and we settle in anticipation of the winter ahead. The market is calm and unafraid; no one is worried which of course worries the hell out of me.