Tag Archives: alternative

Just Energy Is In Hot Water

Summary Just Energy is an energy reseller. The business model has many questionable elements. Several factors could cause the earnings to decline in FY2016. Just Energy (NYSE: JE ) is a Canadian retailer of energy across select regions in North America and the UK. The company has a long rap sheet of customer complaints, fraud charges, and consumer watchdog warnings. Investors have bid the stock up in recent weeks on a swing to profitability in the first quarter. That profit is based on a one-time item. Beneath the surface, Just Energy is a company with lengthy legal concerns, a declining customer base, and an inherently flawed business model. Flawed Business Model One of my favorite financial quotes is from famed investor Jim Chanos. “A business model that relies on deceiving customers is an inherently flawed model.” No sentence more accurately describes Just Energy. The services offer no value to consumers. In fact, one study found that the average JE customer pays more for their utility service than those who pay for their utilities through a traditional utility provider. If your business model is built on saving customers money by switching them to your service, shouldn’t your service actually be less expensive? It appears that in 98% of cases , it is not. According to a lawsuit in Illinois, “there is no reasonable person who could market this product by suggesting that a customer would ‘save’ money.” The lawsuit also noted that “almost all of [Just Energy’s] plans have cost customers far in excess of what [utilities charge].” This could partially explain the aggressive sales practices. If your services cannot deliver as promised, why not just bend the truth? The company’s profits rely on selling long-term contracts to customers at rates higher than can be achieved in the marketplace. Essentially, the company locks customers into 5-year contracts and hopes that energy rates decline. The only way it makes a profit is by overcharging customers. Again, a business model marketed as a less expensive alternative to utilities that can only make a profit when it is, in fact, more expensive, is deceptive and fundamentally flawed. Legal Concerns There is a litany of formal complaints filed against the company, so many in fact that it has had to change its name and buy new brands in an apparent attempt to hide the past misdeeds. Among the most notable concerns are lawsuits brought by the Attorneys General of Illinois, Massachusetts, Ohio and New York. Complaints filed by the Canadian Energy Board and consumer watchdog groups have also caused reason for concern given the repeated allegations of misconduct. The company has an almost unheard of F rating by the Better Business Bureau . The BBB cited “a large volume and pattern of complaints concerning misleading sales practices.” (click to enlarge) Source: Internet review websites Just Energy could arguably have received more complaints per customer than any other publicly listed company in North America. The Illinois Attorneys General lawsuit found that the company received about 30,000 complaints annually in the state of Illinois alone. So what caused so many formal complaints against the firm? As most lawsuits describe, the company’s sales team goes door-to-door soliciting homeowners to purchase energy contracts. It also utilizes telemarketers in its sales process. The fraud complaints stem from thousands of sales reps purposely lying about rates, and in some cases, signing up customers without their permission. Source: News articles The unbelievably poor compliance at JE is a cause for future concern, as the practices are systemic of the organization and do not seem to have been curtailed. In fact, they are getting worse. In July 2015, Just Energy partnered with an alleged pyramid scheme to distribute its products. Lyoness is a MLM firm with a long history of pyramid scheme accusations. Think Herbalife (NYSE: HLF ), but worse. If the company’s former sales team was so inadequately trained that hundreds had to be laid off after defrauding clients, why would the distributors for a company under numerous fraud investigations be any better? According to an Australian regulator, Lyoness’ distributors “lie about every aspect of the business they are promoting.” These people will now be the face of Just Energy. Cue the forthcoming onslaught of Attorneys General investigations that are likely to emerge. Declining Customer Base While the company has largely weathered the past concerns, that luck seems to be eroding. As customers are coming out of their five-year contracts, they do not seem to be re-enrolling. Additionally, the company is failing to find new customers. Perhaps the years of negative reviews, multiple fraud investigations, and bad press coverage have dissuaded customers from trying out the company’s service. Or perhaps they can just do math and do not want to pay more for a service they already receive. For the first time in years, the company had a net loss of customers in the most recent quarter. Additionally, the number of new customers was the lowest since 2012. In red below, we can see that new customers are down 31% from Q1 2015 and down 15% from Q1 2014. The company is not growing the customer base enough to offset those leaving the business. (click to enlarge) Source: Investor presentation (with Q1 info added by author) How This Will Impact Earnings With a clear downward trend developing, investors should prepare for a future decline in sales. The average Just Energy contract is 3.5 years. The decline in new customers is not directly felt on the income statement just yet. As customers leave (about 1.15 million per year), the inability to replace those customers will cause revenues to decline. For the first time in years, JE is losing more customers than it is gaining. Customers leaving today locked into a temporarily low point in natural gas prices, thus new customers that replace the customers being lost are “higher margin.” While management has spun this as a positive, in reality it is a massive headwind. As noted, the average customer contract is 3.5 years. In early 2012 (exactly 3 ½ years ago), natural gas prices bottomed at nearly $2. So yes, the customers leaving are being replaced by new customers with higher margins, but it is short lived. In the coming quarters, as more customers leave, the new customers will be lower margin than those customers lost. Source: NASDAQ The next two years are going to be a massive headwind as the company loses customers that signed up under much higher natural gas prices than today’s prices. Recognizing this impact, the company began diversifying the portfolio over the past several years. In 2009, debts were zero. Today, debts are in excess of C$677 million. The decision to buy electricity suppliers has cost the company in a time when profits and margins are going to begin eroding. Impact On The Stock Predicting JE’s EPS is a challenge. The company often swings between massive losses and equally massive profits. Over the past three years, the company has posted net profits from C$602 to losses of C$579. With customer attrition likely to increase over the next year, it will be virtually impossible to produce a net income. While Q1 saw an EPS of C$0.67, that figure was due to asset sales. That is not a long-term means of growth. Had the company not sold off a unit for C$505 million, it would have posted a loss for the quarter. For FY2016, expect a significant loss (unless JE continues selling off assets). While management is correct that margins are improving, that effect will fade in Q2 and reverse in Q3. New customers will begin to constrain margins beginning in November. That is because 42 months ago (3.5 years) natural gas prices fell to levels below current levels. That lasted from December 2011 to June 2012. Every customer who signed up after June 2012 is a higher-margin customer than the ones the company is acquiring today. JE requires volatile gas prices for profits. In 2015, natural gas has been flat. In order to turn a profit, gas prices would need to drop. At $2.7 today, that seems unlikely. With all of this in mind, the company could post continuing revenue growth, but will still report losses. Management does not provide earnings or revenue outlook, instead it only focuses on EBITDA outlook. For FY2016, the company expects C$193-C$203 million in EBITDA. The excessive focus on EBITDA is alarming from an investor’s standpoint. Multiple forensic accounting firms have highlighted red flags in relation to how JE calculates its EBITDA. Additionally, it is always alarming when a company with no tangible cost structure (JE does not own any hard assets) only points to EBITDA. In 2015, the company generated sales of C$831 per RCE (residential customer equivalents). This is the non-GAAP figure used to calculate the number of customers. The actual number of customers is around two million. The C$831 per RCE is higher in 2015 because margins are increasing. As margins decline (as I have suggested will be the case in the second half of FY2016), the revenue per RCE should normalize to figures from previous years. About ⅓ of Just Energy’s customers leave each year. In past years that decline was offset by adding more customers, creating a net gain. That trend reversed in Q1. If the rate of decline experienced in Q1 continues throughout FY2016, total RCE will decline to 4,390,000. Using the C$831 figure (which I feel is very generous), total revenue for the year will come to C$3.6b, a 7.7% decline from 2015.   RCE Sales per RCE Sales (in millions)   Q1 4,609,000 C$202.4 C$933   Q2 4,535,000 C$202.4 C$918   Q3 4,462,000 C$202.4 C$903   Q4 4,390,000 C$202.4 C$889   Total – – C$3,643   Source: 10-Q The exact nature of any declines are subject to a number of factors including the timing of margin contraction, the severity of the contraction and the ability of the company to aggressively increase marketing to obtain new customers. All of these factors could impact the above calculation. At the end of the day, things do not look good for Just Energy. It is hard to imagine how the company will grow EBITDA by 5.5% (as it predicts) when the business is facing declining customer growth, increasing attrition and declining margins for 2016. Long term, there are too many headwinds to keep this electricity and natural gas reseller from being an attractive investment. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

401(k) Fund Spotlight: Templeton Global Bond

Summary Lead manager Michael Hasenstab is a contrarian who is not afraid to take concentrated positions in securities where he has a high degree of conviction. Templeton Global Bond has outperformed 99% of its global bond peers over the last 10 years. The fund is wisely avoiding the most dangerous areas out there for global bond investors – sharply higher yields and sovereign debt of Japan, Western Europe, and Southern Europe. Background I select funds on behalf of my investment advisory clients in many different defined contribution plans , namely 401(k)s and 403(b)s. I have looked at a lot of different funds over the years. 401(k) Spotlight is an article series that focuses on one particular fund at a time that is widely offered to Americans in their 401(k) plans. 401(k)s are now the foundational retirement savings vehicle for many Americans. They should be maximized to the fullest extent. A detailed understanding of fund options is a worthwhile endeavor. To get the most of this article is important to understand my approach to investing in 401(k)s. Here are my key principles: 1. I do not buy ‘index hugging’ active funds if a similar index is available. Index hugging funds are those that are overly diversified and their performance never strays far from the index. Index funds almost always have a lower fee so I prefer to just own the index and let the fee savings provide a performance tailwind over time. Lastly, index hugging active funds are generally managed by people who don’t really know how to invest. This may sound harsh, but it is true. They are institutional herd products. 2. When buying actively managed funds, I look for those who are willing to go against the institutional herd and follow their own independent investment approach. I do not mind the higher fee if they have an established track record and it is not necessary that they always beat the index. Sometimes investment positions take a bit longer to pan out than investors would like to see on their quarterly statements. I take comfort in putting money with a manager(s) who is not afraid to stray from the herd. 3. I do not care what Morningstar says. Templeton Global Bond Fund Templeton Global Bond has five different share classes: A (MUTF: TPINX ), Advisor (MUTF: TGBAX ), C (MUTF: TEGBX ), R (MUTF: FGBRX ), and R6 (MUTF: FBNRX ). The class A shares are often found in 401(k)s with the load waived (i.e., no up front sales charge) and a net expense ratio of .90%. This is a reasonable fee given all that this fund offers. With $65 billion of assets it is one of the largest global bond funds out there (in fact, it was the largest in a screen I ran on Fidelity’s website). Templeton Global Bond is relatively free to roam in the bond world wherever it wants. The fund typically invests the majority of its assets in investment grade government bonds from anywhere in the world. It also regularly invests in various currency instruments and derivatives. The fund tends to focus on sovereign debt and not corporate debt. It may invest up to 25% of its assets in below investment grade debt and all of its assets in developing (or emerging) market debt. The fund’s lead manager, Michael Hasenstab, is well known within the investment industry, appearing regularly in publications such as Barrons . He has gained a reputation as a contrarian with a willingness to take concentrated positions on specific bonds that he has a high degree of conviction in. This has generally worked out well, except for a large position in Ukraine government debt that has cost the fund several billion dollars. (About 2% of the fund is currently invested in Ukraine.) In a January 2013 interview with the Financial Times , he warned that it was time to get out of “safe” government debt. His call was right on. The 10-Year Treasury Yield subsequently soared a few months later during the so-called “taper tantrum,” as shown on the following chart (note: bond prices fall when interest rates rise): ^TNX data by YCharts Excellent Performance Track Record Over the last 3-Year, 5-Year, and 10-Year periods (as of December 31, 2014), Templeton Global Bond has crushed both the benchmark and its peer group. The following table shows this: 3-Year Return 5-Year Return 10-Year Return Templeton Global Bond – Class A (without sales charge) 6.3% 5.8% 7.4% Citigroup World Government Bond Index -1.0% 1.7% 3.1% Lipper International Income Funds Average 2.1% 2.9% 4.0% As far as performance goes, there is little to complain about. The fund has consistently shown is value relative to its peers. Portfolio Positioning The makeup of the current portfolio is always the most important thing I look at when evaluating a fund. Currently, given the dynamics of my forecast , my general view on the global bond market is as follows: Completely avoid the sovereign bonds of Japan and Western Europe denominated in Yen and Euro. Completely avoid local currency emerging market bonds (non-U.S. dollar denominated) except for Russia (I expect oil prices to spike soon). U.S. and Pound Sterling government debt with very short maturities is okay. Selective U.S. dollar denominated emerging market bonds are okay, especially debt of corporations with U.S. dollar revenues and local currency expenses. Duration should be short though. Cash positions should be sizeable to take advantage of potential price dislocations created by a lack of market liquidity. (Fund cash positions should also be high to meet shareholder redemptions without having to sell quality bonds at low prices.) How does Templeton Global Bond stack up in light of my outlook? Notably, as of July 31, 2015, the fund has an average duration of only .07 years and an average weighted maturity of only 2.49 years. With a duration of .07, rates could theoretically rise 300% and the fund would only fall by .21%. (Duration measures the exposure of a fund to interest rate fluctuations.) Hasenstab clearly has the fund positioned exceptionally well for a rising rate environment. However, the trade-off here is a low yield. The fund’s 30-day standardized yield is only 2.18%. The distribution yield is higher at 3.04% (calculated by taking the standard monthly distribution of .03 x 12 divided by the current NAV price). Given the near-term danger of a sharp rate rise, I think the low yield is worth accepting. I like the fact that 79% of the fund’s currency exposure is in the U.S. dollar (as of June 30, 2015), which is more than twice that of the comparable index. I especially like the fact that, through derivative exposure, the fund has a 24% net short position in the Japanese Yen and a 36% net short position in the Euro. I am expecting the Yen to outright crash and this fund is well positioned for it. As of June 30, 2015, the fund’s largest sovereign debt holdings are as follows: South Korea – 14% Mexico – 9% Malaysia – 7% Poland – 7% Hungary – 7% Brazil – 5% Singapore – 4% Indonesia – 4% Currently, the fund also holds some smaller positions in the debt of the Philippines, India, Sri Lanka, Serbia, and Slovenia. These 13 countries are pretty much it. Sovereign wise, there is nothing here that is overly concerning to me given that the duration of the fund is so low. I like the fact that the managers have taken highly concentrated positions in the countries they feel have the strongest economic fundamentals. Hasenstab is clearly an investor and not an index hugger. This fund is by-and-large safe from the disaster awaiting holders of Japanese, Western European, and Southern European government debt. In fact, countries with strong fundamentals could see an influx of capital seeking safety as it flees these developed markets. Lastly, the fund is 28% in cash. This gives it ample room to meet client redemptions during a crisis and the flexibility to pounce on higher yielding debt when rates rise. Conclusion I think now is a good time to hold this fund if it is available in an employer-provided 401(k) plan. The hits to the fund from holding Ukraine government debt are behind it. Most notably, the fund is clearing avoiding the most dangerous risks to global bond investors. When it comes to the potential for a fixed income fund to deliver decent returns in the current market environment, Templeton Global Bond is an oasis in the midst of a desert. Investing Disclosure 401(k) Spotlight articles focus on the specific attributes of mutual funds that are widely available to American’s within employer provided defined contribution plans. Fund recommendations are general in nature and not geared towards any specific reader. Fund positioning should be considered as part of a comprehensive asset allocation strategy, based upon the financial situation, investment objectives, and particular needs of the investor. Readers are encouraged to obtain experienced, professional advice. Important Regulatory Disclosures I am a Registered Investment Advisor in the State of Pennsylvania. I screen electronic communications from prospective clients in other states to ensure that I do not communicate directly with any prospect in another state where I have not met the registration requirements or do not have an applicable exemption. Positive comments made regarding this article should not be construed by readers to be an endorsement of my abilities to act as an investment adviser. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Consider Adding Some CRAK To Your Portfolio.

Summary The Market Vectors Oil Refiners ETF launched this week is a compelling play in the energy sector. I conduct a review of the ETF itself and the opportunities & risks associated with the ETF. I believe CRAK is worth considering because of its strong performance in comparison to other energy segments. In this article, I will be reviewing the new Market Vectors Oil Refiners ETF (Pending: CRAK ), which launched yesterday. I believe investors should consider adding some CRAK to their portfolio because the refiners have been the lone bright spot over the last year when oil prices have collapsed. The following chart from the CRAK fund profile page shows that refining and marketing stocks are the only sub-segment of the energy sector (NYSEARCA: XLE ), which has posted a positive return over the last year. Crack Spread One of the most important things to consider when looking at refining stocks is to look at the crack spread. The crack spread is the difference between the cost purchasing the crude oil and the price of the products that the crude oil is refined or “cracked” into. I created the following chart using the ThinkorSwim platform that has the crack spread plotted over the last two years, as well as the performance of Valero (NYSE: VLO ), which is one of the largest holdings in CRAK. The chart shows that over the last two years Valero’s performance [Blue Line] has been highly correlated to the crack spread. (click to enlarge) [Chart from ThinkorSwim Platform] Opportunity The opportunity for refining stocks is promising because crack spreads are higher than a year ago, which will show up in the form of year/year earnings growth. In a troubled energy environment where oil companies/drillers etc cannot earnings, the refiners stand out above other energy segments. Using Valero as an example, you can see in the chart below for the last four quarters, EPS has been trending upward, even as oil prices had fallen to near $40, went back to $60 and are now back at $40. As long as the crack spread remains somewhat stable at these elevated levels, the refiners will continue to outperform the rest of the energy sector. (click to enlarge) Risks The primary risk of CRAK is that it is highly concentrated within its top 10 holdings. The top 10 holdings account for nearly 65% of the portfolio, therefore when considering CRAK investors should be comfortable with this fact and the underlying companies that are in the top 10 holdings. Second, another item to watch for is currency risk. As the following chart from the portfolio analytics section of the CRAK fund page shows, CRAK has a large international currency exposure. With nearly 50% of CRAK priced in foreign currencies investors who are also, bullish on the dollar could potentially pair a purchase of CRAK with the small-hedged position in the PowerShares DB USD Bull ETF (NYSEARCA: UUP ) or the WisdomTree Bloomberg U.S. Dollar Bullish ETF (NYSEARCA: USDU ) to mitigate the foreign currency risk. Closing Thoughts In closing, because CRAK just launched this week and I believe it should be added to investors watch lists for a period to make sure there is interest in the product. If there is adequate volume and CRAK attracts assets the refiners are a compelling choice when considering investing in energy because they have performed very well during this tough energy environment in comparison to other energy sector segments. Disclaimer: See here . Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Share this article with a colleague