Tag Archives: alternative

RSX: What Happened?

Summary RSX enjoys a rally while oil prices continue to fall. Political developments are the main reason for this. Fundamentally, Russia is under increased pressure due to falling oil. Earlier in October, I wrote an article discussing what worked and what did not work in my initial Market Vectors Russia ETF (NYSEARCA: RSX ) bear thesis. What interested me most was why RSX gained more support than I expected. I arrived to the conclusion that the combination of capital inflow and stronger ruble played a role in RSX’ relative strength. Nevertheless, I remained bearish on RSX. My bearish view on oil played a key role in this thesis. RSX’ top holdings Surgutneftegaz ( OTCPK:SGTPY ), LUKOIL ( OTC:LUKFY ), Tatneft ( OTCPK:OAOFY ) and Rosneft ( OTC:RNFTF ) are directly dependent on oil prices. Banks Sberbank ( OTCPK:SBRCY ) and VTB Bank are dependent on oil indirectly, as weaker oil leads to weaker Russian economy. Polyus Gold ( OTCPK:OPYGY ), Uralkali, Polymetal ( OTCPK:AUCOY ) get hurt by low commodity prices. This list can go on and on… However, as I’m writing this article, RSX gained 6.6% in two days, while oil prices remained under pressure – WTI is trading near $42 per barrel and Brent is trading below $44 per barrel. So, what happened? French tragedy boosted outlook for Russia G-20 leaders met after the horrific terrorist attacks in Paris. The sense of urgency made them turn to Russia, seeking to unite efforts on war with terrorism. The change of tone towards Russia was so dramatic that S&P even stated that new developments could help lift sanctions and boost Russia’s credit rating. In a separate event, Russia proposed Ukraine to pay off its $3 billion of debt by $1 billion per year starting from 2016. Russian also wanted U.S. and E.U. guarantees for Ukraine’s debt. If this deal is executed, it will effectively mean a new emission of Russia’s dollar-denominated debt. Currently, the country is cut from capital markets because of sanctions, so such a development will be a major breakthrough. Russia will become investable again. This was probably what went in the heads of fund managers when they looked at their exposure to Russia (there was little if any, I suppose). So, they just pushed the buy button regardless of oil prices. This is a bet that sanctions will be lifted by mid-2016, boosting the troubled economy. Is it sustainable? In the past few days, I’ve been thinking about whether my own perception of the Russian economy disturbs me from some “real picture”. Perhaps, all the bad news – poor economy, falling oil, various inefficiencies – are already priced in RSX and I’m just stubborn not to admit it. There is such a possibility. However, I don’t think the current rally will be sustainable unless oil prices actually rebound. The first reason for this is the Russian ruble – it became too strong in recent days. After a long and hard debate, Russian government approved the country’s budget for 2016. The main variable in the budget is the price of oil, which is denominated in rubles. The ruble-denominated price that Russia expects to get in 2016 is 3165. As I am writing this article, the ruble-denominated price of Brent oil is 2837 – way too low for the budget. As Russia’s reserve fund could run empty by 2016, according to the Ministry of Finance, the Central Bank may be forced to do something about the ruble if it stays strong. The only viable way is to cut the key rate, which stands at 11%. At the same time, the Fed might finally raise the rate, boosting the dollar and further hurting commodities. The combination of these two possible events will be detrimental to Russian securities. The recent enthusiasm in RSX may be short-lived as investors realize how much of a burden are low oil prices to both Russian oil producers and the economy in general. There’s most likely a long way before sanctions are lifted, and please remember this is politics – you can smile and say one thing and do the opposite. I think there are fundamental reasons to be very concerned about the Russian economy. However, in the light of recent events, anyone interested in shorting RSX should proceed with caution. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

How ‘Economic Moats’ Can Help International ETF Investors

Companies with structural competitive advantages earn more. 5 Sources of economic moats. Increased competition drives down profitability. The Market Vectors Morningstar International Moat ETF (NYSEARCA: MOTI ) can help investors diversify into international markets and potentially provide more attractive returns. MOTI may act as a strong core position as investors seek greater overseas exposure. On the recent webcast, Improve International Stock Selection , Dan Lefkovitz, Content Strategist for Indexes at Morningstar, pointed out that investors have been slowly shifting out of U.S. stocks and taxable bonds while putting more money into international equities. Looking at the rolling 12-month flows in open-end and ETF categories, international equity funds are attracting over $200 billion, whereas U.S. equity fund flows look slightly negative and taxable bond fund funds came in about $50 billion, according to Morningstar data. Many investors may have a home bias, solely allocating toward U.S. stocks. However, Lefkovitz also noted that the world stock market is more than the U.S. The developed world stock market capitalization, as of the end of 2014, stood at about 58.4% U.S. and 41.6% foreign markets, so a diversified international investment portfolio would include about 40% foreign assets when considering total market-cap exposure. Brandon Rakszawski, Product Manager at Van Eck Global, explains that MOTI, like the popular U.S.-focused Market Vectors Morningstar Wide Moat ETF (NYSEARCA: MOAT ) , tracks a proprietary Morningstar wide moat, smart-beta strategy in selecting international components. [ Wide Moat ETF Gets an International Counterpart ] “The Morningstar’s moat philosophy aims to identify companies with structural competitive advantages that are more likely to earn above-average returns on capital over a long period of time,” Rakszawski said. Specifically, the Morningstar Moat Focus Indices target companies with a wide economic moat or sustainable competitive advantages and focuses on the most undervalued moat stocks, which have helped generate significant excess returns relative to the overall market. According to Morningstar’s indexing methodology, there are five sources of economic moats: Intangible assets that include brand recognition to charge premium prices. Switching costs that make it too expensive to stop using a company’s products. Network effect that occurs when the value of a company’s service increases as more use the service. A cost advantage helps companies undercut competitors on pricing while earning similar margins. Lastly, efficient scale associated with a competitive advantage in a niche market. “Capitalism works,” Michael Hodel, Technology Strategist at Morningstar, said. “High profits attract competition. Competition reduces profitability, but some firms stay very profitable for a long time by creating economic moats to protect profits.” Hodel also added that the Wide Moat Focus and Global ex-US Moat Focus indices track “high quality companies trading at a discount to intrinsic value.” Moreover, the Morningstar Moat Focus targets wide moat companies that may sustain economic profits for at least 20 years, whereas a narrow moat company would only be able to sustain profits for about 10 years. The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

A Warm Winter Forecast Provides Downside Risk For CMS Energy

Michigan electric and natural gas utility CMS Energy recently reported Q3 earnings that beat on EPS despite missing slightly on revenue. The company’s earnings report and earnings call were largely upbeat despite the presence of underwhelming demand growth from its overall customer base. Low energy prices will make it possible for the company to maintain earnings growth via higher capex without negatively affecting customer demand via the imposition of higher rates. The company’s shares are overvalued relative to historical valuations, however, even as a strong El Nino is likely to result in a warm winter across its service area. Investors are advised to refrain from initiating a long position in CMS Energy until its share valuation provides them with a larger margin of safety. Michigan electric and natural gas utility CMS Energy (NYSE: CMS ) reported Q3 earnings last month that beat on diluted EPS despite missing slightly on revenue. Revenue came in at $1.5 billion, up by 4.2% YoY but missing by $60 million. Diluted EPS came in at $0.53, missing the analyst consensus estimate by $0.04 and improving from $0.34 YoY. The third quarter is historically one of the company’s weaker periods due to the seasonal presence of mild weather in its service area, however, and the earnings beat only prompted the company to slightly tighten its earnings guidance for FY 2015. The company’s share price has fallen by 3% in the aftermath of the earnings report’s release, although this volatility is likely the result of shifting expectations regarding the Federal Reserve’s upcoming interest rate hike. In a June article on the company I wrote that the interest rate increase would likely cause its share price to decline to $30 from price of $31.59 at the time of writing, although its longer-term growth potential was robust due to a rebounding economy in its service area. Weak U.S. economic indicators caused the Federal Reserve to delay the rate hike, however, resulting in a broad rally in the utilities sector that pushed CMS Energy’s share price as high as $37, although profit-taking and renewed rate hike fears have caused it to settle during the subsequent three weeks. Much of the company’s Q3 earnings report and subsequent earnings call focused on its ability to grow over the next several years by way of capex rather than increases to its customer numbers. One unique strategy that the company is envisioning is to take advantage of the lower natural gas prices that are being passed onto consumers via lower rates by investing heavily in infrastructure upgrades. While the capex would normally be passed onto consumers in the way of higher rates, in this case the impact of the increase would be offset by the effect of lower energy costs. In this way the company could make the investments to its infrastructure that are needed to maintain service reliability without causing rates to rise to the point that customers reduce their consumption in response. Implementation of this tradeoff will require the permission of regulators, although the company is strongly arguing its case. It is important to note that capex growth is expected to be the primary driver of earnings growth moving forward in large part due to a lack of consumption growth in CMS Energy’s service area. While Detroit’s economy in particular has been rebounding following the resolution of its financial crisis, this has yet to translate into demand growth by the utility’s residential and commercial customers. In fact, demand growth by its industrial customers is the only thing keeping the company’s overall demand growth forecast in positive territory over the next year. Barring an unexpected recession in the U.S. this industrial demand is unlikely to worsen, but investors should be aware of the sensitivity of the company’s demand growth forecast to industrial demand. That said, I have grown bearish on natural gas demand by the company’s residential natural gas customers, in particular due to the strong arrival of this year’s El Nino weather event. This year’s El Nino is, as was predicted earlier in the year, already showing signs of being one of the strongest on record. What is expected to be a boon for southern utilities will, counter-intuitively, likely be a detriment for their northern counterparts. Previous El Nino events have been associated with warmer and drier weather across Michigan, including CMS Energy’s service area, between October and April. A similar occurrence in Q4 2015 and Q1 2016 will result in reduced natural gas and, to a lesser extent, electricity demand by the company’s residential customers in particular (industrial customers, on the other hand, tend to base their consumption on facility online time rather than the weather). While not as important to its earnings as electricity sales, a plus-or-minus 5% change to annual natural gas sales has a corresponding plus-or-minus $0.07 change to annual EPS. Furthermore, the company’s natural gas sales tend to be highest in Q4 and Q1, meaning that this sensitivity is likely to be higher still over the next two quarters. An especially warm winter, then, has the potential to noticeably reduce the company’s earnings. The consensus analyst estimates for CMS Energy’s earnings in FY 2015 and FY 2016 have remained steady over the last 90 days, the former actually increasing slightly, despite the growing likelihood of reduced natural gas demand in its service area that has developed over the same period. The company’s trailing and forward P/E ratios remain quite high relative to their historical ranges at 19x and 18.8x, respectively, leaving investors with a minimal margin of safety in the event that this year’s El Nino event is a drag on the company’s Q4 2015 and Q1 2016 earnings. The earlier strength of its share price notwithstanding, then, potential investors are advised for a larger margin of safety to develop before initiating long positions in CMS Energy. The company’s current valuation is simply too high given the downside risks posed by a warm winter and looming interest rate increase.