Tag Archives: investing

Do Covered Call ETFs Deserve A Look?

Covered Call ETFs (or Buy-Write ETFs as they’re known to some) are an intriguing option for investors looking to generate a little extra portfolio income. But you have to have some sense of where the market is heading in order to really profit from them. Covered Call ETFs are generally known for their high yields. One of the largest covered call ETFs – the PowerShares S&P 500 BuyWrite Portfolio (NYSEARCA: PBP ) – sports a trailing 12 month dividend yield of just over 4%. That number is actually low in the covered call ETF universe as smaller funds like the Recon Capital NASDAQ 100 Covered Call ETF (NASDAQ: QYLD ) offer yields in the 8-9% range. Here’s how they work. In a typical equity ETF the fund’s managers buy individual stocks and hold them within the portfolio. In a covered call ETF, managers take the same stock positions but simultaneously write call options on those positions (thus the name “buy-write”). The goal is to benefit from the equity position while at the same time generating an income on the side. While the yields are nice, the overall performance of the buy-write ETF really depends on the direction of the market. In up markets, buy-write ETFs tend to underperform as the written calls start getting exercised limiting an individual stock’s upside potential. Conversely, these funds tend to outperform in sideways or down markets as many of the written calls expire worthless leaving the fund to simply collect the option premiums. The PowerShares S&P 500 BuyWrite Portfolio has historically performed about as would be expected. It outperformed the S&P 500 during the time right after the financial crisis as stock prices were dropping and subsequently lagged the index for much of the last four years. However, the fund has returned roughly 5% year-to-date outpacing the S&P 500’s return of almost 2%. If global economic weakness would be expected to continue, covered call ETFs could begin outperforming again.

A Strategy To Defend Your Portfolio From Bear Markets

It is important to protect one’s portfolio from crashes like 2007-2009 where the major market indices lost more than 50%. Historically, markets have seen long 4-10 years runs of steady Bull market interspersed with shorter 1-2 year Bear markets. Most losses in a bear market come within a short span of few months. An investor playing good defense will look to time an early exit in a crash. When market is sufficiently oversold, short term bounce backs present further opportunity to make gains. An investor who remained invested during stock market crash from October 2007 to February 2009 lost more than 50% of his investment (based on SPY performance ) during that period. Similarly, between September 2000 and September 2002, fully invested investors lost ~40% ( using SPY as a benchmark ). Both bear markets wiped out 3-5 years of preceding year gains. While timing the market is a hard proposition, it is incredibly important to preserve your portfolio from a major whitewash during a crash. “Defense wins Championships” is a famous saying in football but is more aptly relevant for investors that can successfully maneuver through a bear market. NFL teams with good defense minimize points scored against them by opposition; a good portfolio needs strong defensive strategies to protect from bear market onslaught. Further just like strong defense can actually add to score by triggering turnovers, bear market presents opportunities for sizeable gains which if not exploited means missed opportunity cost. For example, investors who were too risk averse and did not participate in the post-crash rally of 2009-2011, lost out on capital appreciation opportunity of 80-90% within that 2-year period. To build a good defensive strategy, an investor needs to understand the market dynamics. The picture below best illustrates the US stock market history of bull-bear markets ( Source: Business Insider ). (click to enlarge) Key takeaways we can derive from the above picture are: The large part of this graph is dominated by long running bull markets, with most runs lasting many years or even more than a decade. During this multi-year period, the market sees steady returns with small intermittent corrections interspersed. Some examples include the bull market in 1990s, 1980s, 1950s and 1940s, all of them lasted 10+ years. Bear markets are relatively short in terms of overall duration (1-2 years), and the losses come at a much faster rate (compared to gains in bull market). For example, 2008 crash lasted 1.3 years and 2002 crash lasted 2.1 years. The longest bear market was in the 1930s and lasted close to 3 years. “Market goes up in an escalator but down in an elevator” is a famous stock market quote that can summarize the overall dynamics. Understanding the wisdom behind these select few words is important for all investors. The picture below shows 1 example of Bull-Bear cycle in SPY adjusted close graph during the 2003-2008 period ( Source: Yahoo Finance data ). Notice the steady increase in SPY for 4+ years (escalator) followed by a dramatic 1-year crash in 2008, wiping out a large part of multi-year gains. Hence the saying, market goes like an escalator and comes down like an elevator. (click to enlarge) Here is another graph that shows SPY monthly returns ( Source: Yahoo Finance data ) during the 2008 crash period. Notice even during the bear market, the bulk of losses (~-46%) came over a short 9-month period from June 2008 to February 2009. Hence the analogy of elevator coming down vertically or fast. (click to enlarge) The above historical perspective presents multiple takeaways that should influence our investing strategy. Given the long runs of Bull market, sitting out of stock market for extended period of time has significant opportunity cost of not participating in Bull rally. If one wants to protect their portfolio in the event of a crash, they need to get out of market early in a crash. However, getting out too early has risks too as it may only be a temporary dip i.e. no crash, market recovers and one has to get back in at a higher price. So timing the market exit is a balancing act between these two scenarios. Exiting out late in a Bear market can double the pain as one will take the losses but not participate in the rally that should be soon to follow. Buy and hold investors who finally give up on stocks after seeing their portfolios trounced for a year or two, have the risk of exiting out at close to bottom of crash. Building a Defensive Strategy: The above takeaways can be formulated to build a variation of Simple Moving Average (SMA) based strategy. For our example, we will use SPY as a representative market index that we play the strategy on. However, the strategy should be verifiable on most indices with varied performance. The SMA gives an overall trend of market direction that is not easily seen with day-to-day variations. So a simple strategy could be to stay long in SPY when SPY is above its say 50-day SMA and sell all holdings when SPY falls below its 50-day SMA. When SPY index is above the SMA, it is pulling the SMA upwards i.e. leading to a positive trend in index. One big drawback of SMA-based strategies is the whipsaw effect. This happens when stock dips below the SMA, we sell the index but then stocks recover, goes above SMA and we get back. Because we are selling at a lower point and then buying back again at a higher price, this leads to a loss. If this happens with large enough frequency, the strategy can lead to sizeable losses and NEGATIVE returns as compared to Buy and Hold. Since history is dominated by large bull runs interspersed with shorter bear runs, it is probably wiser to side on being long for the most part. So we assume that more often than not the market is expected to bounce back after a dip below SMA leading to whipsaw. To reduce the number of times we go out of market and whipsaw, we can use a longer duration SMA. The longer the duration, the less likely the chance of temporary short-term dips breaching SMA and giving a false sell signal. Let’s take 250-day SMA which is equivalent to 1 year in terms of trading days. Further even when SPY touches or breaches the 250-day SMA that is a major support level indicating a high chance of bounce back. So I would propose the sell SPY signal to be even lower, say when SPY has breached more than 2% below 250-day SMA. So let’s assume that we sell SPY when it’s hit more than 2% below 250-day SMA. On top of this, let’s try to take advantage of the fact that once market is sufficiently down, volatility increases and we expect to see several bounce backs from the lows. The bounce back can be temporary though as we don’t know for sure when the actual bottom is or if the bear market is close to end. To take advantage of this short-term bounce backs, we can define a lower point at SMA for market to be oversold. In this zone, we could look to do some bottom fishing by trying to do the reverse, i.e. buy SPY when SPY is below its short-term SMA, say 4-day SMA and sell it as soon as it recovers. So our strategy becomes as follows: Stay long in SPY as long as SPY is greater than -2% (say X) of its 250-day average. Sell and go in cash if it falls below X. If SPY falls below 6% (say Y) of 250-day SMA look to bottom fish. Buy SPY when it is below its 4-day SMA expecting a short term bounce back and sell as soon as it comes back above its 4-day average. These are short-term trades that take advantage of market’s volatility. Now while the thresholds pick (X and Y) may feel like magic numbers, in my test almost all combinations of X and Y where X

Alterra Power Is Still Underestimated By Mr. Market

Summary In 3Q 2015 Alterra delivered decent financial results. Very soon the company should commence operations at two new renewable energy projects: Shannon Wind Farm and Jimmie Creek hydroelectric power plant. In my opinion, Alterra’s shares are still underestimated against its peers. Alterra Power ( OTCPK:MGMXF ) runs five renewable energy power plants with a total capacity of 553 MW (megawatts). Apart from operating facilities, the company holds a portfolio of energy projects, of which two are at their advanced stages of development. In my first article on Alterra I made a statement that the company’s shares offer an impressive upside potential. Since that time Alterra’s shares went up from $0.31 to $0.41 (August 17) and then retreated. Now they are trading at $0.34 (up 9.7% since my first article). I am not impressed – Mr. Market still underestimates these shares ignoring the fact that Alterra is quickly strengthening its position as a provider of green energy. In this article I am trying to defend my earlier investment thesis on Alterra. Time is appropriate – the company has just announced its 3Q 2015 results . Business philosophy. Alterra is focused on growing its business through construction of new renewable energy power plants. Apart from HS Orka, at which Alterra holds a majority stake, all power plants are constructed as partnerships with strong financial partners: Toba Montrose – a partnership with Fiera Axium, with Alterra holding a 40% economic stake Dokie 1 – partnership with Fiera Axium (a 25.5% stake belongs to the company) Jimmie Creek – another partnership with Fiera Axium, with Alterra holding a 51% stake Shannon Wind – partnership with Starwood Energy Group Global (Alterra holds a 50% stake) The philosophy standing behind this approach is simple – Alterra wants to grow its power plants portfolio as quickly as possible and partnerships are one of the best methods to finance the company’s development. These partnerships are accounted for using an equity method of accounting – that is why the analysis of the company’s partnership stakes is crucial to have a thorough perspective on Alterra’s performance. 3Q 2015 results Alterra is quite a complicated company to analyze. For example, although it runs five power plants and two advanced development projects, only two of them are accounted for using a consolidation method of accounting – the rest is accounted for using an equity method of accounting. In my analysis I am firstly presenting the overall results of the company and then the results reported by each plant / project, most of which are accounted for under an equity method. The overall results The table below shows basic financial measures, reported in the first nine months of 2015 and 2014: (click to enlarge) source: Simple Digressions and the company’s reports As the table shows, in the first nine months of 2015 the company’s revenue decreased 18.3%, compared to the same period in 2014. However, this revenue is attributable to two geothermal power plants, Reykjanes and Svartsengi, located in Iceland. Alterra controls these plants holding a 66.6% stake in HS Orka, a mother company to those two geothermal facilities. Similarly, other lines in the earnings statement, apart from “Share of results of equity-accounted investees”, are attributable to HS Orka and the overall corporate issues. Note: I have to remind my readers a crucial accounting rule. Although Alterra holds a 66.6% stake in HS Orka, the earnings statement considers all (100%) operations carried by HS Orka. To exclude a 33.3% stake held by other stakeholders, an appropriate correction is made at the bottom line of the earnings statement (in the line called “Net income attributable to non-controlling interest”). Therefore, during the first nine months of 2015 Alterra printed a net loss of $7,128 thousand, but the other HS Orka stakeholders, classified as non-controlling interest, booked an income of $1,566 thousand. In this way a net loss attributable to Alterra increased to $8,694 thousand. This quite poor picture of the company, presented in its earnings statement, would be much poorer if it was not partly mitigated by an item called “Share of results of equity-accounted investees”. This line shows the results reported by power plants and projects, which are accounted for under an equity method. As the table below shows, in the first nine months of 2015 these entities reported a profit of $21,251 thousand (87.5% up, compared to the same period in 2014). Let me break down this figure: (click to enlarge) As the table shows, the results, attributable to five plants / projects, are accounted for using an equity method. Three of them: Toba Montrose, Dokie 1 and Blue Lagoon are plants in operation. The other two, Shannon and “Geothermal development projects” are projects under development, of which one project, Shannon, is at an advanced stage of development. As the table shows, the biggest part of an increase in “Share of equity income” is attributable to Shannon. For a better comparison, this project should be excluded (last year Shannon was accounted for using a different method of accounting – full consolidation). However, after doing it, “Share of equity income” is still higher than last year ($13,813 thousand against $11,333 thousand). Simply put, Alterra’s power plants, other than HS Orka, are doing better than last year. In my opinion, it confirms a thesis that Alterra’s business is in good shape. Now, let me analyze the company’s plants / projects separately. Currently Alterra is a company under development. It means that it is a mix of a number of active power plants and projects at various stages of development. Let me take a closer look at these facilities and projects: Plants in operation HS Orka HS Orka consists of two geothermal power plants: Reykjanes and Svartsengi, both located in Iceland. In the first nine months of 2015 HS Orka reported revenue of $41,664 thousand (down 13.0%, compared to the same period in 2014). This decrease was attributable to the exchange rate between the Icelandic krona and the US dollar because revenue, if reported in the Icelandic currency, went up from ISK 5.31 billion in the first nine months of 2014 to ISK 5.39 billion in the same period in 2015 (an increase of 1.5%). Note: as a matter of fact, Alterra owns operating facilities located in Canada and Iceland. While the company’s reporting currency is the US dollar, Alterra’s operations are measured in the Canadian dollar and the Icelandic krona. Therefore to catch a full picture of the company, I recommend studying statement of comprehensive income (which measures the impact of exchange rates, cash flow hedges and other issues on the company’s bottom line). The HS Orka EBITDA and cash flow from operations followed revenue, expressed in ISK. EBITDA went up from ISK 1.96 billion to ISK 2.1 billion and cash flow from operations (excluding working capital issues) went up from ISK 1.9 billion to ISK 2.0 billion. Due to an increase in non-cash line called “Embedded derivatives in power sales contracts” HS Orka reported a decrease in its net income from ISK 1.2 billion in 2014 to ISK 0.3 billion in 2015. In my opinion, fluctuations in the value of embedded derivatives are standard features of this business and should not be taken as a risk. Toba Montrose Toba Montrose comprises two hydro power plants located in British Columbia, Canada. In the first nine months of 2015 Toba Montrose generated 704 thousand megawatt-hours of electricity (8.2% up, compared to the same period in 2014). The plant delivered net income of $18,403 thousand (1.9% down, compared to 2014), of which $7,417 thousand was attributable to Alterra (the company holds a 40% stake in Toba Montrose). Dokie 1 Dokie 1 is a wind farm located in British Columbia, Canada. Year to date Dokie 1 delivered revenue of $20,515 thousand, slightly above revenue reported in 2014 year to date. Due to lower costs (mainly costs of sales and financial expenses), year to date the farm showed a net income of $2,158 thousand (last year Dokie 1 incurred a net loss of $1,380 thousand). Of this income, 25.5% ($647 thousand) was attributable to Alterra. Blue Lagoon Blue Lagoon operates the legendary Blue Lagoon geothermal spa in Iceland. HS Orka owns a 30% stake in this company (Blue Lagoon) therefore this stake is reported directly in Alterra’s books using an equity method of accounting. In the first nine months of 2015 Alterra recognized net income of $6,241 thousand (up $2,057 thousand, compared to 2014). Summarizing, in the first nine months of 2015, all Alterra’s power plants operated with no major problems. Power plants, accounted for using an equity method, brought $14,305 as “Share of results of equity-accounted investees” (compared to $11,577 thousand in 2014). In my opinion, these figures confirm that Alterra’s power plants are heading for the right direction. Projects under development Currently Alterra has two projects under advanced development: Shannon and Jimmie Creek. Shannon Shannon is a wind farm project located in Texas, USA. It is owned by a partnership between Alterra (50%) and Starwood Energy Group Global (50%). Shannon is accounted for under the equity method (previously it was fully consolidated in Alterra’s books). The project is fully financed through a mix of an equity contribution (delivered by Starwood) and project financing ($286.8 million in credit facility). According to the company, commercial operations should start before the end of 2015. Jimmie Creek Jimmie Creek is a hydro power plant project located in British Columbia, Canada. It is owned by Alterra (51%) in a partnership with Axium (49%). Similarly to Shannon, this project is fully financed. In the beginning of 2016 Jimmie Creek should start delivering electricity to BC Hydro, under a 40-year power purchase agreement. The excerpt below, taken from the company’s 3Q 2015 report, summarizes Alterra’s stakes in all plants and projects (excluding HS Orka): (click to enlarge) As the picture shows, at the end of September 2015 the company was holding $186 million in various issues accounted for under the equity method. The company’s long-term performance Before writing this article I was wondering how to show the company’s long-term performance. After second thought, I have chosen book value as a leading measure. I think that any energy producing company should increase its book value in the long term. Calculating Alterra’s book value I have excluded two issues, which distort it: Accumulated other comprehensive income (AOCI) – it is part of the equity section of the balance sheet, representing accumulated unrealized gains and unrealized losses, such as cash hedges or currency translation adjustments. Every year or quarter this item fluctuates, very often quite much. What is more, AOCI depends on exchange rates, interest rates and other issues, which the company does not control. Therefore I have eliminated AOCI from my calculations of book value. Non-controlling interest – because non-controlling interest represents the stakes other entities hold in the company’s consolidated assets I have excluded this issue from my calculations. Now, let me take a closer look at this issue, taking Alterra as an example: (click to enlarge) source: Simple Digressions and the company’s reports The chart shows Alterra’s book value per share starting from 2011. It is not a nice picture – the company’s book value decreased from $0.69 per share (at the end of June 2011) to $0.33 per share at the end of September 2015. Someone would even say that the company was destroying value in the long-term. Well, it would be a half-truth. Since its beginning Alterra was trying to explore / develop quite a large number of projects. Part of expenditures on project development was accounted for as costs – in that case these costs were disclosed in the statements of operations. However, much larger part of development expenditures was capitalized in the balance sheet as “Development costs”. According to the company: “The Company capitalizes direct costs associated with its hydro, wind and geothermal development projects. Such costs include acquisition costs, exploration and development costs (including materials, direct labor, directly attributable overhead costs and borrowing costs), net of any recoveries and grants. Costs associated with successful projects are amortized over the useful life of the projects upon commencement of commercial production. Costs of unsuccessful projects are written off in the statement of operations in the period the project is abandoned or impaired” The last sentence is particularly important – unsuccessful projects are written off in the statement of operations. In 2013 and 2014 Alterra recognized impairments charges of $120,504 thousand and $22,439 thousand, respectively. On the per share basis it was $0.26 and $0.05, respectively. If the company did not recognize these charges, its book value at the end of September would stand at $0.64 per share, a little bit below its book value at the end 2012. Of course, it still means that the company has not built value in the long-term but every investor should remember that Alterra is at its initial development stage. At that stage a number of projects is doomed to failure. Alterra is no exception and it will take some time before the company starts to create value. Debt Alterra holds relatively high debt: (click to enlarge) According to the company (3Q 2015 Report, Note 13, page 20): “The Company currently plans to retire the holding company bonds (Sweden) through refinancing in 2016, for which the Company is currently in negotiations ” As for HS Orka loans of $81.7 million, though they are disclosed in the company’s consolidated balance sheet, they are non-recourse to Alterra – it is HS Orka, which has to pay this debt down. A holding company loan facility of $64.6 million will mature in 2023; till that time no principal payments are scheduled (the loan facility will be paid down on expiration). I believe that HS Orka will be paying down its debts so in the short-term there is only one small question mark – the company’s negotiations aiming at refinancing the holding company bonds (Sweden). Valuation To demonstrate Alterra’s market valuation I am using an Enterprise Value / EBITDA multiple. Including a non-controlling interest in the company’s valuation, currently Alterra’s shares are trading at a multiple of 11.7. The chart below shows valuations of a few renewable energy companies (as of November 20, 2015). In my opinion, Alterra’s shares are not overpriced, compared to its peers: (click to enlarge) source: Simple Digressions Summary In my opinion, Alterra is going in the right direction. Its current power plants operate with no major problems. In the coming future the company should increase its capacity through completing two additional, fully financed, energy projects. The first one, Shannon Wind, is a wind farm facility with a nameplate capacity of 204 MW. Shannon should be in operation at the end of this year. The second project, Jimmie Creek, is a hydroelectric power plant with a nameplate capacity of 62 MW. This project should start its operations in early-2016. After commencing operations at these new power plants, the company’s capacity will increase from 553 MW to 819 MW (an increase of 48.1%). Despite these positive developments, the market is valuing Alterra’s shares at an EV / EBITDA multiple of 11.7. I think it is relatively low valuation, compared to other renewable energy stocks. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.