Tag Archives: seeking-alpha

Playing The Ratings Game

By Alan Gula Care to take a guess at Lehman Brothers’ credit rating right before its bankruptcy? I’ll give you some help. Investment-grade ratings range from AAA down to BBB- (on the Standard & Poor’s ratings scale). Anything below investment grade (BB+ and below) is considered high yield , which is also known as speculative grade, sub-investment grade, or “junk.” The higher the credit rating, the higher the perceived credit worthiness. In other words, high-rated companies can probably pay you back. Thus, you’d assume Lehman Brothers had a solidly junky rating – perhaps CC – reflecting the high risk of default during the credit crisis… right? Actually, Lehman had an “A” rating right before it went bust! The major ratings agencies – Standard & Poor’s, Moody’s Investors Services, and Fitch Ratings – took a lot of flak for this egregious misjudgment. To be sure, credit ratings still provide valuable information. In fact, looking up the credit rating and reading the commentary from the ratings agencies is a great place to begin when evaluating a stock. You can access Standard & Poor’s ratings for free by registering on their site. Just keep in mind that the ratings agencies may have missed some material risks. Therefore, we should really take notice when a company has a high-yield rating. Yet, most equity investors are unaware of the credit ratings of their holdings. For example, the following table shows three real estate investment trusts (REITs) that are in the S&P 500. Equinix Inc. (NASDAQ: EQIX ), Crown Castle International Corp. (NYSE: CCI ), and SL Green Realty Corp. (NYSE: SLG ) specialize in data centers, wireless communications towers, and commercial properties, respectively. I guarantee that the vast majority of retail investors in these stocks have no idea that the S&P’s long-term issuer rating of these REITs is sub-investment grade. It’s easy to see why these REITs have relatively low ratings, too. Their net debt (debt minus cash) to EBITDA (earnings before interest, taxes, depreciation, and amortization) ratios are all at least 4.0 times, which is high. The average net debt/EBITDA in the S&P 500, excluding financials, is 1.36 times. At a time when many high-yield bonds are coming under significant pressure, investors need to be vigilant . I’m not saying that these companies will default on their debt. However, I do think these REITs should have much higher yields to compensate investors for the additional risk, which is being ignored. The cost of debt capital will likely rise for most high-yield issuers during the next few years. This will be a painful process for unsuspecting equity investors in highly leveraged companies. Most stock watchers fail to appreciate the inextricable linkage between the credit and equity markets. Keep in mind, very few companies have rock solid balance sheets like Johnson & Johnson (NYSE: JNJ ), which is AAA rated. Sadly, many people’s idea of “research” involves pulling up a stock chart and (improperly) drawing some trend lines. If that’s the extent of your analysis, then you shouldn’t be investing in individual stocks. Stick with exchange-traded funds (ETFs). If you insist on individual stocks, at least do some credit analysis on your portfolio. You’ll thank me when defaults spike, sending shockwaves through the credit – and equity – markets. Link to the original post on Wall Street Daily

El Paso Electric: Fairly Valued, No Significant Upside

Summary We initiate coverage on El Paso Electric with a Neutral rating and TP of $40. The TP is based upon company’s future financial performance and historical valuation against industry peers. Current political situation in El Paso may cause challenges in reaching a settlement with the PUCT. Thus, the company would have to face uncertainty related to litigation. PVR anticipates the regulators of Texas and New Mexico to finally allow the significant increase in rate base. However, the current stock price is not including uncertainty related to regulatory. EE would have to apply for relief in rates in challenging jurisdictions as a result of new generation investment. Plain Vanilla Research ((NYSE: PVR )) initiates coverage on El Paso Electric Co. (NYSE: EE ) with a Neutral rating and a target price ((TP)) of $40. Since September, the stock price of El Paso Electric has outperformed the Utilities Sector by 7.28 percentage points (ppts). This is shown in the chart below: (click to enlarge) However, we think that the performance is not sustainable in the future as the company is facing challenges on multiple fronts. This restricts the stock from offering significant upside potential. In addition to that, a dividend yield of only 3% is not very attractive to tempt dividend investors. We will be discussing the challenges below: 1. Political Circumstances In El Paso In the past, proceedings related to change in rate base in El Paso have been engulfed with politics a lot. The company can be anticipated to face an interesting stance from the City Council officials as they will try to create challenges for the company to reach a settlement agreement. Furthermore, the supporters of solar-powered energy have also entered the arena as the publicly-listed corporation is trying to create alterations in rate design, which would cause installers of rooftop solar panels to make a partial requirements fee payment. Instead of reaching a settlement with the City Council authorities, we think the company should play the long game and wait for a decision from the Public Utilities Commission of Texas (PUCT). Although, the road is long and would result in higher uncertainty but it will result in a more favorable decision for the organization. 2. Approval From Texas And New Mexico Regulatory Authorities We anticipate that the regulatory authorities of Texas and New Mexico will allow the significant increase in rate base at the end. However, the current stock price reflects that investors expect the regulatory authorities to allow the increase in rate in any case. We think that slight hindrance in regulatory approval will result in the stock price on a downward trajectory. Texas is responsible for contributing roughly three-fourth to El Paso Electric’s bottom line. Meanwhile, the remaining contribution is from the state of New Mexico. 3. Demand For Rate Relief Requests In Challenging Jurisdictions El Paso has the finished the construction of two peaking units located at the Montana Power Station (MPS). In addition to that, the company will be finished with the construction of the third unit by spring of next year and by year-end, the company intends to complete the construction of the fourth unit. The four units are natural-gas powered and will have a capacity of 352 megawatts ((NYSE: MW )). These units are built to cater the increasing requirement of electricity in El Paso’s service territory. Montana plant and support infrastructure is anticipated to have a cost of $375 million. The company has been lucky to experience an annual growth rate of 1% to 1.5% for the past several years in the service territory. Normally, the industry has been seeing flat or decline in power consumption. Derivation Of Price Objective PVR has based its target price (TP) of $31 at earnings per share ((NYSEARCA: EPS )) of $2.67 along with a forward P/E multiple of 15.39x. The following forecasted income statement reflects as how we have arrived at our 2018 EPS. Currently, El Paso Electric’s stock is exchanging hand at PVR’s forward price-to-earnings (P/E) multiple of 15.44x. In the past three-years, the stock has traded at an average forward P/E multiple of 14.94x. This reflects that the stock is trading at a premium of 6.5% against its three-year average forward P/E multiple of 14.94x. (click to enlarge) Meanwhile, against its peers’ combined forward P/E multiple of 12.23x, El Paso Electric’s stock is presently trading at a premium of 26.2%. In the past three years, the stock has traded at an average premium of 22% against its peers’ combined forward P/E. (click to enlarge) We have arrived at our target forward P/E multiple for El Paso Electric by calculating the three-year average forward P/E multiple of 12.24x for the combined industry peers. After that, we have applied the three-year historical premium of 22% to the historical average peers’ combined forward P/E multiple to reach El Paso Electric’s target forward P/E multiple of 14.93x. We have formulated the peers forward P/E multiple by combining our forward P/E ratios of Consolidated Edison (NYSE: ED ), PG&E Corporation (NYSE: PCG ), PNM Resources Inc (NYSE: PNM ), American Electric Power Company Inc (NYSE: AEP ) and Xcel Energy Inc (NYSE: XEL ) along with El Paso Electric. We have given their respective P/E weight according to their market capitalization.

The V20 Portfolio Week #7: Outperformance

Summary The V20 Portfolio appreciated by 5% against S&P 500’s increase of 1%. Don’t celebrate my “win” on MagicJack. Spirit Airlines was pitched by a hedge fund manager. Conn’s boosted overall performance, likely as the result of buybacks. The V20 portfolio is an actively managed portfolio that seeks to achieve annualized return of 20% over the long term. If you are a long-term investor, then this portfolio may be for you. You can read more about how the portfolio works and the associated risks here . Always do your own research before making an investment. Read last week’s update here ! It was another great week for the markets, and an even greater one for the V20 Portfolio. The S&P 500 was up 3%, lagging behind the V20 Portfolio’s performance of 5%. Month to date, the index is up by less than 1% while the V20 Portfolio has appreciated by 5.3%. Portfolio Update MagicJack (NASDAQ: CALL ) continued to underperform this week, falling 6%. There were no news, so it would appear the investors have become bearish again. I was rather fortunate in that I reduced MagicJack’s stake by 50% last week after earnings. Since then, the stock has dropped by almost 20%. Did I foresee this sharp decline? The answer is no. My original rationale for the position reduction was that because the investment thesis has shifted to more of a growth story, the company no longer deserved the exposure that it had. If I had the foresight to realize that the market will again be pessimistic about MagicJack, I would’ve sold the entire stake and rebought at current prices (or whatever prices that I deem to be the “bottom”). The point is that there is no need to celebrate this “win” on MagicJack as you should not let price dictate the validity of your original decision. Had MagicJack shares appreciated significantly after I sold my stake, the mentality would’ve been the same. This reminds of Icahn’s sentiment on his Netflix exit: You’re never going to get the top. Once in a while you get the timing right, but that’s like Vegas. As MagicJack slides further, the odds tip more and more in my favor. Similar to Conn’s, at a certain point, I will add to the position once again. In other news, one of our major positions was brought into the limelight by Whitney Tilson , who coincidentally owns MagicJack as well. Spirit Airlines (NASDAQ: SAVE ) was one of the top performers this week, with its shares rising 7%. If Spirit Airlines was not the top performer, then what was? It is none other than Conn’s (NASDAQ: CONN ). The stock remains controversial for investors, just look at the comment section in my past articles ! With the buyback program in place, there will be more upward pressure in the near-term. This week, the position rose by 12%. I cannot determine how much of this increase can be attributed to higher demand caused by the buyback program (as opposed to market participants), but I do believe that this upward trend will likely continue until the buyback program is halted. Looking Ahead From a risk perspective, I continue to look for a cheap energy company to offset my commodity exposure stemming from Spirit Airlines. As for Dex Media (NASDAQ: DXM ), the forbearance agreement will expire on Monday, so I do expect news regarding the restructuring proceedings soon. Since the position is so small (