Combining our experience and daily focus, we aim to process, distill, and comment on various activities in the market place here in the Market Commentary section. Our purpose is to get you thinking about things in order to avoid just re-presenting otherwise meaningless statistics like unemployment level, S&P 500 closing price, etc. Ballast will provide you this commentary on an ongoing basis with the intent of delivering insight and color that is not readily available through public outlets. We assume that you are familiar with common sources for latest readings of Dow or S&P closing prices and that you see the major headlines like the Federal Reserve Bank having increased or decreased the Fed Funds rate.
In our opinion, a great deal of time and energy from sell-side economists is spent addressing unemployment, ISM Index, payrolls and all the other monthly economic releases, speaking to facts without necessarily instilling wisdom. To us, this is an outcome of the age of Google – anyone now has the ability to quickly search the internet for facts and information (and now disinformation). But knowing facts and information is different than having knowledge and wisdom.
Here are some insights from July events to highlight some of the things we have worked on and thought about on behalf of our clients:
With oil prices in decline for most of the month of July, high-yield debt markets began to reflect trouble in energy-related credit again. The Ballast team began re-examining some of the companies/bonds from 2015-2016 to reacquaint ourselves with the energy sector. It’s still early, but we think the opportunity could re-open if WTI oil trades back below $40/barrel, a price not seen since early 2016 when the energy sector “recovered”.
There remains a variety of reasons that oil could trade lower. First, U.S. shale oil producers continue to grow output through increased drilling and well completions (a large number of wells were drilled but uncompleted from before and during the “crisis” of 2015-2016), which are relatively cheap to turn on in the current price environment. Operations are booming again so much so that there is said to be equipment scarcity. What!? Further, OPEC (Organization of the Petroleum Exporting Countries) is struggling to maintain its output reduction quotas due to turmoil across much of the middle east, select members being exempt from the cuts (Nigeria, Iran, Libya, et al), and suspected cheating. Oil demand continues to fall short of projections, which has kept supply in excess of or matched demand, leaving oil storage facilities around the world highly utilized much more so than in recent history. Storage levels have fluctuated regionally and traders have reacted in a number of different ways, with the result being price volatility. We think these points highlight the sensitivity and vulnerability of oil at present and therefore, positively reflect the opportunities that may arise over the next year.
Energy Private Equity
EnerVest, a large energy-focused private equity group based in Houston, Texas, splashed investment headlines during July. They had the distinguished honor of having the first private equity fund of initial size greater than $1.0 billion to go bankrupt – that’s right, their investors are likely to get zero ($0.00) of their capital back. One of EnerVest’s other funds has a NAV (Net Asset Value) described as “pennies on the dollar” and yet another one of their funds is at a material discount to initial contributed capital. We are not surprised to see such news for the industry and would not be surprised to hear of more of these instances in coming years.
Amazon Retail | Financial Services
Amazon never ceases to amaze and bewilder investors. Sears announced it had reached an agreement to sell its Kenmore appliances on the online retailer. The news boosted Sears while competitors in the space – Lowe’s, Home Depot, et al – saw their stock prices fall by 4% or more. This goes back to our thoughts on Amazon from June Market Commentary. While we think the agreement may help Sears at the margin, we remain unconvinced of the near-term implications for Lowe’s, Home Depot, et al.
Amazon hasn’t stopped making headlines there, though. In fact, there is nothing this company seemingly cannot disrupt. The latest news here is that Visa, Mastercard, Paypal, et al face long-term disruption from Amazon. Although the news did not seem to move stock prices adversely, we think the article commentary was another example of analyst over-reaction. Otherwise, we hope Amazon does not start an investment advisory business. On that note, robo-advising is on the rise and is likely to be a topic of a future Ballast piece. Stay tuned.
Under pressure from both Chinese and U.S. governments, there has been more news of Chinese companies slowing acquisitiveness. We think a significant portion of today’s market valuations reflect takeover premiums – that is that the potential for company to be acquired is reflected in its price. Since Chinese companies have been a large participant in acquisitions in recent years, we think the absence of Chinese buyers will slow acquisitions and cause the equity markets to move sideways until another catalyst emerges for an up or down movement.
Greece has been in financial trouble for a number of years. The EU, rightly or wrongly, has held Greece financial prisoner. The country has been forced to implement strict measures to shore-up large and long-running deficits in order to stabilize outstanding debts of the country. Further, Greece has been in and out of recession for at least half a decade, and needless to say, the bond issuance from the country has been both infrequent and high-yield. The country is at a level comparable to emerging market countries.
Greece was able to issue €3.0 billion five-year bonds to the market at 4.625% yield with the deal two-times oversubscribed, which means there was twice as much interest in the deal than bonds available. While it’s not a century bond like Argentina issued in June, we think the Greek issuance echoes our thoughts on the Argentina bond we commented on in the June Market Commentary piece. Investors appear to be yield-hungry regardless of risk.
AstraZeneca (AZN), a global pharmaceutical company, reported disappointing research of a key trial drug in the company’s pipeline. The drug is an immunotherapy for treating lung cancer, and it was expected to be a blockbuster (high revenue and earnings potential) and a primary treatment for lung cancer patients. On the news, AZN stock promptly traded 16% lower. This made sense to us given the significance the drug represented to future earnings.
Thinking this would be an opportunity for the credit side, we looked to the bonds for more attractive value. What we found did not make sense – bond spreads remained at recent tights (low spread means high price) and so the bonds remain richly valued. Having followed the company for a few years, we think the announcement means more than has been reflected in the credit spreads. Front in our mind is that Pfizer (PFE) made an offer to acquire AZN three years ago for £55/share and AZN “successfully” resisted the takeover, causing PFE to walk away. As of this writing AZN shares trade at £42. We’ve seen this type of thing several times in the last five years and cannot understand the governance at some of these pharmaceutical companies.
Underscoring our caution with AZN valuation, the CEO was rumored to be a top candidate to take the vacant seat at Teva, another pharmaceutical company – and a story we have followed. The AZN news may be just the thing for its CEO to make the switch. This would open AZN to strategic uncertainty, and it confirms the execution of strategy at AZN is not what was otherwise anticipated, as well as the fact that the Pfizer deal was a good deal. The only thing we can think of is that creditors believe a takeover is now back in play (which would come at the cost of shareholders’ lost opportunity three years prior), and so credit spreads may be reflecting this. A takeover is uncertain and the acquirer could be of weaker credit quality, so tight spreads are of little interest to us here.
We think this was a rare instance where the equity analysts and market reacted correctly and the credit analysts and market did not. We passed on AZN for now as the opportunity has not materialized as we expected.
The Ballast investment team continuously monitors events like those outlined above, as well as the opportunities that arise from them.