Mexico Is Having A Yuuuge Donald Trump Victory Sale

December 17, 2016 7:40 PM


I am writing to you from Santiago de Queretaro, Mexico, where the whole country is having a yuuuuge Donald Trump victory sale. Mexico is one of my favorite countries to visit. It combines a laid back attitude, friendly people and an outstanding culinary tradition. It also helps that it’s currently one of the cheapest places on the planet—one of many reasons that I’ve spent 5 weeks here recently (Yucatan and Central Mexico thus far).

Mexico has always been known as an affordable place with cheap beer and tacos, but the last two years have taken that dynamic to an extreme. Where else is the brand new AC Marriott $42 per night? In touristy San Miguel de Allende, we booked a 2,500 foot, 2 bedroom suite on the main square for $75 a night. Food for two with a bottle of mezcal is about $30 at the most posh of restaurants. It’s verging on silly. Between the two thirds decline in the Mexican Peso over the past two years and an over-dramatized fear of violence, the tourist economy is basically running on free. They’re just happy to see you and thankfully, my Mexican fiancé can translate my pathetic gringo Spanish as we travel around.

5 year Peso

5 Year Peso Chart. 2/3 of the value is gone in just the last 2 years.

 

If you don’t have a trip planned to Mexico, get working on it. I don’t think it will stay this cheap for long. Let’s start with the obvious question—is it dangerous? I tend to like statistics as opposed to jaundiced media reporting. The USA has a 4.5 per 100,000 homicide rate. Mexico is pushing 20, or about four times as bad. Given that I’m not terribly scared in America, four times worse doesn’t seem that bad. When you dig into the numbers, you realize that much of this crime is drug related. In fact, if you aren’t involved in narco-trafficking, the homicide rate isn’t much worse than that of the USA. Furthermore, most of the violence seems clustered in a few cities and states. I wouldn’t go to Baltimore or East St. Louis on vacation, why go to the Mexican version? Strip that all out and Mexico is on par with most of America. Unfortunately, a few dramatic incidents have cost Mexico millions of visitors a year. Eventually, perceptions will adjust to reality and the tourists will flock back—especially given how affordable it is.

I have now taken two trips to Mexico during the past 10 weeks. The whole time, I’ve kept asking myself, “How do you play this?” It’s so cheap. Despite threats of change from Trump, I know this is an overreaction. Mexico is sure to bounce back and keep growing--though, the economy may shift slightly from manufacturing towards tourism due to how cheap it is to visit.

The thing is, just because something is cheap, that doesn’t mean there’s always a “play.” There’s an old adage in finance that you don’t buy the currency of Spanish speaking countries. Pull up a 10-year chart of any of these countries and it will be obvious why that adage has weight—pull up a 50-year chart and you won’t even be able to zoom in to where we are today. The Peso has overshot recently, but it’s not an asset I want to own.

What about assets benefitting from a weakening currency? In property, if you can borrow at a reasonable rate in a depreciating currency and get paid rent in US Dollars, you’re going to make a fortune. Unfortunately, for most foreign property companies, rents are long-term and struck in depreciating local currencies. However, the hotel sector is largely immune to this. They can adjust their room rates daily. Fibra Hotel (FIHO12: Mexico) and Fibra Inn (FINN13: Mexico) have both borrowed in Mexican Pesos. Right now, the rates they’re receiving are silly. Look up some of their hotels on the internet--$20 here, $30 there. This is because there is a lag in how fast they can re-price room rates to take advantage of the decline in the Peso—especially as many of their customers are business travelers with budgets in Pesos. However, their costs are mostly fixed, the assets were built with pre-depreciated currency—they’re now worth much more in current Pesos than it cost to build them. The supply of new hotels will slow as it costs much more in current Pesos to build new ones—all the old ones have a massive competitive advantage until room rates fully reset. Meanwhile, due to Trump’s victory and the decline in the Peso, Mexican hotel REITs are being priced like something awful is about to happen—instead, a weaker Peso is a huge boon to them.

In terms of valuations, I don’t think annualizing current quarter cash flow is the correct measure to look at—as room rates in Mexican Pesos will likely rise in future quarters. That said; they trade at about ten times pro-forma AFFO and pay pro-forma Q4 dividends around 9% adjusted for stabilization of new assets. That’s very cheap for a property company with minimal leverage. With mostly fixed costs, I can model these companies to be trading for more like 6 to 8 times AFFO looking forward a year—due to a normalization of hotel rates on a fixed cost structure. A more typical measure of valuation in the hotel industry is price per room. Adjusting debt for rooms still under construction, these companies trade at enterprise values of around $30,000 to $35,000 a room, while comparable rooms cost at least twice that to construct in Mexico. This would imply that they trade for less than half of replacement cost. Interestingly, the Mexican hotel market is much more fractured than the US market. As the market consolidates, there are lots of hotels that can be purchased for 10 cap rates—even before economies of scale at a larger REIT increase the returns. Given the low leverage at both of these companies and how cheap debt is, there is likely to be continued growth as these companies take advantage of distressed players and make highly accretive acquisitions.

Fibra Inn

Fibra Inn priced in US Dollars since the IPO

Fibra Hotel

Fibra Hotel priced in US Dollars since the IPO

 

In summary, I have started small positions in each—I’m looking for further declines before I really add size. Deep down, I don’t think they’ve bottomed yet. However, they’re very cheap based on almost any metric you can use. They have growth pathways and the re-adjustment of room rates over the next few quarters should flow through the cash flow statements. Meanwhile, due to dividends, you’re paid well to wait. No one ever gets the exact bottom and Mexico is stunningly cheap, incredibly close for Americans and I expect that travel will increase as a result.

Over the next few quarters, one of two things will happen—either Trump and Mexico will reach an acceptable solution on trade where the currency recovers and average daily room rates reflect something closer to historical rental rates in Mexico when priced in US Dollars or the cheapness of the country drives more tourists and occupancy increases, while room rates are re-priced closer to previous dollar rates. Either way, I see RevPAR in US Dollar equivalents increasing dramatically over the next few quarters. In any case, I’m celebrating Trump’s victory with cheap cerveza, a cheap hotel room and two very undervalued REITs. I continue to seek out other opportunities in Mexico (stay tuned).

 

Disclosure: Long FINN13 and FIHO12

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Oil Services Update

December 15, 2016 12:16 AM


Back in August, I noted that oil looked to be making a right shoulder and that I was buying a basket of oil service companies as many of these companies, particularly in the offshore service, space traded at tiny fractions of NAV. Since then, most of my basket made new lows before rallying strongly in the past few weeks. The companies in my basket are now up 20% to 80% since I wrote about them in August. With Trump's focus on making America great again, I've now exited all of these positions in order to focus on companies that will benefit more from strong economic growth--as opposed to simply the price of oil and demand for oil services.

Despite the recent rally in the market, I'm finding great values in interesting places. Stay tuned for more updates.

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Believe In America (Part II)

December 1, 2016 2:44 AM


When the Central Bankers started printing money in 2009, I knew they wouldn’t be able to stop before they took things to an unimaginable extreme. When you’re in government and your policy isn’t working, you keep pushing harder—like your career is at stake if you fail. When China embarked on a massive infrastructure binge to re-ignite economic growth in 2008, it was obvious that once started, this would also continue for quite some time. What they’ve learned is that US $1 trillion a year just doesn’t kick-start an economy like it used to. This is why I don’t think Trump’s US $1 trillion infrastructure spending plan will stop at that. What’s $100 billion a year over ten years when the Chinese are doing a trillion a year? It just won’t create the sort of job growth needed.

With Trump at the helm, we can be proud that America is leading the western world in a new trend. You cannot fix an overleveraged economy with artificially low rates—you need spending on infrastructure. Trump realizes that. When America starts spending others will follow—just like they followed us with QE. What happens when everyone starts spending? Well, you’re going to need a lot of stuff and someone has to move that stuff around.

Last week, the Baltic Dry Index (BDI) hit a two year high following one of the worst bear markets in the index’s history. This bear market was caused by a crushing glut of ships that were ordered during the bull market of 2006 to 2012, but delivered en masse from 2010 onwards. The last of this glut should come in online in 2017. After that, there are almost no ships on the order book, meaning almost no more new deliveries until 2020—as it takes about 2 years to build a ship. So, a sector that has seen double digit tonnage growth crushing charter rates will now enter a period of no tonnage growth or even contraction as older boats are scrapped. At the same time, more stuff will suddenly need to be moved around on its way towards becoming infrastructure.

BDIY

Baltic Dry Index is finally showing some life after making a multi-decade low at the start of this year.

 

My favorite company in this sector is Star Bulkers (SBLK: Nasdaq), which owns 68 bulk carriers today. After a two year period of declining asset values, repeated equity raises and forced ship sales, the business has stabilized. The loans have finally been restructured. There won’t be any more forced ship sales. Instead, you have one of the world’s lowest cost operators with a fully financed fleet that will grow to 73 ships by early 2018. Based on current BDI rates, they should be making good cash flow for the first time in two years. I expect charter rates to come off a bit over the winter, as they often do, but even then, SBLK should be roughly cash flow neutral—nothing like the past two years where charter rates didn’t even cover operating costs. Effectively, you have a long-dated call option on demand for bulk shipping recovering at a time when supply should finally cease.

You can buy the shares today for just a bit over $5 while net tangible book per share, should be a little over $7 based on current vessel values. Of course, vessel values are currently highly distressed and should charter rates increase, vessel values should increase dramatically. Additionally, $476 million of equity was raised in the past two years, with roughly two thirds of it put up by management and noted value investment group Oaktree Capital. I like it when the insiders keep buying and at a market cap of $289 million, you can buy the whole company at 60% of the price that they thought was appropriate for their investments in less than the whole company. You’re paying less than the insiders paid, less than the boats are worth and the BDI is going to continue rallying because Trump intends to make infrastructure great again.

Disclosure: Long SBLK, Short SBLK puts

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Is This The Right Shoulder?

August 18, 2016 5:54 AM


Everyone is asking: “Is this is the right shoulder in oil?”

I know, I’m not a chart guy, but I certainly respect charts for entry points. Sentiment on oil is awful. Inventory is high. Refined inventory is off the charts. New supply is expected from all sorts of countries. Yeah, I’ve heard it all, but so have the charts. Here we are, and it sure looks like oil is forming a 2-year inverted head and shoulders (H&S) reversal.

oil H&S

Look at the S&P Oil & Gas Exploration & Production ETF (XOP:NYSE) for the past 6 months. When oil took a $10 drop in July, the XOP barely even flinched. In my experience, when you’re coming out of a commodity bear market, the producers tend to lead the commodity higher.

xop chart

It’s been approximately 2 years since oil began its slide from nearly 100. A lot has changed at the producers and it makes sense that they’re starting to outperform. They’ve dramatically cut costs, reduced exploration spending and focused on debt reduction. The survivors now have stronger balance sheets. Plenty of their brethren didn’t make it.

If you think oil is coming back, you can go and chase these producers, but there’s a sector that really interests me and that is the oil services sector where many sub-sectors are still bouncing along their multi-decade lows—or making new lows as I write this. Many of these companies have just reported awful quarters. Their businesses are down dramatically, their cash flows are a mess—many of them are blowing covenants and some even have scary “going concern” notices in their financials.

Why shouldn’t these companies suffer? Producers are focused on paying down debt—they’re doing everything possible to stop spending. However, if there’s one thing that I know about the oil companies, it’s that they’ll start to spend if oil starts to rally. They can’t help it. That’s what oil companies do. De-levering is boring.

I’m not going to tell you that buying highly leveraged service companies with covenant breaches and revenues that are down by half in the past year is a “sleep well at night” sort of investment, but I think that a basket of them can be. I bring this up, because many of these companies trade at less than 20% of book value and book value is mostly made up of equipment that is only a few years old. Heck,some of the offshore service companies trade at less than 10% of book. Even better, many of these companies have already taken a few rounds of impairments to their book value. Hence, true replacement value is even higher. Sure there’s debt, sure there are going to be hiccups and a few more scary quarters, but these guys have also been cutting costs for 2 years. Plenty of competitors have already failed and been liquidated. If there’s going to be a bounce-back in business it will flow to the survivors' bottom line in a hurry. If that happens, I don't see why these service companies can't trade back to book. In fact, for most of the past few decades, they’ve traded at a premium to book. I don’t want to name names, because I’m pretty sure a few companies in my basket will go to “oil services heaven” but if I'm right, a few 10-baggers will balance that out. The question then is: "Is this really the right shoulder?"  

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Fake Currency, Fake Exchange...(uggh)

August 7, 2016 12:26 PM


So, the inevitable happened, someone hacked Bitfinex where I kept part of my Bitcoin stash. It sounds like I’m getting back 64% of my bitcoins and a BFX token which I can potentially exchange for shares of iFinex Inc., which happens to be the Bitcoin exchange that lost my damn bitcoins in the first place!!! Why would I want to own non-tradable illiquid equity in an exchange that no one will ever want to put money into again? Why do I want BFX tokens? Why do I want Bitcoins in the first place? This has now been the second sizable hack in 2 months (the other was ETH), where someone successfully stole crypto-money and turned it into real money. Momentum may still rule the day, but when your fake currency can be stolen by real crooks, it’s unlikely that a true mania bubble can form—manias are built on misplaced trust. At this point, Bitcoin may not even appear safe enough for the Chinese to launder money with. At least Beanie Babies and baseball cards were safe in your basement. The whole premise of Bitcoin Bubble 2016 was that a new group of exchanges had grown up with venture capitalist supervision and there would be no more Mt. Gox style implosions.

Fortunately, I split my bet between 2 exchanges due to security fears. Even more fortunately, I kept substantially more at the other exchange due to it having more prominent backers—I chose Bitfinex because it was the exchange with the most US Dollar trading volume. Over the past few days, I’ve been cashing out my Bitcoin from the exchange that hasn’t been hacked. In case you're curious, even if I hadn't been hacked, I would still be selling as it is much less likely that this becomes a bubble now. While I haven’t figured out the value of my (likely worthless) BFX tokens, with a bunch of sales at just under USD $600 at the un-hacked exchange, compared to my cost basis at USD $450, and a 64% recovery of my Bitfinex Bitcoins, it seems like I will actually come out with a small gain on this fake currency.

woohoo

Back to real investing…

 

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