Figuring out First Uranium’s trading

Over the past five days, First Uranium equity has gone up approximately 50%:

Nothing public has happened to the company in the past five days, and the last major piece of news coming out was on October 20th when they announced their Q2 production results (which one can extrapolate into a quarterly report). The only explanation here is that either there is some insider news that is leaking into the marketplace, or there is a technical factor, such as very short term covering of short positions, or institutional demand on the stock.

The stock trades an average of $500k-$1M/day in volume, while not Microsoft-style liquidity, it is sufficient for most investment funds that wish to accumulate a position.

Something interesting is the effect on the debentures – if the equity trades higher, then it is more likely the debentures will mature at par because the company can recapitalize the debt by doing an equity swap. The subordinated debentures have not moved too much – up from roughly 70 cents to about 73-75 cents, while the notes (where I was a little more fortunate on my timing) have moved up from about 90 cents to par value.

There is an embedded call option in the notes to buy equity at $1.30/share, expiring at maturity (March 31, 2013) that has to be priced into the valuation of the notes – obviously if the equity is trading above $1.30/share, then the notes will be trading above par.

With an equity value of $1.07/share at present, the notes at 90 cents are a very compelling value. This price is now gone.

Readers should be cautioned that I do own the notes and subordinated debentures of First Uranium, but not the equity.

Food price inflation

It is visibly evident, especially going through the supermarkets, that food prices have been heading up. In light of the fact that commodity prices (e.g. grain, sugar, etc.) have been rising, there is no way that producers can sell the same products and maintain margins without increasing prices.

Reducing the size of packaging has been one approach some companies have been taking – seen with such products such as breakfast cereals, to name one.

This is a function of loose monetary policy and demand for goods – the net result is that everybody is going to have more money, but the purchasing power of that money will be less. It will be nearly impossible for the average member of the public to maintain their purchasing power – you are forced to make a financial decision of some form to maintain it.

Superior Plus – expect a dividend cut

I have been posting about this very high-yield stock since late July, stating that their dividends would have to be chopped by about 25% or so to maintain their financial health.

Their last quarterly announcement was generally below expectations, and for the comparable period from 2009, they are down about $19M in operating cash flow.

They were trading at about $13.50/share when I posted about them originally, and they are now at $10.80/share. Their indicated dividend is still a whopping $1.62/share, but it is more likely than ever that management will reduce the dividend by a factor of 40-50% (compared to my expectations of 25% before), and that this increased dividend cut has been baked into the stock price. It is likely when they make the announcement the shares will drop further, as retail investors that assumed they were getting a 15% yield will be bailing out.

The company operationally makes money and will likely make money in the future, but their primary problem is they have slightly over a billion dollars of debt on the books and the financial leverage is quite high. SPB debentures are still all trading at around par, so management would be very wise to cut the dividend, and then lengthen the term structure of their debt – the first of which matures in December 2012. One never knows when this mania for fixed income will resolve itself.

SPB sticks out on my equity radar like a sore thumb (and likely on the radar of many others), but there is a reason why I am not buying it.

Whistler Blackcomb – quick IPO analysis

Whistler Blackcomb will be trading next week under ticker symbol WB in Toronto.

They priced their shares at $12 – down from the expected $15. The entity, assuming no exercise of the over-allotment, will have 37.8 million shares outstanding, so $12/share will have a capitalization of $454M.

The final prospectus was released on SEDAR yesterday and I went through it. What Fortress is leaving behind for the public is the empty husk of an entity that is heavily indebted, negative tangible equity on the balance sheet, and 97 cents of pre-capital expenditure cash flow to play with from the September 2009 fiscal year. 2010 will be a slightly worse year in terms of cash flow.

The biggest sham of this IPO is the dividend talk – 97.5 cents per share, based on a very flawed calculation on page 19 which will be very safe to say will not be sustained. Still, you will have enough retail investors that would be foolish enough to purchase shares strictly based on the 8.1% yield, but my guess is that this yield is not going to be sustainable in the medium term. They will have enough of a cash buffer ($29 million) to fund dividends beyond their cash generation, but it will not last long.

There is value in the shares, but certainly not at $12/share. This one is an easy avoid. I might take a look at the shares if they dip below about $5.30/share – they’ll likely get there once they cut distributions and/or have a bad season and/or are forced to recapitalize their $255 million debt.

There is more quantitative work that went behind this post, but for the sake of readability I have omitted most of it and stuck to the salient details of this IPO.

How this stock will trade will be interesting to watch – I suspect it will do a little better than $11.40/share (IPO proceeds minus fees) simply because it is an “income stock”.

The big macroeconomic picture

Sometimes when you step back, get away from the computer for a couple days, and then step forward again, you take a different perspective on things. Such as what to sort through first in an inbox that has 60 unread emails.

I have typically experienced that a hands-off approach works better than a hands-on approach to portfolio – every time you touch your portfolio, you have to be making a correct decision compared to the person on the other end of the trade.

This time when I returned, I noticed that practically all resource and commodity-based equities, in addition to the broad indexes were up. My portfolio received a minor increase, so it is always emotionally difficult to look at everything else go up, but I am buffering that against the fact that I have a risk-adverse portfolio with a significant amount of cash.

The two obvious factors that went on this week was:

1. US Congressional Elections – Republicans take the House, Democrats keep the Senate. My projection here is that the state of the fiscal situation in the US government will not change to a significant degree – there will be massive fiscal deficits for years to come. It will be unlikely that this new congress will be able to restore some sort of fiscal balance. In fact, the decision might be whether to bail out certain states or not, which have accrued liabilities that is far beyond their ability to pay. What is interesting is that the market predicted this result in advance, but there was no significant market reaction.

2. Federal Reserve engaging in potential quantitative easing – they announced a number less than what the market was expecting, but announced it nonetheless.

The big macro issue is that in order to stimulate exports, countries are reducing the value of their currency by pumping more of it into the economy, which you see in the form of government deficits. Since every country that has an export base is doing the same thing, you do not see much of a shift in relative valuation, but you do see a shift in valuations with hard assets, such as commodities and to a lesser degree, equity and debt. This creates a rather volatile situation in the marketplace.

I don’t know how this will resolve itself – my instinct has always been to purchase commodity-linked equities, but it feels like a crowded trade. Cash feels like it is depreciating by the day. Fixed income has valuation and risk/reward issues, especially if/when long term rates increase. Shorting long-term bonds is something to be considered, but doesn’t alleviate the problem of what to do with cash. Income-related securities have also been bidded to the roof, and barring any price corrections between now and year end, one of my 2011 predictions will be that income-related securities will underperform.

The least of what seems to be all ugly options is cash, specifically Canadian currency cash. There are a few reasons for this:

a. You can get a 2% yield on it (retail) or slightly less in institutional amounts (1-year treasuries are about 1.2% right now in Canada).
b. The Bank of Canada is not engaging in quantitative easing. In fact, by smartly increasing short term rates to 1%, they have probably done the whole country a favour.
c. Being a Canadian resident, I am intimately familiar with the country and the Bank of Canada, although I should point out there are three provinces that I have yet to visit.
d. Cash is very liquid and can be deployed at a button click’s notice into something better that appears on the radar.

Ultimately, investing in what you know will be in demand, at a good price is the generic fallback, macroeconomics be damned. But the macro situation is becoming something an investor has to pay very close attention to even with their microeconomic investments. A couple weeks ago I mentioned that some of my research lead me to place orders in two (US-denominated) securities. One of them went above my order price and has not gone back down. The other has been hovering in a range, and I have established a 6% position in.

Besides for this, I continue to watch, although I know my US cash holdings feel vulnerable to depreciation of purchasing power.