Late Night Finance with Sacha, Episode 8

Late Night Finance with Sacha, Episode 8

Date: Friday, November 20, 2020
Time: 8:00pm, Pacific Time
Duration: Projected 60 minutes. Could go longer.
Where: Zoom (Registration)

Frequently Asked Questions:

Q: What are you doing?
A: This will be an “ask me anything” edition – I’ll pick some topics of your questions and potentially answer some of them.

Q: How do I register?
A: Zoom link is here. I’ll need your city/province or state, and if you have any questions in advance just add it to the “Questions and Comments” part of the form. You’ll instantly receive the login to the Zoom channel.

Q: Are you trying to spam me, try to sell me garbage, etc. if I register?
A: I can hardly manage a mailing list without breaking my own website, what makes you think I will spam you? No, if you register for this, I will not harvest your email or send you any solicitations. Also I am not using this to pump and dump any securities to you, although I will certainly offer opinions on what I see.

Q: Why do I have to register? I just want to be anonymous.
A: I’m curious who you are as well.

Q: If I register and don’t show up, will you be mad at me?
A: No.

Q: Will you (Sacha) be on video (i.e. this isn’t just an audio-only stream)?
A: Yes. You’ll get to see me, but the majority will likely be on “screen share” mode as I explain what’s going on in my mind as I present.

Q: Will I need to be on video?
A: I’d prefer it, and you are more than welcome to be in your pajamas. No judgements!

Q: Can I be a silent participant?
A: Yes. I might pick on some of you though. Bonus points if you can get your cat on camera.

Q: Is there an archive of the video I can watch later if I can’t make it?
A: No.

Q: Will there be a summary of the video?
A: A short summary will get added to the comments of this posting after the video.

Q: Will there be some other video presentation in the future?
A: Yes.

Get ready for a big wealth transfer!

Bitcoin.

With Microstrategy (Nasdaq: MSTR) and various exchange-traded crypto funds that are blind buyers of Bitcoin, it serves to ramp up the price on a fixed float. You can even do this through Paypal, and some brokerage platforms.

In regular stock trading, you buy a stock. You hand somebody cash. The net transaction does not involve any new shares, nor does it involve any new money. The price is instead a reflection of the relative value of the stock. We generally do not think about the relative value of cash when conducting this transaction. Circumstances are changing this.

Right now, when central banks are QE’ing their currencies and governments running fiscal deficits, institutions are trying to get ahead of the curve by finding alternative forms of collateral under the presumption that the value of cash is dropping at a rate that requires a consideration to its depreciating ability to purchase other assets.

Historically, forms of collateral included salt (Roman era), spices, precious metals, and today, the backing of nothing other than the sovereign state. The fundamental value of the Canadian dollar is to pay taxes to the Crown. Every other usage of the currency is a derivative (beyond attempting to burn the plastic polymer notes for their heat content!).

Instead of holding CAD/USD, the rationale is to hold Bitcoin. There is going to be a speculative frenzy and it is going to be insane. I have no idea when it will end. Just 45 days ago, Bitcoin was trading at around $10k, and today it is touching on $18k. There is no arbitrary number this will go to simply because it is akin to a zero-sum casino where timing the exit will be everything.

The scheme ends when the last dollar has been sucked into the demand side of Bitcoin, just like a good old fashioned Ponzi scheme.

Maybe the trigger comes in the form of confidence restoring in the US currency. Perhaps this comes in the form of the Bitcoin transaction network collapsing or being manipulated to an extent that limits its usefulness. Perhaps Bitcoin transactions become completely prohibited by sovereign governments (and indeed, Bitcoin transactions that post on the blockchain are open for everybody to see – it is the least anonymous mechanism possible).

I’ll let other people play this game, but the speculation fury is going to be intense. The narrative (that US currency is doomed) is a great story and easy to understand. My suspicion is that it is early in the process. What happens if Bitcoins head up to $100,000? $1,000,000? The people invested in Bitcoins will have some price they will want to liquidate.

I’ve been very wrong on Bitcoin for a considerable period of time, so please do not give me much credibility when I talk about this cryptocurrency. Perhaps I am too old fashioned and behind the times.

The good news is that alternative forms of collateral come in the form of assets that produce goods and services that will clearly be in demand in the future. They have less speculative fury and much less visibility, but unlike Bitcoin, I won’t be worried about when they crash when everybody runs for the exits.

The biggest single stock re-indexing in history

This will be written about for years, if not decades to come.

The insertion of Telsa (Nasdaq: TSLA) stock into the S&P 500.

Tesla is projected to be about 1.01% of the index, although this will certainly rise as the re-indexing occurs. Already speculators have shot the stock up another 14% in after-hours trading. Tesla’s market cap is about $440 billion. S&P estimates that about $50 billion will be indexed to Tesla stock, and this is effective December 21 (when the rest of the index is also rebalanced). They released a short consultation whether institutions want to include the stock in tranches or in one gigantic bite.

Normally inclusions (and deletions) are given shorter notice, but presumably they thought they needed to give a whole month to do this one. What’s going to happen is there will be intense games played with Telsa, the likes which will never have been seen in history. Every day trader on the planet will be on this like moths to a raging flame (and indeed, some of those moths will get engulfed into the fire!). This will be one to watch. Of course, I’m too old to be doing the daytrading but I’m sure all those Robinhood players will have fun, especially with casinos still closed.

Tesla’s products are great, but valuation-wise one has to think that this really feels “toppy”, including the index as a whole. Perhaps monetary policy is such that default capital continues to get parked into the index, valuations be damned.

So the conclusion is that we have a captive buyer that is forced to pile $50 billion into a single stock. Who’s going to sell?

Canadian Energy Update

Here is a quick post on the state of Canadian energy production companies – especially as the federal government continues to destroy the industry. As of September 30, 2020 there are 12 companies listed on the TSX that are over a billion dollars in market capitalization. There are 24 between $100 million and $1 billion, and some of these names are in very bad shape indeed. Also out of these 36 companies, some are TSX listed but have the majority of their operations outside of Canada.

For this post, I will focus on those above $1 billion. Companies that are under this threshold are still invest-able but one has to pay careful attention to whether they will survive or not in the hostile regulatory environment.

If your central thesis is that fossil fuels are going to decline and die in a relatively short time-frame (e.g. 20 years) then you probably won’t want to invest in any of these. Demand destruction will impair pricing and the ability to produce supply will not accrue excess gains to any names.

However, this is not going to be the case from a simple perspective of energy physics (laws of thermodynamics if anybody is interested in studying). Renewable sources do not scale to the magnitudes necessary. It also costs massive amount of up-front investment to implement renewable energy sources. It is relatively easy to ramp up energy usage from 0% to 5%, but above this, it becomes very obvious what the deficiencies are of renewable power sources (California discovered this in the summer). Putting a long story short, the more renewable (intermittent) sources you have on a grid, the better will be for on-demand generation sources – this means either you go with natural gas (fossil fuel!) or hydroelectric (we’re mostly tapped out in North America). Batteries make sense in smaller scale operations but not in state-province level grids. Or you can rely on imports, which just like liquidity during a stock market crash, is generally very expensive or not even there when you need it the most.

With respect to transport fuels, we will classify this as passenger, freight and aviation. For passenger vehicles, we all see Teslas and the like on the road, but the infrastructure required to refine and produce the battery materials to replace a substantial portion of the automobile fleet is still a long ways away. For freight, battery-powered transport automobiles are an illusion due to the requirements of existing freight haulers (you need to be able to transport 80,000 pounds of goods at a long distance and also cannot afford to spend 12 hours at a charging station to refuel).

My opinion will change if nuclear becomes a viable option again for power generation (from a political and cost perspective, not a technical perspective).

Some pithy notes (these are the C$1B+ market cap companies):
SU, CNQ – Clearly will survive and represent playing a very long game. Personally like these much more than the big majors (e.g. XOM, CHV, COP, BP, etc.).
IMO – Majority foreign (US) held (XOM), wonder if they will make an exit
CVE – The best pure-play SAGD oil sands player (maybe to be contaminated by HSE acquisition)
TOU – Spun off another sub, largest of the Canadian NG players, FCF positive
HSE – Soon to be bought by CVE – will be interesting to see how CVE makes more efficient
OVV – Mostly American now, with big major style culture and cost structure (i.e. $$$)
ARX – Second NG/NGL play, FCF positive
PXT – Substantively all Colombia operations, that said their financial profile is quite good relative to price
PSK – Royalty Corp (royalties are not my thing – just buy the futures, although pay attention to price, if they get cheap enough, royalties are typically a better buy)
CNU – Chinese held, illiquid security
VII – Liquids-heavy gasser, FCF positive (barely), a bit debt-heavy

Chemtrade Logistics, or yield investors be very careful

If any of you hold units in Chemtrade Logistics (TSX: CHE.UN), it is quite possible in the mid-term future that the current $0.05/unit per month distribution (which was already reduced from $0.10/unit per month during the Covid crisis) will be chopped down by about a half. It’s not a guarantee that this will happen.

Chemtrade’s underlying businesses are profitable, but the amount of financial leverage they have accumulated over the years is impressively high. Back many years ago, they were trading in the upper teens despite having an effective payout ratio higher than their free cash flow generation. Although the business itself is relatively stable (it is a staple commodity producer of industrial chemicals that are foundational in nature for many industries, similar to Methanex (TSX: MX)), the leverage is probably going to be too high for the banks to get comfortable with extending credit. CHE did receive a relaxation on covenants until 2022, which will give them a couple years to get their financial leverage metrics in the right direction.

In September, they did manage to close the deal on some additional unsecured debt financing (TSX: CHE.DB.F), but it came at a higher cost – a coupon of 8.5% and conversion price of $7.35/unit, when previous issues (when the units were trading at $20/unit) were around 5% coupons and $25-30/unit conversion prices. Needless to say these debentures are well out of the money. The proceeds of the new unsecured convertible debt was used to redeem the near maturity unsecured debt that was set to mature in June 2021.

The total debt is about CAD$812 million in senior bank debt, and CAD$531 million in unsecured convertible debentures, for a total of $1.34 billion in debt capitalization. Looking at the first nine months of this year (which is not typical due to Covid, but reflects the existing reality), after interest expenses and lease payments, the company generated roughly $85 million in cash. A good chunk of this (CAD$55 million) went out the door in unitholder distributions. There’s a couple scenarios that are possible, but the easiest route is to slowly reduce debt by reducing or eliminating the distributions. The unit price will most certainly take a short-term hit, but as the company’s credit profile improves, the equity pricing (currently at a market cap of roughly CAD$450 million) looks cheap, although it is this way right now because of the high magnitude of leverage.

If there is another credit crisis (whether it is induced by the company’s actions or not) that comes along in the next year, you can be sure these units will be cratering, even further than they have already.

I remember people pumping this income trust around $15-$20, citing the high distribution yield. Right now, I don’t see a lot of pumping, and if they do cut distributions again to get the bank debt down, I’ll be closely examining the equity. I do have a small position in one of their debentures.