Completely insane – May 2020 Crude Futures

The May 2020 futures contract expires on April 21st, but nobody wants the oil!

Attached is a chart of trading today in May 2020 crude futures. Amusingly enough, Interactive Brokers doesn’t support negative price quotes, so I couldn’t chart it through TWS:

I have never seen anything like this before in my life – you buy a contract for 1,000 barrels for negative $40. The counterparty pays me $40,000 and I take delivery of 1,000 barrels of crude oil. I then go light it on fire.

What a strange, strange world we live in.

FLIR Systems

This is a short post. No hard financial analysis here.

A few weeks ago I purchased some stock in FLIR Systems (Nasdaq: FLIR). I have been familiar with the company for more than a decade, but this is because of their technology and less from a financial perspective although I have checked in from time to time.

They hit a few sweet spots for my investing criteria. One is that their technology is likely to be utilized in mass deployment across the planet in regards to temperature detection. The other is that they have US Military contracts and have a sufficient amount of their IP and technology on-shore (some supply chain is manufactured in China but not the military sensitive ones for obvious reasons). As a bonus, they are getting into the UAV, military robotic and sensor business, and they have strategic synergies that will work with this.

Financially, the only real current blemish is that they have US$425 million in the form of a unsecured note due on June 2021, but I do not envision any difficulty them rolling it over later this year or early next one. They are cash flow positive. Prior to Covid-19, I generally got the sense the market viewed them as a stagnant business (their position in IR imaging was quite strong competitively).

As this is a large-cap stock ($5 billion market capitalization) I am not worrying about my rambling spiking up their share price. They’re even one of the smaller components of the S&P 500. But clearly somebody with money clued in today how well positioned this company is strategically in the post Covid-19 environment. I’m not a typical large-cap stock investor but this one was too much to resist in the depths of the CoronaCrisis.

The other company I considered was Fortive (NYSE: FTV) but they are a larger industrial products company and have other economic sensitivities that I particularly did not care for.

Keep shorting volatility

Perhaps the biggest no-brainer trade of this COVID-19 economic crisis (which is going to come to an end pretty soon) is shorting volatility on spikes. Today was the first real spike up since April 7th (which wasn’t much of one). I’ve attached the spike – and note just before Easter it was at around 33-34%:

Long-time readers of the site knows that I’m generally into fundamental analysis but once in awhile, there are trades out there that are so seemingly skewed to risk/reward that I just have to take them. The even better news is that unlike scammy marijuana companies, in the futures market your only price of admission is the initial margin and you don’t have to worry about borrowing, or carrying costs or anything like that, only a US$2.38 commission to get short a contract of US$1,000 times the index of notional value (i.e. every point the VIX goes up or down, your equity goes up or down US$1k per contract).

Of course, there are always risks. Who knows, Supreme Leader Kim might decide to launch the nuclear missiles, or there might be a 9.0 Richter scale earthquake in San Fran or some other catastrophic event, so this is why you never, ever go all-in on a trade (VIX would skyrocket). However, on the skewed balance of probabilities, by the time May comes rolling around, I’m pretty sure VIX is lower. Every quant fund out there on this planet that didn’t get wiped out on March 23rd is now applying the same rubric in our ultra-loose monetary policy situation and is making coin with volatility suppression – the S&P 500 doesn’t even have to rise to make this trade work. In fact, if it meanders, the trade works even better.

One of the biggest winners of all of this volatility has been the HFT firms, including Virtu (VIRT), but I would not invest in their stock. It is interesting to note, however, that they averaged about US$9.5 million in net trading income a day in Q1-2020! Holy moly!

Ag Growth International

I have taken today to complete my position in Ag Growth International (TSX: AFN), a Winnipeg-based company that can be classified as “all things grain-related”. I started picking up shares in the 16s and even 15s but today was a good chance to top it up to a full position. I also have a small portion of the debentures (TSX: AFN.DB.D).

I’ll spare you from the cut-and-paste description of their business from their annual information form, but the business is about providing everything you can imagine it takes running a grain and feed-based farm on an industrial scale. The sales from the business are international, and they are an integrator of various agricultural technologies.

The stock is not widely followed. There is hardly any ‘buzz’ at all from the usual message boards, BNN, etc., which is always a plus (less buzz means less competition for accurate stock pricing).

The thesis for the recovery of this COVID-19 investment (the stock has been taken down about 2/3rds since the COVID-19 pandemic) is pretty simple.

People have to eat. Food has to be grown (whether plant or animal) and the quantities of food that need to be produced require industrialization and equipment. Farming for over a century has shifted toward industrialization which promotes gigantic yields, and this industrialization requires investment in proper capital equipment to obtain these yields.

As long as the population is rising, food consumption will remain a core industry where demand over a medium range period of time will be steady – any demand not met today will simply be reflected in demand experienced later on in time.

Thus, COVID-19 should have a transient effect on the business of AFN.

Financially, 2019 was a poor year due to various cyclicalities of the grain business. In a more “normal” earnings environment, the company should be able to earn at least $3/share of GAAP net income and I would expect to see this in future years. The only financial issue of concern (and likely the reason why the stock has been taken down so much) is that they are quite leveraged, with about half of their debt via a senior secured revolving credit line, and the other half through issued unsecured debentures (AFN.DB.D to H on the TSX), which currently trade at YTMs of 10-12%. The original cost of capital for the unsecured debt was around 5%, and the secured debt at a function of LIBOR plus 1.45 to 2.5%. At the end of 2019 the combined rate was 5.11%, but this surely has gone down due to the rate cuts post-COVID-19.

To this extent, they made the not so surprising news release last night that they are reducing their dividend from $2.40/share to $0.60/share and this will allow them to deleverage. They extended the credit facility to 2025, and obtained a relaxation of the senior debt covenant. The next issue of debt that is due is AFN.DB.D, which is due on June 2022, and is also convertible into stock at 95% of TSX market value if the company so chooses – typically in the past it has rolled over the debt and when things normalize that is the likely route here.

The risk is that COVID-19 is prolonged and there will be some form of permanent demand destruction among the customers (e.g. if the industrial farms were to exhibit financial stress and had to scale back their capital investments), but I am discounting this possibility in the longer term just simply because of what I wrote in the earlier – people have to eat, and capital investment in farm equipment is required to facilitate this need. It is easily conceivable that we can see a $60 stock price again like two years ago, but it will take some time to get there. I can wait.

Quick market commentary

The month of March (up until the 23rd) was like pushing on a spring, where people and funds were getting cashed out on margin.

We’re still on the spring back. How high this will go is anybody’s guess, but my trading instincts suggest it’s probably a good time to take a few chips off the table, at least temporarily. There will be some ‘rebound’ news that will get injected into the the world that things aren’t as optimistic as projected, that the lockdown will have to last for longer, that secondary infections will come back from people previously confirmed without the virus (when it probably turns out that they were false positive diagnosed to begin with and just caught Covid-19 from somewhere else), etc. There is also the element of sheer greed from participants that want to make the quickest buck.

The rebound down will take the market down 3 or 4%, the people that have loaded up will get frightened and dump, a bunch of people will panic over the revenge of the Coronavirus and that’ll likely be the best time to load up, just when it looks like things are getting awful. The speed that this is all happening, however, is quite remarkable. The market action is happening three times as fast as the 2008-2009 economic crisis.

You’re not going to get anywhere close to the bargain pricing you saw in March but there’s still considerable upside coming as long as you avoid the sectors that are sensitive to the “main street” economy (e.g. I wouldn’t want to be owning a sports franchise).

Continue to pay attention to debt covenants, but note that credit is going to become easier to get as the corporate debt market normalizes (this is what happens when the central banks are buying corporate debt – they’ll clear out the investment grade, which means banks can loan to the BBB, BB and Bs of the world). As long as there aren’t significant maturities coming up in the next 12 months or so, you’ll probably be fine if the debt loads are ‘reasonable’. This crisis will also scare a lot of corporations into de-leveraging or lightening up on leverage – the better capitalized companies will likely clean up better in this environment. Entities that should be trading at low yields (e.g. Rogers Sugar, RSI.DB.E/F) are already at a YTM of 600-650bps while just a few weeks ago they were well into the double digits. Of course, the trashy companies are trading in the teens and above still, but even then the ones that generate reliable cash flows will get back to normal (looking at Chemtrade).