Research in Motion

RIMM (Nasdaq: RIMM) is down to lows not seen in a long, long time. They closed today at US$9.11/share.

The story is fairly well-known: they’re getting cleaned out by Apple and Google/Android. It is frighteningly similar to Nokia in nature, where a technology giant becomes obsolete in short order by failing to catch up. The one moat to their business, a secure email and messaging system, seems to be eroding. As a result, they are losing the game in the corporate world, and when this occurs, it is pretty much lights out for RIMM. Or is it?

I haven’t been tracking the technology and I believe somebody would intuitively have to be keeping their knowledge updated of the upcoming technology trends in order to make an informed call on that front. Since my cell phone is considered to be barely functional in today’s terms, I am not that person. All I can do is read their financial statements, but while they historically have been quite profitable, it appears that the market is indicating otherwise. For example, look no further than analyst estimates, as compiled by Yahoo Finance:

Without knowing anything, my advice to any potential investor in RIMM would be to hold back until that February 2014 estimate is deeply negative.

RIMM has about $1.8 billion in the bank without any debt, so they do have some maneuvering room for research and development. I have no idea whether Blackberry 10 will actually be a competitive product or not, but clearly the market is not thinking so. If you believe the market is wrong, wait until those estimates go even lower and overreach on the downside – then invest. Today’s analyst report from Morgan Stanley that downgraded the company to a sell and called for its break-up was one more piling onto the bad news sentiment. Will there be more?

A fairly interesting tidbit is that Prem Watsa, from Fairfax Financial (TSX: FFH) fame is recently on the board of RIMM and Fairfax has 26,848,500 shares of RIMM, a position that is now deeply underwater.

A rare article on the Canadian sugar industry

Investors in Rogers Sugar (TSX: RSI) will doubtlessly be interested in reading this article in the Globe and Mail.

In my past, I have put in more time and effort into understanding the sugar industry in the country and the protection that both marketplaces (Canada and the USA) have on their sugar industries are very relevant factors in terms of Rogers being able to compete. Rogers Sugar has a virtual monopoly on the Western Canadian operations because of transportation logistics, while on the eastern part of Canada (Ontario, Quebec) there is competition between Rogers, Redpath, and a lesser competitor called Sweet Source Sugar.

After the Canadian trade panel ruled against the domestic sugar industry’s wishes by opening up the Canadian market to EU imports, I was actually quite surprised at the decision. I was even more surprised when the sugar producers appealed and managed to overturn that ruling. This alone was worth quite a few pennies on Rogers’ stock price – mainly the implied degradation of pricing power as Canada continues to open up its borders. For instance, there is a free trade agreement between Canada and Costa Rica which will enable the duty-free import of a relatively small supply of sugar, providing that it is produced from Costa Rica. Other free trade agreements that are pending the sugar industry has been able to flex some regulatory muscle to get specific provisions against opening domestic sugar into such agreements (Columbia being one example).

From an investment perspective, I sold my sizable portion of Rogers around the 5.50 range, but continue to watch the stock, albeit, it is a rather boring company to track. If there is a hiccup in the future (and there may be considering that some of its domestic production is derived from Alberta-grown sugar beats and thus represents a slight amount of operational risk) that takes the stock price down, I may get interested again. But at $6/share, there isn’t a heck of a lot of capital upside in exchange for a 6% yield.

Odd-lot trades and execution algorithms

Today’s trade execution report from Interactive Brokers showed that I bought 3 shares of a company, and since the share price is in the single digits, at this rate of accumulation I will more likely die of old age than getting my desired allocation level. The slap in the face is that the stock closed at around 3.7% above that level. My total portfolio allocation in this particular stock is currently 1% and my sense of the tape suggests that somebody else is out there very slowly gobbling up shares as well as myself, while the sellers are just dumping them with market orders here and there. This probably means the stock price has bottomed out for now.

Since the stock is relatively thinly traded (daily average volume is around $100,000 traded), I have an algorithm running that breaks my order into relatively small pieces. A market order to get my desired allocation would be suicidally inefficient – I’d probably spike the stock price a good 20% by doing so, which requires breaking down the order and being patient. As each piece is sold into, the price of the order declines by about two percent immediately, but over the course of a day, the bid price notches up slightly every time increment. This is incredibly easy to do in Interactive Brokers and is the simplest type of algorithm to employ when not dealing with million dollar trade sizes. It saves so much money on trade execution it is unbelievable.

General market commentary and research screening processing

The market is going through its usual manic cycles, with Greece voters purportedly saving the EU by voting in a pro-austerity government (which will kick the can further down 6 months), today’s downturn revolved around the release of not-so-good economic data and Moody’s downgrading various major financial institutions. I also note that the EU’s problems are nowhere close to being solved, with Spain and eventually Italy should be on the debt crosshairs unless if they can get their fiscal act together (quickly).

I note that the S&P 500 volatility index is still hovering around 20%, which is not exactly a big sign of panic.

My focus has been far away from the broad markets and on lesser capitalized issues (anything less than $1 billion and preferably under $500 million). I have also been purposefully avoiding anything commodity-related since it is fairly evident that most of the sentiment out there is still relatively bullish even though the charts have been indicating otherwise. I’m not too heavily into technical analysis, but clearly something is going on with WTIC crude oil being pushed below US$80. Measuring sentiment and expectation is about as good as reading tea leaves or the horoscope, but the tea leaves that I read still indicate that sentiment for oil is still high. When I start seeing analysts and news commentators shunning oil because of huge supply gluts and expanded production, that’s when I will start getting interested again.

Ironically this is what natural gas producers have had to face and I would be more inclined toward natural gas than crude oil at present. Encana (TSX: ECA) would be the prototypical large cap stock that a buy-and-hold-and-forget type investor would probably do okay with, but again, it depends on whether there will be this purported recovery in gas prices since Encana has been living off of its hedges.

I’ve taken the opportunity to put more capital to work and am hoping for more funds liquidating these smaller capitalized companies since the underlying companies will make for a better risk/reward ratio.

Finally, I’ve been trying to look over companies with high insider purchasing or high management ownership of shares (but not companies with dual-class voting shares where they maintain voting control but not economic control) and have been trying to sort through a stack of them, both in the USA and Canadian markets. I quickly scanned the Canadian debenture market and really didn’t like anything there – most of the energy-related companies continue to trade as if there is nothing wrong. As a result, I am not that interested in that asset class at present.

I do have one company that is outside my normal screens (is larger than $1 billion market cap, gives out a healthy dividend, is majority-owned by another entity) that I have been accumulating a stake, but there is a fairly good reason why I believe the market is significantly mispricing the company (i.e. factoring in more risk than actually exists) and why I think the market is materially incorrect. I am purchasing shares at a level that I think is about 30% under what my fair value is for the firm. My estimated “floor price” for the company, however, is quite close to current trading levels, so the risk/reward ratio is fairly handsome at present – risking around 10-15% for a potential gain of 50% is a decent ratio, especially since the probability of the positive side occurring is better than 50/50.

This post is still relatively abstract since I don’t really want to give away too much of my research.

Mortgage insurance rule changes and a small example

The government announced today some changes to the minimum criteria required in order for mortgage insurance to be offered on housing. The details are here.

This is fourth in a series of changes that the government has taken (the others being in October 2008, February 2010 and January 2011).

The more stringent requirement for retail people on the street will be the amortization requirement – from 30 years to 25 years. Plugging some sample numbers on a calculator, using a 3.00% rate, a 25-year amortization requires $473.25 in monthly payments per $100,000 mortgaged. A 30-year amortization would require $420.60 in monthly payments per $100,000 mortgaged, or about a 12.5% increase in the monthly outlay between 30 years and 25 years.

More relevantly for mortgage insurance, after a 5-year fixed period, at a 25-year amortization, approximately 14.5% of the loan would be paid off. At a 30-year amortization, about 11.1% of the mortgage is paid off. Presumably this would significantly reduce the risk of mortgage default after the typical 5-year fixed term.

Notably, the minimum down payment for a new owner-occupied residential purchase in Canada that will still qualify for mortgage insurance is still 5%. As a result, a residence purchased at 5% down, with a 3%, 5-year fixed mortgage at 25 year amortization will have about 18.8% amortized at the end of the 5-year term.

The tightening of mortgage credit will undoubtedly have a marginal economic effect of taking out higher-risk clients out of the housing market, which will have a marginal suppression on housing prices. I do not believe this will have a strong effect – that will be reserved for an increase in interest rates.