Performance Addicition

Article on the Financial Times – “How to best avoid performance addiction” which you might have to type into Google and click through there in order to get the full article. It describes how performance is the only barometer that most (retail) investors allocate capital, so when fund managers get money, they usually are already in quite “hot” sectors due to the prior years’ outperformance. A quotation is the following:

Most asset managers exhibit “enabling behaviours” that reinforce investors’ performance addiction by selling investment products on the basis of past – particularly short-term – performance. Although we all repeat the mantra that “past performance does not guarantee future success”, we still pay too much attention to performance.

…

Imagine a world in which every adviser and asset manager had to discuss three categories of investments with their clients: out-of-favour strategies worthy of consideration; high-performing strategies that continue to have legs; and “hot” performers that have had their run, from which investors should scale back their investments. It certainly would lead to rather different discussions than what typically occurs today.

Unfortunately I disagree with the conclusion. In the investment world, risk-adjusted future performance is everything. Risk-adjusted past performance is the only measurement tool. Note I mentioned the phrase “risk-adjusted” – a fund could have achieved a 1-billion-percent increase of capital by winning a $5 bet on the Lotto MAX (into $50 million) which would be very good fund performance, but the risk taken to get that performance was ridiculously stupid.

Most retail investors know nothing about performing this risk calculation when glossing through various promotional literature of mutual funds.

From an individual perspective, you should absolutely crave inefficient capital allocation (e.g. what we are likely seeing in the Vancouver Real Estate market). It causes less capital to chase other assets (which presumably will exhibit relative undervaluation) which you can snap up for cheaper prices. From a macroeconomic perspective, however, it is very unhealthy for economies to have significant inefficiencies, so when the focus of the speculative boom busts, you usually have to content with economic fallout (e.g. late 19th century/early 20th century railroad companies, mid 20th century automakers, the internet stock bubble, 2008 US real estate market etc.).

CRA Prescribed Rates – Update

Earlier I wrote about CRA Prescribed Rates and how they are used.

Given that it is nearing the end of June, the CRA has not published updated prescribed rates for the third quarter yet. They traditionally publish the next quarter’s rates at the beginning of the month before the next quarter (i.e. for a second quarter announcement, they would announce the prescribed rates at the beginning of March).

I would suspect they are doing this because they are planning on increasing the prescribed rate for interest on loans to 2% from 1% currently. They would want to give as little notice as possible of this, to avoid a scurry of people making quick 1% loans to avoid interest attribution.

So for those of you that take advantage of this process, I would highly advise you to get your paperwork prepared for a quick transaction at the end of June in the event that my suspicions are correct.

First Uranium reports FY2010 annual report

First Uranium, which is a completely mis-named company in light of the fact that most of its revenues are derived from gold sales, reported its fiscal year-end report on a Friday evening. Note their calendar quarter ends on March, so FY2010 is April 1, 2009 to March 31, 2010.

While the company has been, kindly put, a basket case over the past year, the report does give glimpses that recovery is on the way. It has two primary operations – Mine Waste Solutions, which reprocesses previous tailings for gold (and uranium in 2012 and beyond), and this part of the business is quite profitable – about $22.8 million in profit from this operation and likely to increase in the future. However, the other project, the Ezulwini Mine, has suffered through massive setbacks and managerial incompetence and has lost about $63 million for the year.

First Uranium spent most of the first calendar quarter of the year getting rid of its management and restructuring its board of directors with people that seem to have extensive credentials in the mining business.

Most of the solvency concerns were alleviated with the March 2013 secured debenture issue, which will be listed on the TSX sometime in August.

First Uranium at this point becomes an interesting case on whether they can turn around the Ezulwini mine operation or not. From the MD&A:

The Ezulwini Mine has yet to build up sufficient production to generate positive operating cash flow. The production build-up to date has progressed much slower than originally anticipated due to a number of factors including:
– The estimation of gold available compared to the gold accounted for was significantly below expectations, a relationship better known as the mine call factor. The planned mine call factor for the year was 87% whereas the mine achieved a factor of lower than 70% during the first nine months of the year.
– The face length creation proceeded as planned but the start-up and conversion from development to stoping was slower than anticipated. Significant improvements are expected in FY 2011.
– The face length utilization was relatively low during the year due to the newly appointed mining teams as well as inadequate face equipping. Special attention is being paid to the training of crews and equipping of panels, thus mining readiness is expected to improve in the forthcoming year.
– During the fiscal year, some seismic activity occurred in the shaft pillar which caused delays but more importantly required special attention to resolve it in a safe manner. The extra precautions and diligence paid to rock engineering issues resulted in slower than anticipated performance in FY 2010. The majority of the engineering issues are now resolved, thus improved mining performance is expected.

The new management appears to know what’s going on, and they are performing a detailed bottom-up production plan which is apparently going to be ready by the end of June 2010.

On the equity side, FIU closed Friday at $1.25/share, and has 180.8 million shares outstanding. Factoring in the senior secured debentures converting at $1.30/share, this brings shares outstanding to 315.3 million shares.

I am not sure how much cash flow they can get out of Ezulwini even if they turn around the operation. The interest “bite” is not too severe – the unsecured debentures have $155M at 4.25%, while the seniors are approximately CAD$150 at 7%. It is likely if the common shares are trading higher than $1.30 by the time June 2012 comes rolling around that it will simply be a debt-for-equity swap which will make the unsecured debenture holders whole.

The unsecured debentures have turned very illiquid and have recently traded around 66-70 cents on the dollar. Assuming a purchase of 70 cents at the ask, you are looking at a 6.1% current yield and 19.5% annualized capital gain assuming a maturity payout at par. I do own these debentures, and think they represent a fairly priced risk. I still cannot recommend the common, although it could double or triple in value if the Ezulwini project does indeed turn around from the financially disastrous fiscal 2010.

If they managed to pull off a steady-state operation of about 250,000 ounces a year (note: far above 30,000 in the last year, geologist report has 5.2 million ounces over 18 years), at current gold prices that would suggest First Uranium would clear operational profits of roughly $80-100 million. Flow this and the Mine Waste Solutions project into the bottom line and you get a justification for a much higher stock price than present, even with all the potential future dilution – my paper napkin valuation model suggests around a $4-5 share price with a conservative valuation multiple. There are a lot of “ifs” and given the track history of the company, it’s no wonder that First Uranium equity is currently in the toilet – it indeed represents a large risk.

Canadian Finance Links

I have been very slowly adding in links to my sidebar in the “Canadian Finance” category. The criteria are as follows:

1. The site author posts with his real identity;
2. The site’s focus is of a Canadian investor’s perspective and has decent content;
3. Site is focused more on fundamentals rather than technical analysis;
4. The site is not too “spammy”.

There are amazingly few sites out there that fit these criteria.

What will the US do with Transocean?

Now that BP has effectively settled with the US Government to the tune of $20 billion and taking out their shareholders’ dividends for the next year, it leaves the question of how Transocean, the owner of the drill, will fare.

I’m guessing that the cessation of risk with BP’s settlement with the US government will not last too long when the government decides to go after Transocean for something. I don’t believe this is correctly priced in the market yet.

One of the smartest decisions Transocean made was relocating its corporate headquarters to Switzerland for tax reasons. Most of the assets of Transocean are international, and thus they can be shielded from US taxation. The ability of the US government to extort money out of Transocean is potentially more limited considering that the only active offshore drilling area in US waters is around the Gulf of Mexico.

I have a mental buy order where I will purchase shares of RIG, but it would require a price trend down in order for the market to reach it.

Fundamentally, the supply of crude oil is limited by the amount of drills available to do offshore drilling, and there are only a few companies on this planet that have the capability of providing such services. Until the field becomes saturated, lease rates should be substantially profitable for the players that are doing it and consequently the shareholders. Higher oil prices will also stimulate more demand for offshore drilling (as well as on-shore development) and are obviously more beneficial to those companies that have unmined oil reserves.