BWX Technologies – year-end

BWX Technologies (NYSE: BWXT) has a huge competitive advantage – their primary business is the engineering and production of nuclear reactors for US Navy vessels (including aircraft carriers and submarines). Here’s the amusing movie clip that comes to mind:

The company is undergoing a significant capital expenditure which will end in 2022 that will facilitate future projects. The nuclear vessel business is stable, but the ability for the company to branch off in other industries (nuclear medicine, power generation and nuclear space technologies) make them appear to be a fairly cheap entry for a very limited number of investments in this domain (most of which are very diluted with other businesses, such as GE).

I’ll skip the financial analysis. I’ve performed it, but do not wish to write about it.

I do not know why they sold off this morning (they released earnings and Form 10-K yesterday evening), but those nimble got a mild discount. I originally took a position in them during the Covid crisis and still am holding onto it. Percentage-wise, it has not performed nearly as well as the rest of the portfolio, but the risk-reward ratio is very acceptable. They also raised their quarterly dividend from $0.19/share to $0.21/share, but this is not relevant in the investment decision.

Broad picture thoughts – Post-Covid investing

This is going to be a rambling post.

My investing thesis post Covid-19 is simple – invest in companies producing real stuff, with the sweet spot being primary and secondary industries. I am sure there will also be tertiary winners (e.g. technology) but there is a lot of competition in this space and I am unlikely to pick out the winners relative to current market valuations (for instance, if it turns out that Microsoft is the winner in cloud computing, on their current US$1.6 trillion market capitalization, it might not turn out to be very profitable).

In terms of real stuff, somebody has to keep pulling the raw commodities out of the ground in order to fuel the real (not digital) economy. Companies will incur costs to do so, but ultimately the commodity itself will have value. In a depreciating dollar scenario, these commodities will organically exhibit price increases, all other variables being equal. This is a well known process.

However, ultimately commodity pricing is a function of supply and demand. In many industries, there was an assumption with most producing companies that they did not want to hold inventories during Covid, and took actions to streamline. This is quite apparent in the lumber industry, and it was not generally expected that people would be using their CERB or US-equivalent to improve their homes, build fences, and so forth. The result is that lumber prices have skyrocketed.

Other commodities that have exhibited forced price cuts (e.g. oil) are now being bidded up because liquid energy consumption is clearly headed toward normalization (an examination of the Google Map traffic is enough to be said here, but I am sure the economic engineering department of Google makes much better usage of the data than we can from our consumer perspectives).

Gold is also going crazy right now. I have encountered some friends inquiring about gold, and also people with gains on precious metal funds, and inquiries about how to obtain physical gold, and so forth. It is to the point where it is feeling frothy. Just because things are frothy does not mean they will become more frothy.

The underlying basis of demand is likely a combination of a natural increase from the recovery of Covid-19, coupled with a fright of dollar devaluation. In light of the US Government (and world governments in general) blowing out deficits in record magnitude, it is reasonable to think that joint devaluation of currencies will result in increased prices for everything, starting with commodities, but in general, the price of energy is the core to it all.

The quantity of energy consumed is generally a barometer of the health of civilization – this goes back for millennia. Our lifestyle is inevitably linked to the consumption of energy. Don’t get me started on the production economics of mining bitcoins!

Fossil fuels have been shunned upon for various reasons (carbon emissions) and renewable sources have been promoted, but there is a scale limit to how much renewables can be introduced before you incur significant tradeoffs – either significantly higher costs, or reduced reliability (the higher percentage of intermittent sources you have, the more you need to buffer them with dispatch-able energy).

Despite this, renewable sources have been deemed politically correct and have received sky-high valuations and subsidies.

I will make the claim that in terms of industrial levels of power generation, in North America we are reaching a scale limit to intermittent energy production. This will certainly not be a popular opinion or claim. The short story is that renewable energy cannot scale to high percentages in all jurisdictions on an individual grid. In California, for example, during mid-day it produces a ton of energy from solar sources (on a day like today, 11.8 gigawatts!), but broadly speaking, the following are very relevant questions:

a) How much did it cost to get those solar arrays up and going, and to maintain them;
b) How do you buffer the amount of energy on days where it is no longer sunny, or off-peak times?

Question (a) tells you the trade-off economics of building one type of power generation vs. another. Incomplete accounting makes intermittent power look cheaper both from a raw cost perspective (for instance, you do not have to include the cost of a backup source of power when the wind dies down, or the sun isn’t shining), but also with subsidies and omitting environmental costs of production.

The question of (b) is not trivial, but typically it involves a combination of natural gas, hydro, load-following base power (e.g. coal, but not in California!), storage (very expensive in industrial quantities) or imported electricity.

Essentially, somebody has to produce the supply to meet the electricity demand – this is why the more intermittent supply that is added to the power grid, the better it will be for fossil fuels – either you consume a ton of energy up-front to build up your solar arrays or storage solutions, or you consume it in natural gas. Jurisdictions with ample hydroelectric power (such as British Columbia) are also blessed with dispatch-able power, but building dams is a very expensive endeavour, both in raw costs and significantly increased political costs (permanently flooding land is not popular). In other words, for each incremental addition of intermittent energy sources that you rely on to fuel demand, you need a unit of dispatch-able power from somewhere.

The logical course of increasing intermittent resources can be seen in a place like Germany, where the cost of power has skyrocketed as they have removed coal and nuclear energy from their power grid, and attempted to replace it with solar, wind and tidal power. This is not viable without relying on others in the power grid.

One major event that will occur in the future (a matter of when, not if) will be a significant power grid failure that will have been instigated by having too much intermittent energy sources on the grid, without available backup from domestic or external grid sources. This may be caused by a freak transmission failure (cutting an intermittent-heavy grid from a dispatch-able heavy grid) or some other ‘black swan’ event. When this occurs, there will likely be a dramatic shift in power generation policy to increase the robustness of a domestic power grid.

The preceding few paragraphs lead to very political issues regarding energy production. Many will not agree.

This leaves me to my last point of nuclear energy. It has been shunned for a very long time (the documentary Chernobyl was great to watch although it did embellish in some scenes for dramatic purposes, the Fukashima reactor, etc. are all stories that are in the public consciousness), but this is going to change, for no other reason simply because to expand power generation capacity in a carbonless manner there isn’t much room to go other than nuclear.

This is not a call that Uranium commodity pricing will increase (it is a relatively abundant resource at present), but rather that an exploitable avenue is a resurgence of nuclear power in general. I do not know how that will take place, but if de-carbonization continues to be popular, it would be a logical conclusion to replace base load coal, and natural gas plants with nuclear energy. Reactor technology has significantly improved in safety, where Chernobyl-type disasters have no way of happening.

The other issue is that nuclear technology is (for obvious reasons) highly secretive and countries that have competitive advantages in nuclear energy will tend to keep them, in addition to competitive advantages associated with domestic-only production. In the USA, this means companies like BWX Technologies (NYSE: BWXT), who are more or less the sole-source provider for nuclear engines for naval vessels. I bought them post-COVID.

Finally, we have the nuclear materials themselves. While Uranium is a hyped up commodity, and domestically there is only one Canada/USA credible stable large-cap company specializing in its production (Cameco, TSX: CCO), there are also a bunch of other smaller cap companies, including Energy Fuels (TSX: EFR), Denison Mines (TSX: DML), Laramide Resources (TSX: LAM), NexGen (TSX: NXE). Even further down are a bunch of TSXV companies which I won’t bother listing.

However, the commodity itself faces considerable cost competition from central Asian companies, which makes uranium production in North America relatively uncompetitive unless if you believe that geopolitical constraints (e.g. trade embargoes) will then put North American producers on a level cost playing field. In that case, I would be much more interested.

The refinement of Uranium, however, is a much less competitive space (just ask the government of Iran how their attempts on Uranium enrichment is going for it), and a company that I took a modest position post-Covid was Centrus Energy (AMEX: LEU), which has had its stock take off to the point where I can now freely write about it. Be careful – it is very thinly traded and has a small float in absolute numbers (it is heavily insider owned). A case can be made that in an ideal scenario they will trade for much higher than their current price, which has more than tripled since their Covid lows. I’m sure now that I’ve written about it, they have peaked – the downside scenario is that the next generation of nuclear won’t move from the planning stages.

More Misc market notes

Too much going on today, so will consolidate it into one post.

Everything that is going on is liquidity-fuelled. Central banks buy bonds. Bond yields go down. The equity to bond spread goes in conjunction with this, and hence prices rise. Doesn’t matter what the heck happens to the economy and it will drive most people crazy that do not see this relationship. Eventually they will capitulate and buy at the top, but right now there is a huge wall of worry which favours further equity upside.

* A week ago, I told you about Birchcliff preferred shares – they’re up today and as natural gas strengthens these present a good risk-reward, coupled with some income to boot. I’m sure there are better ways to play the natural gas space with equity (TOU, ARX?). The floor is pretty much in. Dollar-cost average on anything fossil-fuel related over the next couple months and a year later I’m sure it’ll work out.

* Atlantic Power’s performance (and utilities in general) has been disappointing in the COVID-19 recovery, mainly because power demand has dropped as a result of the economic slump. It doesn’t really matter for them as the price of their power generation is secured through power purchase agreements, but it doesn’t bode well for the residual value of their power plants after the agreements expire. After repurchasing 12.5 million shares of their own stock on May 1st, they will not be able to repurchase further equity until 20 business days after the offering concluded (i.e. not until June). I would expect them to resume share repurchases in June, so I suspect that the common shares will be a reasonably good bargain in May. I won’t be adding since this company is a low-medium reward and low risk entity, so it will be like watching paint dry compared to many other offerings in the stock market. But I’m pretty sure that June will see higher prices for ATP than in May.

* I watched Planet of the Humans, available on Youtube until mid-May, which puts a huge hole through the motivations of various environmental activists. Surprise surprise, it’s all about money and not the Earth! Blair King (a professional chemist which I have a very high degree of respect for) has an excellent review on the movie.

The only reason why I mention this movie is because they tear a good strip out of biomass plants as being “renewable energy”, and for a very brief moment, Atlantic Power’s Cadillac plant (the one which had a major explosion and plant fire earlier this year) was mentioned.

* Firms are going to be throwing everything under the bus for the first and second quarter, citing COVID-19. There will be write-downs of all sorts of junk on the books that have been accumulating. Firms that do not blame COVID-19 during the two quarters for various one-time write downs of financial performance are likely to be more honest than not.

* An example of this is BWX Technologies (NYSE: BWXT), which reported earnings yesterday. They have a competitive advantage in nuclear engineering services. They did not blame COVID-19 for anything, probably because nuclear engineering services are booming and they should become at least a US$65/share stock by year’s end. Yes, I own shares. The most profit to be had in the nuclear value chain is not in uranium, people!

* There is an interesting tug-of-war happening in the Yellow Pages right now, which traded more shares today than it has in a long time. Somebody at RBC is very interested in shares, while Canaccord has been on the selling side of the large blocks, mostly around the $10 range. Just announce the takeover bid already, folks!

* I find it probable that the central banks will target a stabilization of equity levels, so they will adjust the rate of their liquidity injections that go into the market. Still, the trend is for further liquidity until unemployment metrics begin to moderate. I will have a comment on unemployment/employment rates in a future post, as this is an interesting topic in itself which has market implications.

* REITs, financials, and insurance companies, in general, I think will disappoint. You can almost take anything that somebody is bullish on whatever that is posted on Reddit CanadianInvestor and just take it off your list of consideration. It is quite remarkable how useful it is, entirely for the oppositely intended reason.

CoronaPanic, edition 5 – random thoughts

Alpha Pro Tech (APT on the NYSE), my proxy for the CoronaPanic, is up 3%, while the S&P 500 is up 3.5% compared to yesterday’s slaughter.

My guess is that this is, with respect to the markets, 80%-90% over, but noting the actual spread counts in the USA/Canada are probably 20% done. Please note I’ve been badly wrong on my timing during this whole panic so take any predictions with a grain of salt, and they change with incoming information. There will be serious damage in terms of supply chains, and GDP to tourism and public-crowd related events (the cruise ship industry is toast, and anything relying on a shopping mall or foot traffic for discretionary consumer sales, e.g. clothing retailers, is in big, big trouble – thinking about TLRD here). On the flip side, Dollarama (TSX: DOL) is a great place to buy cheap panic supplies!

Companies that are close to debt covenants will likely tip over and when the banks come calling, it will not be pretty, but just for them and the financials. Certain corporate debt issuers look very interesting, spreads are hugely wide.

The infected accumulation curve will increase quite rapidly in the USA, and Canada. That said, the new phraseology of “social distancing” will stick and people will discover new-found time at home.

China, Hong Kong, Taiwan, Japan, South Korea, and even places that you don’t ordinarily associate with public cleanliness (Thailand, Malaysia) have it under control. Even if you don’t believe the stats coming out of China (which you shouldn’t, ever), the other countries do have reporting mechanisms that are relatively more trustable. In particular, SARS taught anybody coming out of Hong Kong about how to react and behave. This culture will come to North America and in the longer run, will improve our society.

Nobody seems to be talking about climate change anymore. I wonder why!

The media will hype this up to the point of being one of those “outbreak” movies, with the reality being somewhat more muted, which is:
* around 80% of the people that catch Covid-19 don’t get any symptoms at all
* those that are seriously affected or die from it are older (65+) people prone to other conditions (heart, lung)

The governments are in a ‘stuck’ position, mainly if they panic too much, they look stupid, while if they don’t panic enough, they will be accused of not panicking enough. They’re stuck in a rock and a hard place, but the Government of British Columbia has struck a very nice balance between these two.

There might even be a cultural change where telecommuting may be even more acceptable than it is at present. This has been going on at a snail’s pace, but Coronavirus will accelerate it. Will office REITs be killed?

Netflix, Amazon Prime Video, Hulu will receive record subscriptions; internet providers are going to deliver record amount of bandwidth.

There will be a considerable element of demand destruction in North America over the next month, but after that, things should normalize. Fundamentally, life continues, and pension funds need to make their returns. The character of the returns, however, will be somewhat different because interest rates are once again at the zero boundary. There will be a drive to TINA – There is No Alternative, which means that the drive for yield will be very alluring. You can’t invest in bonds (zero return, or you’ll probably get a 2-3% spread on BBB-A type issuers), so equity will be the only game in town (once again).

Gold, the last safe haven, people are still discovering like preferred shares and bonds, that it is not immune – right now gold is being sold to raise cash to buy other “risk-on” assets, but once the Federal Reserve and other central banks polish off their 2008 game plans and re-execute it, the currency depreciation should flow into commodities in a dramatic fashion – this will include gold to a degree.

Another question is what happens with inflation. Right now with the demand destruction and possible collapse of debts by companies that were already teetering on the brink – this will likely cause a drop in CPI. But I’m wondering about the rebound effect – once that has all been dealt with over the next 12 months, will there be a shortage of goods/services available relative to the money supply? Will we be seeing a huge rebound in consumer costs circa 2021-2022? Just a thought.

Finally, the US and Canadian governments are going to blow deficits like you’ve never seen before. I’m expecting Canada to announce a $60 billion dollar deficit for the upcoming fiscal year. The US will probably blow a couple trillion dollars. They can do so, and have the financial capacity (interest rates are at zero, after all).

Where does all of this fiscal stimulus go? In an idea world, public infrastructure – stuff that will be actually useful and consume domestic goods and services. The question is whether it actually does so or not. But the underlying point here is that companies that have relatively large amounts of revenues from government sources – they will likely do well. Engineering firms, defense, etc.

In particular I’ll disclose a holding in BWX Technologies (BWXT on the NYSE) which specializes in nuclear engineering in defence and civilian fields. This position was acquired within the last week. While it has not been taken down nearly as much as most of the rest of the stock market, I am pretty sure this company will be higher in a year.

I have also taken a long position on the S&P 500 futures at the close of March 12, 2020, which was at 2475. Equity liquidity will reign, and nothing will be receiving liquidity more than the Apples, Microsofts, Amazons, etc., of the US universe. My price target is 3100. This is in absence of having conviction on anything other than a few select names of reasonably credible companies (e.g. BWXT) that I’ve done a ton of due diligence on prior to this crash.

Companies that can collect cash and nowhere close to any credit covenants/maturities are critical variables at this point.