@GSElevator – Teach a man to fish and he'll still vote for the guy that gives him a fish.
1. Quote Of The Week / 2. A Slippery Slope For Oil Producers / 3. Buffett's 2015 Letter To Shareholders / 4. Interesting Links / 5. Joke Of The Week
1. QUOTE OF THE WEEK
Before his presentation to the University of Texas, Bridgewater's Ray Dalio gave a far-ranging interview to Bloomberg's Erik Shatzker where the overarching theme was what to expect from markets going forward. He said that while there are "asymmetric" risks to the downside, asset prices will correct to a point where risk premiums return and investors come back, and predicted that equities will return about 4% in the long term. The concern he had was whether the slowdown in markets will have negative repercussions for the economy at a time when central bank policy is becoming less effective.
Repeating comments he has given before, Dalio said that the "next big move I believe will have to be toward quantitative easing, rather than a big tightening," and that "the recent developments have surprised the Fed, because it is not paying enough attention to the long-term debt cycle" adding that "If you look around the world, our risk is not inflation and our risk is not overheating economies", something all too clear to the nearly 30% of global economies currently blanketed by negative interest rates.
2. A SLIPPERY SLOPE FOR OIL US PRODUCERS
More than one-third of public oil companies globally face bankruptcy, according to a new Deloitte report that paints a fairly gloomy picture of the U.S. shale patch as it struggles to survive under mountains of debt.
The Deloitte report - the first high-profile report on the current financial situation of global oil and gas companies - surveyed 500 companies and found that 175 are facing "a combination of high leverage and low debt service coverage ratios".
"[…] nearly 35 percent of pure-play E&P companies listed worldwide, or about 175 companies, are in the high risk quadrant," Deloitte noted, adding that the situation is "precarious" for 50 of these companies due to negative equity or leverage ratio above 100.
"More than 80 percent of U.S. E&P companies who filed for bankruptcy since July 2014 are still operating (chapter 11) under the control of lenders or the supervision of bankruptcy judges," according to Deloitte.
"However, the majority of these chapter 11 debt restructuring plans were approved by lenders in early 2015, when oil prices were $55-60/bbl. Since then, prices have fallen to $30/bbl, and hedges at favourable prices have largely expired, making it tough for existing chapter 11 bankruptcy filers to meet lenders' earlier stipulations and increasing the probability of US E&P company bankruptcies surpassing the Great Recession levels in 2016."
The debts totalled $353 billion for U.S. and Canadian energy companies at the end of 2015. Deloitte puts the combined debt of those 175 bankruptcy-threatened companies at more than $150 billion, nearly half of the total for US and Canada. That's a lot of debt that needs servicing or restructuring.
Unfortunately, things in the industry are so bad that the usual solutions don't work as effectively as they normally would. Firstly, demand for E&P assets is at best moderate. Then there are the banks, which used to have a soft spot for energy companies when oil was selling for over $100 a barrel. Now that it is hovering around $30, the soft spot is gone and lenders are trimming their energy investment portfolios.
Banks, the IEA, and the IMF have warned that oil prices could reach $20 - Iran is back on the international market and planning to raise production to pre-sanction levels and Russia and Saudi Arabia have made a deal to freeze output at record high levels.
There is one alternative to bankruptcy - sector consolidation - although the problems with consolidation are similar to the problems with asset sales. Few energy companies are in a position to make acquisitions right now. This leaves private equity to pick-up the slack and investors are entering the sector initially though selectively participating in the restructuring of high-yield debt issues. It is likely that assets will be incubated in this environment and then sold to major producers that will consolidate the sector.
3. Buffett'S 2015 LETTER TO SHAREHOLDERS
On Saturday Warren Buffett released his 2015 Letter to Shareholders. In a blog post and brief video published Sunday Bill Gates said a recent investor letter written by his friend Warren Buffett isn't getting as much attention as it deserves.
The letter to shareholders of Berkshire Hathaway marked the 50th anniversary that Mr. Buffett has been at the helm of the massive conglomerate. "I have read all 50 of Warren's letters and feel this is the most important one he has ever written," added Gates. Some of the highlights are:
(1) He praised 3G Capital for buying, building, and holding large businesses in contrast to private equity firms that sell the businesses they acquire.
(2) Berkshire's "appetite for either operating businesses or passive investments doubles our chances of finding sensible uses for Berkshire's endless gusher of cash. Beyond that, having a huge portfolio of marketable securities gives us a stockpile of funds that can be tapped when an elephant-sized acquisition is offered to us".
(3) "For 240 years it's been a terrible mistake to bet against America…America's kids will live far better than their parents did."
(4) "Our definition of interest coverage is the ratio of earnings before interest and taxes to interest, not EBITDA/interest, a commonly used measure we view as seriously flawed."
(5) With respect to GAAP treatment of stock-based compensation: "If compensation isn't an expense, what is it? And, if real and recurring expenses don't belong in the calculation of earnings, where in the world do they belong?"
(6) He defended against charges of predatory lending at Clayton Homes. Clayton Homes retains 100% of its mortgages so its economic interest is aligned with those of its customers. Clayton Homes is subject to oversight by several Federal agencies and its total fines over the past two years were only $38,200, with refunds to customers of $704,678. "Furthermore, though we had to foreclose on 2.64% of our manufactured-homes mortgages last year, 95.4% of our borrowers were current on their payments at year-end, as they moved toward owning a debt-free home."
(7) He provided a discussion of the importance of productivity growth on prosperity, citing examples from farming, railroads, and automobile insurance, and the important role played by 3G Capital.
Bloomberg has posted an annotated version that's also worth a look.
4. INTERESTING LINKS
Business insights from China's richest man [CNN Money]; How mobile payments will reshape lifestyles [WSJ]; Software is the new oil [AVC]; In-depth interview with Jamie Dimon [Bloomberg]; BAML Global fund manager survey – Feb 16 [BAML]; How meditation changes the brain [NY Times]; Does creativity has a place in investment research [CFA Society].
5. JOKE OF THE WEEK