Friday, November 27, 2015

Christmas Trees: What Would Jesus Do?

- by Maryann Khinda

 We are republishing this piece given the Christmas Season...

Is sacrificing trees for decoration rather than consumption ethically and morally responsible?  Is this act frivolous and wasteful?  Would Jesus approve?  Or are there hidden merits to cutting down Christmas trees?

In light of our socially responsible efforts, we would like to explore the pros and cons of purchasing a real vs. artificial Christmas tree this holiday season to see where the pine needles lead us.

 There are many views and thoughts on having a “real” Christmas tree. Besides the beautiful d├ęcor and terrific nostalgic smell, freshly cut Christmas trees provide additional oxygen and consume carbon dioxide in the immediate air of their surroundings.  As per Green America, Tree farms typically use barren un-farmable or rocky land to raise their Christmas trees and grow two trees to every one tree cut.  This is a sustainable method of using the land and a true benefit to having a “real” tree.

Ah, but the cons outweigh the pros.  Why do any trees need to be cut?  We are killing trees, living specimens, for a tradition...?  Here lies nothing but selfish human gain in the act of cutting down trees.  We bring these trees into our homes for a few weeks, decorate them and then use additional electricity to light them.  This is absolutely wasteful!  And not socially responsible?  After the holidays are over, the trees typically wind-up in landfills.  Most Christmas trees are brought from these mass tree farms that use pesticides.  These pesticides are in the air in your home.  If your pet drinks from the tree’s bowl, it could get sick.  Trees even breed mold, which is unhealthy to breathe and creates allergies.

We are not asking you to give up your tradition.  There are alternatives: the United Kingdom has found a unique method which we approve and give two thumbs up for as 100% sustainable – renting potted Christmas trees.  During the holiday season, customers can rent a potted freshly pruned and trimmed Christmas tree.  When the season is over, the tree will be returned and replanted until the next season.  Brilliant!  No waste!

There are also SERFs, Socially and Environmentally Responsible Farms, which raise organic Christmas trees.  Organic trees are free of harmful pesticides.  At this time SERFs are only common in the Northwest.  Please see their site for further details.
 If you must have a “real” Christmas tree this season, we strongly urge you to adhere to the many recycling efforts available.  Most local governments and municipalities participate in tree curbside pickups for compost and mulching.  If this is not available, there are other great ideas that are sustainable. Using your tree for firewood has mixed reviews – please make sure you do this correctly as you could ruin your chimney (see this page for details on the dangers).  There is always the easy option of throwing the tree into your backyard for your own composting.  This will, in time, improve your own garden.  Mother Earth News gives a few great suggestions:  in the winter, you can use the tree branches to protect your delicate garden and use the trunk as a post or bench.  You could also throw the tree in your lake or pond – the wildlife will thrive.

The other option is buying an “artificial” or plastic Christmas tree.  Artificial trees can be reused year after year, without waste as a whole, but these trees cannot be recycled further due to their iron and plastic structure (though there are other materials used, e.g., aluminum).  Also they contain PVC (polyvinyl chloride) and the production process may use a small amount of lead.  While the risk of lead poisoning is low, it increases as trees age. Though recent regulations have made trees safer.

In conclusion, we find freshly cut Christmas trees not to be as socially responsible as some of the alternatives, such as renting or purchasing potted or artificial Christmas trees.   As we like to present other opinions, Justmeans, a Sustainability website, did a write-up (Sustainability and Christmas Trees: Let's Get Real) not too long ago stating real trees are the way to go.  If you must have a freshly cut tree, please utilize one of the recycling methods above to retain some sustainability.  Happy Holidays!

SRI, Socially Responsible trees, sustainability, Green Christmas trees. 

Wednesday, October 14, 2015

How Socially Responsible Investing Changed the World

Source: Nick Ut at the Associated Press

Recently a smug investor asked me, "What's SRI good for other than making one feel less guilty about living a fancy lifestyle." After hearing that remark, I was really angry repeating it over and over in my mind.

After several weeks I got to thinking, "maybe he's got a point.  I'm a limousine liberal not having really dirtied my hands in any good cause."

But first, a brief history and explanation.  SRI stands for Socially Responsible Investing.  SRI has had many names including:
  • Ethical Investing
  • Impact Investing
Historically, SRI was mostly about avoiding "sin stocks", companies that are involved with alcohol, gambling, pornography, tobacco and (nuclear) weapons.   But today's SRI isn't just about avoiding certain industries, but about investing in companies that are doing positive practices and having specific attributes (i.e., "best in class"). These practices fall under three areas, called ESG (Environmental, Social, Governance). Here, SRI has made substantial progress.

So, I started wondering, reading books, watching interviews and keeping up with headline news to determine if SRI was in fact doing some good in society.

Usually when an issue captures our minds, we contemplate supporting or opposing it through voting, how we act as customers (e.g., buy), or how we act as employees (e.g., strikes, unions).  Seldom do we think of our roles as investors.  The fact is, while we are intrigued by certain investments in companies like Tesla, most of us invest indirectly via mutual funds. So the link between companies and ourselves is broken.

I came up with a list of three important successes going back to the first example of modern-day SRI:

  • In 1758, the Religious Society of Friends (aka "Quakers") prohibited its members from participating in the "slave trade."  Another religious order, the Methodists was highly influenced by John Wesley whose sermons said that your business shouldn't harm its workers or its neighbors.
  • In 1972, the country was outraged by the photo of a 9 year old girl that had just been burned by Napalm, which is a burning agent.  This ignited a protest, placing pressure on its sole maker, Dow Chemical, to stop producing the chemical-agent. Napalm was only 1% of its revenues, as the company was known for Saran Wrap. While the company refused to stop making Napalm talent veered away from Dow and the company was vilified for years. The pictures also prompted Dr. Martin Luther King to go public with his opposition to the Vietnam War.
  • In the 1990s, the world was appalled by Apartheid in South Africa. The movement against Apartheid actually began in 1960 after the Sharpeville massacre. In 1976, the UN imposed an arms embargo to the country. By the late 1980s and 1990s, investors including large institutions, divested all their investments in South Africa. That prompted businesses operating in South Africa to draft a charter to end Apartheid. And you all know the result...
  • 2015: Modern SRI is quite different than in the past. There has been a huge increase in the quality of Governance at most corporations. This has given investors the ability to monitor corporate behavior almost "real-time".  This is done through proxy voting, oral dialogue, letter-writing, filing shareholder resolutions (usually a last resort) etc...At first glance, it appears that SRI hasn't had any "big-wins" since the 1990s, but in fact, investor activism has been so strong that few companies get to the point where there is a big issue to topple.

2015 - 2020: The Next Battleground:
The Palm tree is a beautiful, elegant species and Palm oil is supposed to be a healthier oil compared to trans fats. However, ever expanding plantations are endangering Orangutangs, increasing Green House Gases as well as taken advantage of hungry workers.

In the next article, I will dig deeper into these issues.  But for now, I'll leave you with some wise words from Mohandas Gandhi:

 "You must be the change you wish to see in the world.  

 It's the action, not the fruit of the action, that's important. You have to do the right thing. It may not be in your power, may not be in your time, that there'll be any fruit. But that doesn't mean you stop doing the right thing. You may never know what results come from your action. But if you do nothing, there will be no result.” 

Thursday, September 10, 2015

Here's an Interesting list of the most "Do-gooders" Athletic Companies

As a fellow runner, I often am asked if I know of any truly socially responsible running companies.  This is a difficult question due to the well-known supply chain issue of Child Labor.

This list does mention Adidas but the author had not verified the data. Still it is a good start.  It was a good surprise to hear about Under Armor as the company is performing fantastically and I often wondered about their ESG efforts.

In fact, the company is probably one of the best performing of all U.S. retailers with both strong revenue and earnings growth.  However, its stock-price gain of 865% over the last 5 years has elevated its Price/Earnings ratio beyond reason (and ahead of expected earnings growth).

Below is an except from the link to Nick English's article.

Tuesday, September 8, 2015

Green Bonds are Giving SRI a BLACK EYE

This article marks my website's first commentary on the fastest growing trend not only in social investing but ALL of investing.  No, I'm not talking about Enhanced Exchange Traded Funds.  In just the last five years, the emerging asset class of Green Bonds has come from nowhere, growing to $36.6bn (2014) outstanding.

A "Green Garage" courtesy of The Wall Street Journal

Climate Bonds Initiative (a leading London-based research organization in this area) thinks the market will more than double in 2015, to nearly $100bn after tripling in 2014 (see graph).  Total issuance reached $24.5bn year-to-date as of August 2015, so it appears that forecast is untenable. The total addressable market amounts to over $0.5 trillion.

Source: Climate Bonds Initiative, Barclays.

What is a Green Bond?
Green Bonds (aka Climate Bonds) are fixed-income instruments whose proceeds go towards a benefit to the environment.

Green bonds are similar to other bonds. The main types are "Use of Proceeds", Project Bonds and Securitized Bonds. Use of Proceeds use either dedicated revenue streams as collateral backing the bonds, or are standard bonds which are backed by all of the issuer's cash flows. Project Bonds, as the name implies, are backed only by specific projects and not the issuer.  Securitized Bonds are asset backed vehicles that are specially-structured and designed

The evolution of Green Bonds is similar to what has been seen for early stage industries. The modern Green Bond "movement" began in 2007 when supranationals, mostly highly-rated banks (e.g., European Investment Bank) issued their first bond. Years later the market broadened to public finance/municipal entities and corporates. During 2014, a corporate name issued the first high-yield bond.  That year, 2014, was a key catalyst for Green Bonds as the market grew deeper and broader. It is very important for the Green Bond market to have corporates in the same manner that the junk-bond market propelled corporate financings during the 1980s (we'll leave Michael Milken out of this one!)

Proceeds by Issuer Type (source: Climate Bonds Initiative)

The U.S. Green Bond market
The U.S. took a back-seat during the Green Bond market's early years.  The Europeans have taken the lead due to their socialist nature (see chart below from Climate Bonds Initiative). Several European asset owners and investment managers have signed on to the United Nations Principles for Responsible Investment (PRI) initiative.  Furthermore, European governments have encouraged (via subsidies) socially responsible investing and green projects such as solar power, wind, etc.  Though recently, large liberal States (and cities) of California and Massachusetts have issued municipal Green Bonds.  Given the overall SRI movement in the U.S. and the influence of large pension finds (i.e., TIAA-CREF) corporate issuers are expected to become a larger contributor to the overall Green Bond market.

At this time, the only investment vehicle that focuses in Green Bonds is a mutual fund called Calvert Green Bond (CGAFX). The fund has underperformed, partially due to its high front load (3.7%) though it has underperformed other funds too. It invests 90% of its assets in the U.S. and has an effective duration (maturity) of 5 years.

Recently, Ameriprise Financial subsidiary (Columbia Threadneedle) opened a new muni fund called Columbia U.S. Social Bond Fund which utilizes ESG criteria.

Where do we go from here
The Green Bond market was born in Europe, broadened in the U.S. but it will reach escape velocity in Asia.  During 1Q'14, Toyota Motor Corp. issued the market's first ABS, backed by auto leases. The proceeds were earmarked towards electric vehicles.  Despite its $1.8bn size, the Japanese market will pale in comparison to the tidal-wave of Green Bonds emerging in China, according to a study conducted by The Intl. Institute for Sustainable Development.

Anyone that has ever visited China or ran the Beijing Marathon could see for themselves that pollution is a BIG problem.  Some observers say environmental costs may be as high as 10% of GDP.  Consequently, the Chinese State Council announced plans to grow a corporate Green Bonds market as part of its Five-Year Plan. There are several drivers that are expected to quicken this pace including:
  • High levels of household savings
  • the movement away from Shadow-Banking towards transparent markets
  • limited financing for small and medium-sized businesses
  • Urbanization and its affect on public health
  • High foreign investor demand
  • Large infrastructure programs that are Green Bond friendly (see below)
Transport, primarily rail, will be a dominant way of reducing emissions in China, according to the IEA. Despite declining rates of rail investments here in the U.S., China recently added 6,000 km of high-speed rail track - which is double the ROW.
Beijing Marathon'14 (Reuters)
Green Standards Need to be Refined Yet Again
There are several standards that define what exactly (or not so exactly) a Green Bond is. The most popular are the Green Bond Principles and Climate Bonds Standard.  There are also Green Bonds indices in which investors can determine if a particular bond is an index component. Both sets of standards are evolving and voluntary. The Climate Bonds Standard was developed by the Climate Bonds Initiative. It is very focused on Green Bonds from solar and wind companies and needs to be broadened to other industries such as transport, water, agriculture, etc.  The Green Bonds Principles were developed by the ICMA and represents over 50 large financial institutions. It is a set of Best Practices for determining what is a Green Bond as well as the process of issuance, management of proceeds and reporting. The Green Bonds Principles were updated on March 27, 2015.  I read them and thought I had mistakenly read the executive summary as they were too general in scope.

When Green Bonds go Bad
There are several ways a Green Bond could turn ugly.  For example, bond proceeds may be diverted from their original noble cause towards activities that are not green. Green-proceeds may also be loosely-tracked and mixed with an issuer's other bond proceeds.  Reporting may not be transparent enough and assurances may not be objective or from a reputable third-party.  While the above risks are valid, I believe they could be lessened over time. But there is an even greater overarching issue...

Is Green Bond investing really Socially Responsible Investing?
The short answer is a resounding No!

Socially Responsible Investors seek to purchase those companies that are practicing ESG (Environment Social Governance).  These are companies that are striving to reduce their carbon-footprint, treat their employees (and community) well, and become more transparent. Few companies attain five-stars in all three letters, so investors emphasize certain areas.  But overall, SRI asset managers tend to judge the whole company.  The website Socially Responsible Investing, for example, focuses on how companies treat their employees because I believe if you don't treat your own well you will never treat society well either. Others focus on companies with a mixed track-record that are progressing towards social responsibility. Apple under Tim Cook is a good example of this.  Again, these asset managers are focusing on the merits of the whole company.

The overriding problem with Green Bond investing is that any company (or municipal) could issue such a bond so long that its proceeds go towards benefiting (i.e., less harm) the environment.  With this type of definition, I cannot see a case that a borrower can not issue a Green Bond. So if oil company BP Plc wants to issue a Green Bond to make a new efficient LEED-class building (something it may have been planning anyway) socially responsible asset managers would be allowed to purchase those bonds. (In fairness to the Calvert Green Bond fund, I had conversations with its lead portfolio manager and Chief Investment Officer Fixed Income (Catherine Roy) who understood my issues, but stated that Calvert has experience in SRI and would ensure that it was buying bonds of companies that are socially responsible overall.)

However, the Barclays MSCI Green Bonds Index does address the issue of whether or not the whole company is green-bond worthy in its 90% Rule.  This rule says that a general obligation bond is Green if 90% of its revenues fall under one of its five eligible economic categories.  While I give kudos to Barclays for both addressing the whole issuer and for listing specific economic categories and subcategories, they are too lenient determining whether a whole issuer is Green. For example, using its subcategories, a company is Green if it sells superconductors or building-insulation.

The Case of the Green Parking Garage
In March'15, the WSJ highlighted green bonds sold by Massachusetts (Salem State University) whose proceeds would be used to build a garage with electric-car charging stations. Officials said the garage would reduce pollution by cutting down students' circling the parking lot looking for spots. However, environmental advocates noted that having a parking garage still encourages people to drive and create greenhouse gases.

Green Bond investing properly executed will continue helping the broader investment world adopt SRI.  However, investors should fully understand the issuer's core business. Otherwise, these bonds will just be Greenwashing the issuer's dirty laundry.

Sunday, July 26, 2015

CHC Group: This Bird is Flying too Close to the Sun

I first noticed CHC Group (NYSE: HELI) in 2014 when I was examining the Energy Industry. As a former industry analyst I thought that its business of flying workers back & forth to offshore oil rigs was highly sensitive to oil prices, despite being classified as a transportation company. HELI has the world's largest helicopter fleet (231) serving several geographic locations, of which over 81% of FY'15 (ended 4/15) revenues are to the energy end-market (i.e, E&P companies).

Source: CHC Group

What caught my eye was the company's sloppy-looking financials and its huge 10k report.  While the left-brain side is important for company analysis, it is the right-brain that makes investing more of an art than science!

The chart below shows the yearly change in SPDR Oil Service ETF (XES) versus CHC Group (HELI).  Clearly they are correlated.  Further, CHC Group performed much worse than its peer group since Jan'15 due to its high financial leverage.

Courtesy of GoogleFinance

After seeing CHC Group's recent stock price trading under $1.00, I thought why bother writing about this.  It's too late! But then I remembered all the soured investments in penny-stocks I had made as a novice trader.  At that time, I thought these volatile issues just needed to go up 50 cents and I'd sell.  However, investing in low-priced stocks is a fast-lane to the Poor-House.

This article is for all my fellow investors that have no access to brokerage-reports, not even Seeking Alpha has written much on HELI.  So then, maybe this is my social responsibility to investors!

We all know that commodity prices are weak and oil is now trading below $50/barrel. I'm a big believer of Contrarian Investing. However folks - playing a risky small company is not the way to do it - Exchange Traded Funds are.

Source: WSJ Market Data Center
Business Outlook:
CHC Group's business is closely tied to worldwide E&P budgets, of which is correlated with oil prices and the number of drilling rigs. While CHC's business is most closely tied to offshore global drilling, the chart below (from Baker Hughes) is quite useful as it shows the number of months before the industry actually hits bottom.

Below I will briefly list the main reasons why investors should avoid CHC Group.  Essentially, this is a small company bleeding cash that has a highly leveraged balance sheet.  If existing trends continue, the company will likely go into bankruptcy proceedings, or undergo a debt-recapitalization in which a private equity company such as Clayton, Dublier & Rice (CDR) takes over the company. Should this happen, equity holdes will be wiped-out.

Income Statement Issues:
  • CHC Group has never earned a profit going back at least 5 years. If the company cannot earn dollars during a healthy energy market, it will surely continue losing money in the current weak energy environment. CHC's customers are large well-funded exploration companies.  While they're good on their IOUs, they however, have large bargaining leverage with CHC Group and have already begun negotiating down the rates they give to CHC, according to the 4Q'15 conference call.
  • The company still lost money even after excluding special and non-recurring items (which it may have presented to make earnings look better than they really were).
  • Interest Expense and Fixed Charges (including lease, and pension payments) are too high for the company to support going forward. While management retired a chunk of debt ($320mm) in FY'15 that will reduce interest expense about $30mm/year, interest and leasing costs may remain too high for EBITDA to cover. The problem (see reporting issue below) is that the company's reported EBITDA is not a true representation of cash flow or even EBITDA.

Reporting Issues:
  • I have never seen a company with so many versions of adjusted financials. Companies typically report GAAP financials, meaning a standard set of accounting guidelines that can be compared with other companies. They sometimes add EBITDA to their reporting statements, especially if the company is new and growing rapidly (such as Twitter) or if they have a large base of debt and bond investors. However, CHC Group had to add an "R" (i.e., rent) to EBITDA because of a large number of leases, and that is reasonable. But they also show an Adjusted EBITDA, and wait, it gets better, an Adjusted EBITDA excluding Special Items.
  • There are numerous adjustments (i.e., costs) the company makes, I believe, mostly to boost its reported EBITDA. Certain of these should probably be excluded, that is, reduce EBITDA since they are cash expenses. These expenses may include costs due to management turnover, cash restructuring costs & severance
  • CHC Group's Press Releases to shareholders are not clear, and frankly, misleading. The first bullet point on its 4Q'15 earnings press release says that, "Fiscal 2015 revenue down 3% and Adjusted EBITDAR excluding special items down 2%".  This alludes to a company who's business condition is slightly worse than last year, which is clearly not the case.
  • The company's Balance Sheet shows debt of $1.2Bn.  However, the company's huge number of leases increases its OBS (Off Balance Sheet) debt.  The company provides a reconciliation of Adjusted Net Debt, which it values at $2.3bn as of FY'15 (April'15)
  • HELI's heavy dependence on leasing as well as its new $145mm Asset Backed Loan (ABL) significantly reduces transparency.  CHC will use its ABL line to outright buy new helicopters while returning those helicopters that come-off lease. This will affect how income is presented including their timing.  Furthermore, it is uncertain what assumptions management used to attain the net present value of its leases.  For example, it could lower its adjusted debt by simply increasing the rate it utilizes to calculate the present value (loan equivalent) of its leases.
  •  Free Cash Flow:  I typically examine GAAP free cash flow since this is less easily manipulated.  I take operating cash flow then subtract capital expenditures (CapEx).  It's very easy.  However, even here, the company adds a confusing version of its "Total Adjusted Free Cash Flow".  The company makes a bunch of adjustments, of which, the net effect is to sharply boost FCF to a still negative $164mm.
  • In the 4Q'15 conference call, outgoing CFO Joan Hooper refused to answer  questions on its future outlook saying it would not give any guidance of any kind. Typically, when a company readjusts its business via layoffs etc., it gives a proforma outlook of what its cost-structure will look like. The CFO also refused to give any guidance on expected revenues, etc. for the coming year.
  • I found two small errors in the 4Q'15 powerpoint presentation, again something I have never seen before. It gives one the feeling that the company doesn't dedicate enough resources to its business and has poor reporting & governance.

Balance Sheet:
  • The company has a very leveraged *balance sheet (*including the loan equivalent of its future lease payments).
  • Though the company has already written-off $0.4bn in Goodwill, I believe further assets may be written off including $0.2bn in Intangible Assets as well as property plant & equip and a small amount of deferred tax assets (as it's unlikely the company will make money any time soon).
  • While management says they have $3.1bn in Fleet Value of 231 helicopters. Note that it only owns about 20-25% of them, including old helicopters, as per the conference call. This equates to about $0.6bn. Recall that is exactly the amount of the recent Preferred Share offering to Clayton, Dublier & Rice. So before equity investors see anything in a bankruptcy, the secured debt holders, ABL holders, and preferred debt holders would have to get their slice.  In other words, equity holders will receive nothing for their shares.
  • Despite the above mentioned $0.6bn that boosted the balance sheet, shareholder's equity is in deficit by $0.4bn due to net losses and the $0.6bn in asset impairments. In other words, there is a Negative book value on CHC Group's shares!
  • While the company highlights that it has *$500mm in liquidity (FY'15) notice that it has just $134mm in cash and that it is burning about $100mm per quarter. (*There's another $145mm in liquidity from the ABL booked after the fiscal year ended.)
  • Again, the company highlights its own version of FCF, so it was difficult for me to ascertain cash-burn. Readers should note that a company can reorganize through a prepackaged bankruptcy even with a moderate level of cash.

Management & Governance:
  • NYSE (The NY Stock Exchange) categorizes CHC Helicopter as a "controlled company"and the majority of voting power is held with First Reserve and CDR.  CHC's board is not independent and the company is exempt from governance rules. In other words, shareholder protections are weak.
  • CHC is incorporated in the Cayman Islands, which again weakens shareholder protections.
  • Executive turnover is the highest I have ever seen.  Within the last year or so, there has been a new President & CEO, Chief Operating Officer, President of the Heli-One subsidiary, SVP of Human Resources and General Counsel & Chief Administrative Officer. Management needs time to get a grip on the company's business before it is able to assess and execute an action plan.
So what's CHC Group worth?
Given that the firm does not pay dividends, hasn't made money, and has negative equity, an investor or potential buyer cannot value the company using conventional benchmarks such as P/E ratio, Price-book ratio, or dividend discount model.  A discounted FCF model may be used but the company doesn't have positive cash flow so that would be based entirely on assumptions.

So we come down to Enterprise Value (EV).  Even here, one cannot simply use reported debt of $1.2bn as there is another $1.2bn or so of OBS debt.  After including the above, adding preferred stock and netting against cash, CHC's Enterprise Value is $3bn. Buyers typically pay a multiple of EV, however, in this case a potential buyer would likely wait for a distressed situation, then pay a low multiple given that the debt would be trading at a low market value.

While the average investor may not appreciate every detail of this article, my goal was to protect you from making a hasty decision. There are many investments as well as turnaround situations that have much lower risk and higher returns.

Penny stocks are for the birds.  On 7/23/15, the NYSE notified CHC Group that they have 6 months to bring their shares over $1.00 else face a delisting.

Disclosure:  The author has no position in CHC Group (HELI) and has not received any direct or indirect compensation for this article.

Friday, July 17, 2015

Looking for a good SRI manager or Conference ? ?

Looking for a good guy or gal to manager your money? 

These guys out of Colorado (w/ a branch network in various states) are quite exceptional.  Not your slick-salesmen of sorts.  They are named First Affirmative. The two executives running the company are below:

I do not receive any fees of any kind for endorsing them but thought readers should know that there are good people out there that want to invest their clients' money the right way, aligning customers' value with their investments.

I first met the First Affirmative team a few years back at the premier SRI Conference.  Its location typically changes year to year but this year's (Nov'15) event is in Colorado (where it all started).

The conference was great for several reasons including getting to know people from various walks of life, as well as the more left brained information.  This included the educational and quantitative aspects of SRI which ranges from active-investing, climate change. measurement of SRI portfolios to sin-stocks.

We wish you all luck in your investing and in life !

Tuesday, July 14, 2015

Mosaic update: Return on risk has increased since 2013

It's been nearly two years since this website published its first article on Mosaic, of which was also on Seeking Alpha. At that time, the Potash-Fertilizer industry was reeling from the July 31, 2013 event whereby Uralkali pulled-out of the BPC potash cartel.  (This article will focus on Mosaic's vital potash business though the company also sells phosphate.)

At that time, investing in Mosaic (MOS) appealed to me as a contrarian play.  Such tactics are best for cyclical industries such as Fertilizers, Steel, and Energy. If one can be disciplined, contrarian views eventually work-out, but they may take years to work themselves through, as the industry and participants rejigger their strategies and Industry Structure realigns.  Here is a Harvard Business Review paper from the infamous Michael Porter.

(Note: Those asset managers focusing on socially responsible investing might want to examine the company as a way of diversifying their often heavy portfolio weighting in consumer-oriented companies. In other words, SRI funds are overweighted in tech and retailing and adding Mosaic would be a good diversifier.)

My worst fear at that time (2013) was that there would be a price war in potash. The industry was, and remains, in a global oversupply situation, which isn't expected to balance for several years.  The table below shows the net Supply minus Demand balance for each major fertilizer (numbers are in 000s tonnes). The numbers in brackets represent the percentage that each fertilizer is oversupplied.  So (32.8) for Potash in 2018 represents Supply that is 32.8% greater than world Demand.

Source: Food and Agriculture Association of the United Nations

Back in 2013, I expected Mosaic's share-price to decline from the $40s level towards $30-$35 where the shares have much support including on an asset value (i.e., book value) basis.  However, this never occurred.  It appears the shares are supported by another factor, let's call it the "X" factor which I frankly do not know.  I believe, however, that the smart-money is expecting Demand to eventually catch-up with Supply and for the Industry Structure to improve.  In fact, Potash recently proposed to acquire K+S (a very high-cost potash competitor) and potentially close the high-cost mines and keep its new mines that are coming on-line in Canada.

Mosaic's shares also seemed overvalued back in 2013, despite several bullish reports from the sell-side as well as Seeking Alpha writers.  It's forward P/E was at least 16-17x. However, this has come-down towards 13x, which is a large discount to the S&P500's P/E of 17x.  Also the PEG ratio has declined as forecast growth is now greater than its forward P/E of 13x (see below). Consequently, I believe Mosaic offers a good return-on-risk versus what appears to be an overvalued stock market.

While fertilizer supplies remain high, and farmer economics (via falling Corn and Soybean prices) have declined, factors are moving positive in Mosaic's direction.  These are summarized below:
  • A lower Price-to-Earnings ratio compared to historicals and the S&P500
  • Improving forecasted earnings growth (S&P Capital IQ expects 16% CAGR)
  • Initiation of another stock-repurchase program ($1.5bn worth)
  • The potential consolidation of the Potash Industry (via K+S acquisition)
  • Competitor Uralkali recently stated that its potash volumes reached their historical levels, and that it would now work on increasing its revenues (rather than selling potash at any price). It is also possible that Uralkali may rejoin the BPC marketing "cartel", however the company denied that it would.
  • Overall demand is slowly increasing.  Despite China's declining economic growth rate, note that a substantial slice of its population is moving into "meat-eating" middle and upper class.  (Note that meat production is quite ag-intensive!)
  • Declining potash production-costs (new low reached in 1Q'15)
  • Improving industry and business-segment profile in Phosphate (via the CF Industries asset acquisition)

Corporate Social Responsibility:
Mosaic is followed by my website given its leadership in ESG.  In June'15, the company published its sixth Sustainability Report which is in-depth including the usual ESG data as well as self-implied targets. Mosaic has received many awards for its CSR conduct including the prestigious CR 100 Best Corporate Citizens.
Readers may be asking, so what does this have to do with investing in Mosaic? Well it's been proven that good CSR management is reflective of good overall management and lower corporate risk.

While the pendulum of supply/demand has yet to balance for the Potash industry, Mosaic's fundamentals have certainly improved.  Since 2013, the S&P500 has risen, yet Mosaic's share-price remains relatively unchanged.  Consequently, any positive catalyst will likely boost Mosaic's share price.

Full Disclosure: The author is long Mosaic Corporation.