What a RED day!

By | 09/08/2011

Feels like 2008 all over again.

S&P Downgraded … the USA ! I still don't get it, how can you downgrade a country that prints its own debt denominated currency, how can you downgrade a country that cannot go bankrupt. Buffett commented that it was not a wise move. (EDIT: see first comment below)

Ironically, after the downgrade, the yield on the US 10 year bonds decreased to a record low (the lower the yield on the bond, the higher its price and the lower the borrower finance costs) , "as investors flee to safety". Ironically, safety is no other than the downgraded US.

As I discussed here in the past, there is simply no alternative to the USA:

  • Europe is full of debt problems and social problems. Some of the EU members have very low work standards and very high tax evasion standards, and when facing economic problems, cannot print their own currency (Greece? PIGS countries?).
  • China is developing the biggest real estate bubble that was ever created, that dwarfs anything prior to it including the sub-prime crisis. Add to it the lack of transparency, communism and lack of rule of law, you get a country with a problematic future outlook.
  • South America's economies all went bankrupt a few times in the last decade or two and still show instability or economies that sometimes relying heavily on the Chinese.

There is no place to go but to the USA, even with AA+ grade. This is why the USA will emerge from this crisis, there is no other choice.

So today markets may look similar to 2008, but this time, things are different. I know you heard it a million times. "This time things are different". But I do not mean it the way you think I am:

This time, Banks are not as leveraged as before. Companies are not as leveraged. Spending has picked up. Housing and jobs have picked up. Economy is more transparent than before, less CDO's etc. Retail sales is up in July. Percentage of interest as part of the average american income is the lowest in years.

And… I am not the same. I have more experience. I have been there before. Once I was afraid, now I am much more educated and prudent. I see these declines as a gift, not as an obstacle.

Today I have consumed almost all of my cash in my portfolio, buying whatever I could lay a hand on. I am now with less than 4% cash, and I must retain some of it for current expenses so there is not more than 2-2.5% to invest. The downward trend may continue but stocks are already at good prices. 2008 and 2009 had taught me (along with Benjamin Graham's Security Analysis) that stocks that are considered "safe" lose much less on the way down than "less safe" stocks. This calls in for a shuffle in your holdings going down, as they reverse when going up. For instance, Intel lost 50% in 2009, but Marvell lost 75%. On the way up, Intel gained 80% while Marvell gained 350%. One who switched stocks in the right time, lost 50% on Intel but made 350% later on (total of 125% yield).

I did not sell a single stock yet, I was a net buyer. But I am about to run out of cash, so when push comes to shove it will be wise to sell "expensive" stocks and buy "low quality" stocks.

For instance, today I bought ETM at the price of 6.36$ per share. In the past, I bought this stock at 6.67, 5.8, 8.21, 9.00 at a total of over 6% of my portfolio and sold it at 11.09$ per share.

ETM is a radio stock. It owns and operates radio stations.
As radio transmitters equipment is very cheap, it has very low CAPEX. Most of its earnings goes to cover interest and create free cash flow.
As all media stocks, it has a lot of debt and they are returning it in an astonishing pace. At the end of 2007, it had 973 M$ in debt and notes, at the end of 2010, 3 years and a financial crisis later, it had only 650M$. They returned 323M$ in 3 years !
Interest expense on 2007 was 57M$, today it is only 22m$ due to lower interest rates and the fact that it returned over 30% of its debt. Today, its total debt is 625M$. Moreover, its EBITDA will be about 100M$ this year, this means about 4 times cover ratio on interest expense, a pretty conservative one.

Today it published 2nd Q report. Its results for FH 2011 are somewhat disappointing, showing about 15% decline in EBITDA and FCF due to lower efficiency (Management is changing a lot of things that cost the company money, they claim it is "one time expense", we'll see), but the company is very cheap as it is. It had 31.5M$ FCF for the first 6 months of the year, while in the radio business the first quarter is the worst. For the full year, it will probably do close to a 75M$. In the past it produced FCF as follows: 2006: 93.1M$, 2007: 91.7M$, 2008: 94.2M$, 2009: 70.4M$, 2010: 86.7M$. Looks pretty stable to me, considering it passed through the worst crisis in 100 years and that today it has even less debt than before.

Let us not forget that 2012 is an election year in which radio revenue climbs substantially. Last time elections were at 2008. In 2008, even though the economy was crashing, ETM showed an INCREASE in FCF ! I can't wait for 2012…..

Now for the cherry: The company trades for… 240M$ ! This means 3.2 multiple on free cash flow (FCF)!. If one day it will stop returning debt and just distribute a dividend, the yield on the stock will be 33% in this year. 33%! The company is simply dirt cheap. Even if FCF will turn only 60M$, even lower than 2009, the worst year in decades, This still gives the company a multiple of 4. I hope it will continue to decline so I can pick up more in lower prices…
The downside is that management can do stupid things like buying other companies in a hostile takeover in a ridiculous price, or issuing stock (at depressed prices) for the merger.

There are more DIRT CHEAP stocks, like GSL. Since 2009 I made 440% on GSL, buying at 1.58$ per share, 1.18$, and selling at 7.02$. Unfortunately, total investment was only a small amount of about 2%. These 2% delivered about 8% of my yield in 2010. Amazing ha? GSL has its revenue contracted for the next 7 years in average. 7 years !!

I will issue a write-up about these stocks in the coming days.

At these times it is SUPER important to sell your expensive stocks and go for the cheaper stocks with lower multiples, that are of course stable and can swim through a difficult crisis, like ETM for instance.

And – don't panic ! Smile !! I smiled all day thinking of the great opportunities I was given in the last 2 trading days. If the decline continues, I will buy more. I thought I will never do 400% like I did on GSL again, but it seems I will be getting this opportunity once more.
This may give me a chance to repeat the overwhelming yields achieved in 2009, that much more than offset losses in 2008.

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