by Travis Johnson, Stock Gumshoe | January 4, 2013 6:15 pm
Everyone in the investing punditry game has to make predictions, so I’ll go out on a limb here and let you know which of the stocks in the Gumshoe universe I’m most excited about for the coming year.
I’m also, so you know, going to be revamping how I present and track the “Idea of the Month” picks to you in the weeks ahead, since the looooong spreadsheet of every idea I’ve ever shared since 2008 is not doing anyone much good. That work isn’t done yet, and we’re still not going to be recommending a particular portfolio for anyone (that’s beyond the scope of what we can or should do), but I want to maintain some more “live” listings of favorite stocks that I like the most — not just an idea that we shared four years ago that was only a good trade for six months, but some different lists of core ideas and speculative picks that can rotate in and out as my opinion or the market changes.
More on that as we work out the details, but I hope that we’ll be able to share something a bit more understandable in 2013, and something that, while it falls short of being a “model portfolio,” more accurately reflects my favorite ideas and the way I think about them as time goes by … and gives a chance both to work with a smaller list of stocks that are followed more closely, and to have the “almost real” discipline of knowing that at some point you can’t profitably add another stock to your portfolio unless you’re selling something else.
So we’re not ready for this complete revamp of the past ideas I’ve shared just yet, but that should be coming over the next month or so as we do our “annual review” — right now, I just want to share my prognostications since several readers have been asking … what are my top ten picks out of the Gumshoe Universe for 2013?
(That “universe,” by the way, just means all the stocks I’ve personally owned or covered, or that I’ve featured in the Idea of the Month over the years — so this is prioritizing stocks I’ve written about and know pretty well, though I’ll mention a couple others that are “outside the universe” along the way, too.)
And no, these aren’t in order.
My current favorite “theme” for stocks that appeal to me is looking for insurance companies who can benefit from both a hardening market that I think is being driven by low interest rates, and an investment return that significantly outpaces the returns of typical bond-dominated insurance portfolios. Insurance companies are pushing firmer rates than they have in the past because they know they have to at least break even on underwriting — unlike the last 6-8 years, no one can count on losing money on underwriting and making it up with “low risk” leveraged bond portfolios, so they need to make sure they underwrite profitably, which helps all insurers but especially helps those insurers who can also make a strong profit from their investments.
That would also bring Berkshire Hathaway up to the top of the list, but Berkshire isn’t as insurance-driven as it used to be so it’s not as direct a play on that theme … it’s still a great buy on economic recovery, housing recovery, insurance, and investment returns from Warren Buffett and his new managers, but I think I’ve beaten that horse enough — Berkshire is buying back shares if they get back to about 1.2X book value or below, and it’s hard to imagine long-term shareholders losing money with purchases at that price (mid-$80s), but for my insurance speculation specifically for 2013 I’d focus on some smaller players, Markel and Greenlight Re. Probably others, too, but Markel and Greenlight are the ones I’ve written about and own and are my current favorites.
I wrote about Markel just about two weeks ago when their announced acquisition of Alterra dropped the shares by about 10% … and I bought more. I think this transaction has the potential to really juice Markel’s returns over time, particularly because it dramatically increases the size of the investment portfolio. Markel has always in the past been a great buy at anything below 1.2X book value, and that might change with the transactions because reinsurance companies are typically valued at a bit less than excellent specialty insurers like Markel, but I think we could see the combined company experience both a tailwind from a stronger (“harder”) insurance market and the impact of Markel’s much more aggressive and effective investment strategy when applied to a portfolio that will show outsize growth from this transaction (Alterra’s investment portfolio, as a percentage of market cap, is much higher than Markel’s — and Alterra held almost exclusively government bonds, while Markel is more aggressive with equity and alternative investments). The shares have jumped a bit, if you’re interested in buying some I might nibble here but would add on more aggressively if we get some pullbacks into the low $430s or below — there could easily be integration costs or volatility as investors figure out how to value the new company, or just as the market overreacts to whatever news comes out of Washington or to more details about damages from Hurricane Sandy, but I expect that we’ll look back in a year and see the combined company, the “new Markel,” with a book value per share of over $500 and a return to a premium price/book valuation.
Greenlight Re (GLRE)
Greenlight was a recent buy for me, and a recent feature in the “Idea of the Month” space after I took some time to research it following a Palm Beach Letter tease. This is basically a way to get free leverage from a reinsurance portfolio that should be able to return to something close to break even on underwriting, and use that levered capital to invest with David Einhorn. The stock is trading right around book value because of some underwriting mistakes that they think they’ve rectified (by getting out of one particularly business line, for the most part), and I think buying shares at $23, just under book, and getting exposure to David Einhorn investing over $30 for you is going to work out very well. There’s a risk both because underwriting could see new problems, of course, and because Einhorn might be wrong — his portfolio is far more leveraged to his big ideas than is any other insurance company portfolio that I can imagine, and though it’s “hedges” because he has a substantial short portfolio, even the best young investor on Wall Street can have a bad year or two. With a portfolio built on equities and gold, I think GLRE will do far better than most insurers this year in booking investment returns, but that is, of course, a guess about the future. The stock is cheap compared to historic valuations — the company is only five years old so you don’t want to overstate historical performance or stability, but it has never traded below book value for very long.
This was one of my “Idea of the Month” picks for December, so you won’t be surprised to hear that I think it will be one of the better performers of 2013 among the stocks I’ve covered — and it’s still one of my largest personal holdings. This may become a big mistake if it turns out their holiday sales disappointed heavily, as some analysts are predicting, but I think that we still face a huge valuation mismatch with Apple — they’re growing at a far faster rate than the market, and should continue to grow revenue by at least 10% even if things fall apart, but they’re already priced as if the iPhone, iPad and whatever future products they produce have stagnated. That may happen, and it may even happen soon, but with a stock priced at a discount to the broader market, with a 2% dividend yield and enough cash to do anything they want to, I’d argue that stagnation is already priced in … and personally, I don’t think we’ll see it. Apple may not be a great trade, I have no idea whether it will spike 50% in a year again as it has in the past, but they are so strong and so cheap that it seems a foolish investment not to own at these prices…. and I do think there’s a solid chance that the holiday quarter will end up having been spectacular, perhaps reigniting Apple-lust among investors.
Sandstorm Gold (SSL.TO SAND)
I haven’t ever featured Sandstorm Gold as an “Idea of the Month” pick, but I’ve written about it many times and it’s one of my top personal holdings (still the top holding, actually, if you count my warrant position) … and it remains my favorite way to invest in gold.
Gold miners have gotten quite inexpensive again this year, particularly the big miners, as the oft-cited GLD/GDX ratio has risen still further (or the GDX/GLD ratio has fallen, if you prefer the flip side), and I expect that if gold has another decent run in 2013 the miners might again make an effort to catch up — but the fact remains that mining is generally an ugly and terrible business … financing the miners has been much more successful in recent years. If you look at a chart of gold versus the GDX gold miners index, you’ll see that gold has done very well over the last five years, and that gold and the gold miners tend to trade in sympathy most of the time … but when the market tanks, as it did in 2008, it takes down the gold miners much more than it does the price of gold itself. Royal Gold (RGLD), though, has kept up with gold and done a bit better than the metal during that time — more confirmation for me that owning a diversified portfolio of royalties and streaming rights to gold deposits, with no capital requirements, is far more stable a business than digging into the earth with your fingers crossed. If we’re looking at a way to play gold — and I think most investors should have some exposure to gold as a way to diversify a portfolio and hedge against the weakness of all major currencies — then I still think Sandstorm Gold offers the best combination of stability, growth, and management. Royal Gold is a great company, but it’s far larger and trades at a premium valuation to SAND, and will likely grow about half as fast in the next few years. Now that we’ve seen SAND come in a bit off of its sugar high from the NY listing and sudden attention from US investors, the shares have gotten very reasonably priced again at around $11.50. That’s not to say that the stock won’t fall if gold falls, of course, but if you want exposure to gold and some growth potential without the lottery ticket jitters of a junior mining stock or the plodding underperformance of a large mining stock then I think SAND is the best bet for this year.
Golar is probably the most aggressive and creative of the Liquefied Natural Gas shippers — they own a fleet of LNG tankers, as well as floating processing units (old tankers that have been retrofitted to serve as floating regasification units, turning LNG back into “dry” gas and feeding it right into land gas pipelines), and they’re even talking up the possibility of flexible, floating liquefaction units to serve the relatively small gas projects or offshore projects that might not justify a capital-intensive liquefaction plant (or to serve those wells during the years it takes to build a plant). Golar is a John Fredriksen company, one in a long string of aggressive firms that see a long-term trend (double-hulled tankers for Frontline, Deepwater rigs for Seadrill, etc.) and invest in it even as the crowd is worried about overcapacity. Like other Fredriksen companies, too, it uses “alternative” financing, including a captive MLP (Golar Partners, GMLP) to help make sure that investors can get solid cash dividends even from capital-intensive projects. LNG is a story that everyone knows know, and it is possible that the fleet is being overbuilt with the orders that have been placed and the increased number of tankers on the spot market (like Golar’s), but I think we’re still early in this game and that the LNG shippers will be in surprisingly high demand. The near-term risk is that over the next few years the tankers are built more quickly than the big new liquefaction plants come online, so a worse supply/demand outlook for the vessels might bring day rates down for a while, but it’s still an incredibly small market compared to oil shipping so small movements up or down can have outsize impacts … and we had a solid decade or more when almost no tankers were built before the current buildup.
While Golar is the LNG stock I currently own and the one with what I think is the most compelling potential, I should also note that although it hasn’t been in my portfolio or made the cut as an “Idea of the Month,” I actually think GasLog (GLOG) has more of a 2013-specific story — they have their fleet buildup happening right now, and the new tankers are under contract for the next couple years, so they have a very predictable spike in earnings expected this year — if you’re really thinking just one year out then GLOG may be a better pick. They have a similar current yield, though GasLog is likely to be more predictable and Golar is more likely to do something wacky to surprise investors.
Retail Opportunity Investments Corp (ROIC)
Since I’ve in the past suggested buying both ROIC and the 2014 ROIC Warrants, you probably realize that it’s one of my favorite picks — and yes, I also own both the shares and warrants. This is a real estate investment trust (REIT) that’s still in ramp-up mode and still growing their portfolio and their dividend quite aggressively. The “story” reason to own ROIC is that the CEO, Stuart Tanz, has done this before — he built up a portfolio of “necessity retail” shopping centers and then sold them for huge multi-year gains. So far he’s doing an excellent job with ROIC, the dividends have more than doubled in two years and the stock is now priced at a similar valuation (in terms of dividend yield, which is the focus of most REIT investors) to other shopping center REITs … but I think that they’re going to continue to grow much faster than other shopping center REITs, and that the dividend is likely to get another hike quite soon. There’s some uncertainty with the large number of warrants outstanding that can help to keep a lid on the stock if any pessimism hits the market (the warrants have a $12 strike price), but that warrant exercise cash can be put to good use — they have been dipping into debt now to leverage their returns, and they can borrow up pretty aggressively now knowing that, as long as the stock price stays in the $12+ range, they have a locked in equity raise coming in a year and a half to provide more capital. All they have to do is keep growing the portfolio, as they’ve done with their most recent acquisition of $100+ million worth of Southern California grocery-anchored shopping centers, and they can keep feeding the shareholders more cash. For 2013, I actually think that the warrants are a stronger bet from current prices — partly because I think we might see a buyout or exchange offer for the warrants if the company wants to remove that headwind, and partly because the stock is likely to rise further if the dividend is hiked, further increasing the value of the warrants. Oh, and partly because as of this moment, the warrants are actually trading at a small discount (they’re not very liquid, so that won’t persist for long). The warrants don’t collect the dividend, however, so I do think we’ve got a chance for about a 10% rise in the shares this year to go along with what is likely to be a 5% dividend on the current price by the end of 2013. A nice way to provide some ballast to a portfolio, and to give inflation protection if and when that feared beast raises its head.
Agrium is a farm products conglomerate, with a retail distribution network attached to a wholesale fertilizer mining and making business. They are the subject of a proxy fight with hedge fund Jana Partners, which has helped to drive the shares up considerably over the last six months … and I think that will continue for the first half of 2013. Jana has proposed a new slate of five directors, and is launching an actual proxy battle to get those directors on the board in the middle of this year. That may well not happen, many investors think it’s more likely that they’ll negotiate some sort of compromise over changing strategy and creating additional value for shareholders, but I think we have a good chance of seeing the shares up by at least another 20% in the first half of this year as the fight rages on. AGU is reasonably priced right now, at about ten times earnings, and analysts have pretty low expectations for growth in the current year, but they have already dramatically increased the dividend and they just made a deal with Sinofert in China to help alleviate some of the potash glut that we have in Canada right now (the drought took some of the money out of Midwestern US farming this Fall, though with commodity prices strong I expect they’ll rebound if we have decent weather this year). I hold AGU shares and some call options, I’m not sure if this would be my favorite long term holding on agriculture, but I do like agriculture investing in general and I think AGU has the best chance of some positive catalysts in the first half of this year — I expect Jana will fail in their push to actually split the company in two, but that they’ll make more progress in getting a better valuation and/or more capital return to shareholders.
Altius (ALS.TO ATUSF)
I’ve written very little about my holdings in Altius Minerals over the last year or two, but I continue to be patient with them … and I think we have early indications of a rebound in Chinese steel demand/iron ore demand that might bring a substantial spike to Altius shares this year. Altius is a prospect generator, for the most part — they stake out land, do preliminary studies, then sell off their work to explorers to do the expensive drilling and reserves building and, eventually, production … and Altius is trying to build a long-term royalty portfolio by also keeping a 2-3% gross royalty on all of the projects they generate. They have one substantial royalty right now, on the Voisey’s Bay nickel mine operated by Vale, and that royalty is expected to continue to generate about $4 million in cash per year for Altius (it had been low for a while due to the strike at Voisey’s Bay, but all seems to be back on track now), but their big value is in their experienced management and connections, their huge cash hoard, and their position in the Labrador Trough, a major iron ore production area in Canada. The biggest near-term catalyst, and the reason for thinking that 2013 will be a big year for Altius, is that the spinoff company they created, Alderon Iron Ore (ADV.TO AXX) is going to release their feasibility study sometime in the coming weeks … and if iron ore prices continue to be firm and Chinese interest continues to be high, these projects are going to get a lot more respect. Alderon will not be producing until 2015 (assuming everything stays on track), but they will make some progress in getting approvals this year with all permits expected by the end of the year and that, combined with the already existing deals they have with Hebei, should get them a higher valuation based on the massive production they should achieve and the huge size of the project — right now they’re targeting eight million tons of iron ore per year in initial production, and the company is valued at less than $300 million (they will need to raise close to a billion dollars for capital costs — rail access, building the mine, etc., but at their targeted production level that gets paid back in less than three years).
I like Altius now because Alderon provides a possible near-term boost as iron ore recovers, but they could also see other substantial deals in iron ore as investment demand for iron heats up in the wake of yesterday’s Chinese investment in ArcelorMittal’s projects in the same region and talk of more Chinese infrastructure stimulus, but there’s a lot to like for patient investors too — Altius has $32.9 million shares of Alderon along with that 3% royalty on the Alderon project (they have admittedly optimistic projections that this royalty could bring in $10 million in 2015 and rise to $50 million annually by 2018, if that happens they’ll be paying a huge dividend by then), so those shares, ignoring the royalty, are worth about $65 million. To go with that they have $162 million in cash now, so that’s $227 million in easily ascertained value. I’d say that the Voisey’s Bay royalty has a present value of a minimum of $20 million ($4 million a year for 25 years, discount it how you like) if they wanted to sell it, and they have partners doing probably $10-15 million in exploration work on their prospects in most years that will eventually result in a few solid payoffs at no cost. So you can easily value the company at $250 million just on the assets they could sell for that price today — ignoring the $25 million junior resource investment fund they have seeded, and the prospect generation they’re doing in Chile, and the next iron ore projects that could follow Alderon as they monetize their land position.
And in the blue sky future, if Alderon goes through with production in 2015, they could be looking at another huge equity win by selling those Alderon shares (as they almost certainly will over the coming years, assuming the price rises nicely), and a ramp up to $25-50 million in royalty earnings from that one project in three years. For that, the market is valuing Altius at about $300 million right now. So I still like Altius as a long-term holding if you can get it around $10-10.50 a share, and a no brainer if the shares fall further on any market weakness … but I also like them particularly this year because it looks like interest in iron ore investing is going to heat up, which could provide a strong leveraged return if Alderon’s valuation improves, and if investors start to accept that this mine will be built — which seems very likely to me, given the investments already made by Hebei and others — then that Altius royalty on Alderon’s project will become incredibly valuable. For the long term, there are a lot of ways Altius can win … for 2013, it’s all about iron ore prices and investor interest in these projects.
And now, the outliers — the more obscure “emerging” market stocks, both traded in London and somewhat hard to trade in the US, that I continue to hold personally and think might shine in 2013.
Lonrho (LONR in London, LNAFF on the pink sheets — usually pretty illiquid on the pinks)
If you’ve been around these parts for any length of time you’ve almost certainly heard me talking about Lonrho — which has been a substantial personal holding for about two and a half years for me, and which I continue to consider a very long-term speculation. Each one of my personal purchases of this one was above the current price, though the stock is right now about where it was when I suggested it to the Irregulars several years ago. So why particularly look at Lonrho for 2013?
Well, I think the spinoff of their airline, which is now FastJet, has provided a real opportunity to benefit from an aggressively growing airline without having to aggressively invest in that airline — they will gradually get diluted in ownership as Fastjet raises money to add more routes and planes, but I think that’s preferable to tying yourself directly to the capital-intensive airling startup business. Lonrho got them up to their first several planes and hubs, now they can sit back and see if focused management and more financing can turn them into the pan-African discount airline they envision. What I like about Lonrho is that the rest of the businesses are past their bit capital-intensive investment stage and should start to generate real cash flow this year — talk of a potential dividend to spit out some of that cash flow has come from management before, and cries for a dividend have come out from the investing press, but though they’re likely to get their eventually and I actually expect it fairly soon, there’s no guarantee that it happens this year. I added to my personal holdings in November, FYI.
Mail.ru (MAIL in London, MLRUY on the pink sheets — extremely illiquid on the pinks lately)
The Russian internet sector has been one of the real organic growth drivers of the technology world over the last couple years, and in all likelihood it’s going to continue — growth in key areas like credit cards and online payments are helping to fuel the growth of e-commerce, which helps to drive internet advertising rates higher, but Russia also has a huge tailwind because their internet penetration came so much later than in the rest of Europe and is still growing rapidly, so the audience in general still has many years of substantial growth potential ahead.
Mail.ru is one of the two leading globally-traded internet companies in Russia and the Russian-language world — Yandex (YNDX) is the other that most people are aware of, and it’s larger and easier to trade, so if you agree with me that the Russian internet sector should be an appealing growth trend for many years then buying into Yandex is an easier investment thanks to their US-listed shares. But I think Mail.ru is more interesting, and has more potential for non-advertising income. That becomes important because the “mobile revolution” is just as important — more so, in fact — in emerging economies as it is here in the US, where we’re seeing Google, Facebook and everyone else struggling with how to monetize mobile search given the much more limited advertising space and the more-fleeting attention of mobile users. Mail.ru has lost the search engine battle handily to Yandex, but it wasn’t really in that fight in the first place — Mail.ru started as an email and portal company, more like the modern Yahoo, and has expanded through heavy investment into internet value added services and social networking. Advertising remains a key part of the revenue picture for Mail.ru, but in their most recent results they’ve noted that other revenue sources are now larger … user-generated revenue exceeded 50% of revenue for the first time, thanks to increases from gaming and other online community services. Advertising has been running at between 30-40% of revenue, and dropping as a percentage recently.
Mail.ru owns the second and third place social networks in Russia and will likely take a larger position in the leading “facebook of Russia”, VKontakte, in 2013 — that brings more potential as Mail.ru follows in the footsteps of Facebook (in which it was an early investor, they’ve now sold off almost all their FB stake and own just 0.5% of that company) in monetizing social networking. With a toehold in internet messaging and video, social networking, online payments, email, search, and online gaming, Mail.ru is a more diversified way to play the Russian internet market … and it’s run by an aggressive entrepreneurial oligarch who is pushing to gain more control of important technologies in the Russian market. I’m still holding my Mail.ru shares, which are up a bit from when I bought them in 2011 because their Facebook stake was very undervalued (it also paid a 10% special dividend last year, largely to spit out some of the cash from sales in their holdings in Facebook, Groupon and Zynga). Numbers come in late and slow from Mail.ru, but right now they’re still posting revenue growth in the 30-40% range and they’re quite profitable — there’s a profit boost from last year that won’t be repeated, largely from the big facebook sale, but they’re generating EBITDA margins of better than 50% so they generate plenty of cash to reinvest into their activities (or to use to buy more of VKontackte). I suspect they probably won’t pay a dividend this year, but they might after further reducing their facebook stake if they don’t need that cash for their other investments. If you’d like the counter-argument, putting a bit of a damper on the prospects for Russian internet growth, check out this blog entry from the Economist last year.
So there you have it — I rarely invest with a timeframe as short as a year with very much of my own money, but of the stocks I’ve covered for you in the past those are the ones I’d look to for stronger performance in 2013 (and as you might expect, they’re all stocks that I own personally right now — so it’s just my opinion, but it’s not a disinterested one). We’ll see in a year if I was right about these picks being stronger than others in our coverage universe … and if the results aren’t too embarrassing, I might even tell you what they are.
Have a great weekend!
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