Petrobras PBR - expecting a strong recovery

The Latin American nation now runs one of the most orthodox monetary and fiscal policies in the world, and its highly capable central bank and fiscally disciplined government have maintained fiscal and trade surpluses during the entire episode of global synchronic growth and high commodity prices. The very high level of real interest rates avoided overheating the economy and creating an over-expansion of credit, which today would have ended terribly.

The decades-long policy of weaning itself off of imported oil by starting its own ethanol program and focusing on deep-sea drilling have helped Brazil achieve a remarkable level of self-sufficiency in the energy sector. And that self-sufficiency really paid off when oil had its massive spike up to $150 per barrel last year: The country’s savings made it a net creditor of the world.

So, Brazil – unlike the United States, England and much of Europe – was not over-levered. It was well positioned fiscally, and from an oil dependency standpoint, well equipped to face the dramatic events of last year.

As a result, the market has valued Brazil’s consistently prudent policies highly. In the four days after my October 27 recommendation, the MSCI Brazil Index fund shot up 31% as investors realized how cheap high quality Brazilian equities were trading and forced liquidation abated.

The ETF dropped back on some profit taking, but since mid-November, has brutally outperformed the S&P 500 by 37%.

PBR - One of Brazil's best stock

razil’s policy of energy self-sufficiency achieved a resounding victory last year. But there is much more ahead: Brazil is on its way to becoming a major oil exporter. And we are going to profit from it greatly.

Not only is oil going to rise strongly as soon as the major adrenaline shots of fiscal stimuli and massive monetary easing kick in around the world, but Brazil’s production is set to grow exponentially. This double benefit which led President Luiz Inácio “Lula” da Silva to proclaim that God had given Brazil a second chance, will create billions and billions of dollars for Brazil through Petrobras, its leading energy company.

Even with such an incredibly evident upside, there is always a catch to any bullish story. And in this case, some analysts believe that Brazil might resort to taxation or some other arrangement to minimize the upside for Petrobras shareholders and move that upside squarely into government hands.

Others point to the huge costs of developing these extremely deep properties, the difficulty in transporting the oil back to land, the length of time involved in developing these fields, and even the difficulty of obtaining financing now that oil has sold off from $150 down to about $50 per barrel.

Of course, I resoundingly disagree with all these objections. And here’s why:

The Brazilian government, unlike those of Venezuela and Bolivia, has a long track record of welcoming foreign multinationals and individual investors and treating them fairly.

Also, Brazil has been at the forefront of deep sea drilling for years. For example, it has a 25% stake in the biggest U.S. oil find in decades: the Jack II in the Gulf of Mexico. And Petrobras actually anticipated the rush for oil by locking in long term contracts for every major deep sea drill rig that they could get their hands on ahead of the market.

Sure, it faces new challenges, but Petrobras – from ethanol to deep sea drilling – has proven savvy with its timing and consistent with its execution.

Finally, as I had anticipated back in October, projects of huge strategic and financial significance will be a breeze to finance, even in very difficult market conditions. Indeed, China which has been wisely using this crisis to cherry-pick access to commodities around the world, recently reached an agreement with Petrobras, in which China Development Bank will provide Petrobras $10 billion in financing in return for a long-term supply of oil.

We simply cannot pass on Petrobras, with the company ahead of a recovery in activity in the global economy and a devaluation of the dollar.

Petrobras rose 1.83% Friday to close at $35.17 a share. The stock is up more than 43% year-to-date.

DRYShips (DRYS) - Is Opportunity knocking?

DryShips (DRYS) has had problems with its credit lately. It has refused to take delivery of Capesize vessels (and has cancelled many future deliveries). DRYS has had to pay a stiff price for all of this. It has cancelled its dividend. It has, however, been able to renegotiate its credit with Bank of Piraeus to restructure two loan facilities totaling $220 million, with $164.9 million currently outstanding. Under the terms of the deal, outstanding repayments will be reduced by roughly 47% in 2009 and by 21% in 2010. The deal also includes a covenant waiver through Jan. 1, 2011.

DRYS has made a shelf registration to sell $500M worth of its shares purportedly to help shore up its credit situation. This will no doubt cause share value dilution. I have talked to investor relations at DRYS. They say there is no set timeline on the sale of these shares. They will inform shareholders when the shares are sold. The shares have fallen as a result from the recent $13-$15 range to their current price of approximately $6. They were as low as the high $4 range at one point. This begs the question, why buy now?

The answer is twofold. First, nothing has dramatically changed in the DRYS shipping business. It is still a great value. The ship deliveries that were cancelled were cancelled to cut back on CAPEX for the near future. This is something nearly every company is doing in these hard times. The money raised from the share sale will likely be used to retire debt (or make further acquisitions). The money from these shares is going to be used to make the company more financially stable. The BDI has been going up steadily on increased demand from China, due to its infrastructure heavy stimulus package (and a possible second infrastructure package). The imminent approval of the US stimulus package is likely exerting an indirect effect also. The BDI stands at 1642 with the capesize spot price at $30,001. It has risen consistently for the past two months.

Second, DRYS has announced that it is planning to spin off its Ocean Rig holdings as a new company by issuing shares as a dividend to its shareholders. The regular dividend has been cancelled. However, I have not heard that this dividend has been cancelled. The proposed spin off was supposed to occur in Q1 of 2009. However, I have confirmed with DRYS’ Investor Relations that the spin off has now been delayed until 2H 2009.

Investors should take into account that the consistent rise in the BDI lately will likely mean that the market prices of old ships will be going up also. DRYS has one of the best price to book ratios in the industry. If the used ship prices go up, DRYS should soon have no problems with covenant violation, as these problems have largely arisen due to mark-to-market accounting rules.

Visa V - Can the stock hold up?

Visa reported earnings of $0.78 for the quarter ending December 31. This beat consensus expectations which were expecting earnings of just $0.66. After the announcement, the stock rose 11.3% in just two days.

The rebound was good news for investors who had held the stock since the IPO in March of 2008. These investors had purchased the stock at a price of $44 which has turned out to be an area of support on the chart. In fact, this level was in danger of being broken in late January until a rebound in the market allowed the stock to re-take its IPO price.

Ironically, the primary reason that Visa beat estimates is not because revenue levels were high. In fact, US transaction revenue was actually flat with last year’s level. US credit card transaction volume was down about 6% and US debit card volume was up enough to net those losses out to roughly zero. The revenue growth came from international transaction volume, and the earnings beat actually came from significantly lower expenses.

Now, I have utmost respect for a company that is able to cut its expenses during a weakening market in order to operate profitably. However, the bottom line is that Visa is not immune to the global recession which is why management is dealing with expenses so aggressively. Advertising and marketing remained at $210 million for the quarter which is flat with the end of last year. This is not the type of action you would expect to see out of an aggressive growth company.

I’m actually a bit surprised that management is not increasing its marketing budget in order to capture market share and strengthen its competitive position. The fact that Visa has pulled back spending to this point is a testament to just how difficult this current environment really is.

Looking to the quarters ahead, management has reiterated their commitment to growing earnings by roughly 20%. At this point, it looks like that growth will be from cuts in expenses instead of due to actual revenue growth. This game can only be played for so long. Once excess expenses have been cut, management must make the decision to cut necessary projects, which end up affecting long-term revenue growth, or else abandoning the 20% earnings growth target. Neither of these choices will likely have a positive effect on the stock.

On a macro level, Fitch recently commented on credit card issuers stating that late payments on US cards topped record levels. Last month default levels rose sharply and Fitch expects the credit card Asset Backed Securities to worsen because of the delinquency rates. Investors in Visa and MasterCard will argue that this doesn’t matter because these companies simply process the transactions and do not have credit risk.

But credit risk eventually affects Visa because as banks deal with increasing credit risks, they will begin to issue fewer cards which means slower growth or even a decline in the transaction revenue. International markets are facing similar problems and while they may not be saturated to the point that the US markets are, the anticipated growth in international market is likely too optimistic.

Options in Agricultural stocks

MOS – The Mosaic Company – Shares of the crop nutrient and animal feed producer have jumped higher by 5% today to $43.26. Options activity today seems to be a sign of the positive movement in MOS’s share price. One investor initiated what appears to be a 7,500 lot call spread in the March contract. Though the calls were traded to the middle of the market, we believe that this trader purchased 7,500 calls at the March 45 strike for 3.97 and sold 7,500 calls at the March 60 strike price for a premium of 1.00 per contract. By taking in the 1.00 premium, this investor is effectively financing the call spread and lowers his net cost to 2.97. Shares of Mosaic would need to rally to a breakeven price of $47.97 per share in order for this trader to reel in profits.

POT – Potash Corporation of Saskatchewan, Inc. – The integrated fertilizer and feed products company stood out this morning due to some interesting options plays amid a share price rally of 5% to $90.22. It appears that one 5,000 lot 75/95 March call spread was unwound today, perhaps because this investor has realized substantial profits from a previously established hunch that shares would rally. Focus has since shifted to the put side, where one investor purchased 15,000 puts at the June 65 strike price for 5.50 apiece. As shares breathe a sigh of relief on today’s lift, this medium-term bear took advantage of falling put premiums and established substantial protection. We believe that this large trade contributed to the rise in option implied volatility on the stock by 17% to 77%. Though shares have reached a four month high, it appears that this trader still feels the acrid sting of POT’s 52-week low of $47.44 back in December of 2008. While fertilizer seems to be the hot new item, this bear does not look to be ready to join the crowd just yet.

Amazon - Selling AMZN Short

Amazon (AMZN) delivered nice results, but let’s face it, they were not fantastic enough to justify propelling the share price 20%. I admit, I got my head handed to me on a plate, as my 800-share short position caused some serious hurt. I guess I drank too much of Broadpoint Capital’s Analyst Tim Boyd’s bearish Kool-Aid, but as a consequence of the violent run up, I think the shares have become even more overvalued.

I am stubborn and will hang on to my short position until profit taking hits, and knocks the stock down to more realistic levels. The stock ran up more in one day than the company is expected to earn in the next five years combined. Its insane multiple of 40 times 2009 estimates of $1.48 borders on calamity. I realize that AMZN deserves a higher multiple, since it is one of very few stocks still generating earning growth, but more in the range of 20-30% higher, not 100% or 200% loftier than such names as RIMM, AAPL, MSFT, EBAY , CSCO and INTC, averaging about a 15 PE multiple.

Fourth quarter was good, but not that good; when the company issued fourth quarter guidance back in October, it comprised a large range. Sales guidance was $6 billion to $7 billion, while its operating earnings forecast was $145-$305 million. Well, AMZN didn’t even end up surpassing the top end of its revenue guidance when it posted sales of $6.7 billion (they came in the top 30% of the range). AMZN also came in within the top 30% of its earnings range, prompting the question: What is all the fuss about? I just don’t see how the market construed this as a beat? Am I missing something? Could it be excitement about Kindle sales? Bezos made it clear the Kindle reader was attracting strong demand, but refused to provide details. Is this a “pump and dump” scheme?

First quarter guidance was sketchy: AMZN is supposed to be a “growth stock”, yet its low end guidance for its first quarter indicates a falling off as much as 37%. AMZN’s operating income guidance is so wide, you could sail an aircraft carrier through it, comprising a range of $125 million to $210 million. The top of the range is 85% higher than the bottom. When it comes to its revenue guidance range, it is much tighter. The spread of $4.52 billion to $4.92 billion, represents the top end, at only 10% above its starting range. Growth stocks are not supposed to see earnings declines, and AMZN will make sure “at all costs” it avoids this calamity. My best guess is, they will repeat their 4th quarter scenario by coming in within the top 30% of guidance ranges in both sales and earnings, delivering sales of $4.8 billion and earnings of $185 million.

Gross Margin issue: If you compare gross profit margin on a year to year basis (4th Q 2008 versus 4th Q 2007) its decrease does not seem that alarming - dropping only 50 basis points from 20.6% to 20.1%. The decrease represents only a 2.5% reduction. However, if you compare AMZN’s gross profit margin sequentially, the picture begins to look bleaker. The fact is, AMZN produced a 23.4% gross profit margin in its third quarter. In just one quarter, AMZN incurred a 350 basis point loss to its gross margin, signifying a 14% overall deterioration. That is significant when you consider new services with very high margins, such as music and video downloads, seem unable to slow the margin erosion. Remember, AMZN is a retailer, and gross profit margin to a retailer is like fish is to a fisherman, "sacred."

Bottom line: The shares have simply gone up too far in too short of a time frame and are due for a nice dose of profit taking, as longs begin to ring the cash register. The stock also received some nice upward momentum due to massive short covering, but this covering will soon begin to abate. When reality finally starts to set in and the “giddiness” over the quarter evaporates, the stock will sink to a more appropriate multiple. Hopefully longs will have the sense not to get too greedy and use this recent strength as a selling opportunity, before their gains turn quickly into losses. Don’t get me wrong, I think AMZN is an extremely well managed company, with tremendous prospects. It is just too pricey.

Dry Shipping stocks showing strength

DryShips (DRYS) has been in the news of late, taking traders on a wild ride. Last week the company was notified that it was in breach of its financial terms on a large chunk of debt and the company announced it would dump stock and cancel ship orders to preserve liquidity. The stock plummeted more than 50% in just 3 trading days….

On Tuesday, the stock got a reprieve when it announced an agreement with Piraeus Bank to restructure two of its loan facilities in order to regain compliance, resulting a swift recovery rally. DRYS is a favorite of traders, but I prefer to take a look at its competitors - TBSI International (TBSI), Diana Shipping (DSX), Excel Maritime (EXM)& Genco Shipping (GNK).

All broke out yesterday with heavy volume and could gap up this morning. Be very careful about chasing these particularly in this market. Be patient and wait for your price. Diana Shipping (DSX) is probably the safest of the group while Genco Shipping has problems of its own having recently suspended the dividend and share buyback. It should be noted that most of the shippers have suspended their dividend, but as far as I know Excel Maritime (EXM) is still paying out.

Yes, the shippers have problems but these are technical trades of a few weeks. They look quite bullish in the short term.

YRCW stock - US transportation sector

It is amazing what a different story you hear when you compare government reports to company reports. Whatever alternative universe the bulls live in, is one I'd love to languish in - must be a nice place. One area that has been leading this market down of late is transports. They've been horrid. While the dry bulk shippers have been bad for a long time, railroads held up much of 2008. They have been terrible of late; Paul Kedrosky has a chart showing the year over year crash in shipments by category.




It is a similar case with the Fedex (FDX), UPS (UPS) cohort. I'm not that familiar with the trucking industry since it's not really an area I play in on the long side, but I am familiar with YRC Worldwide (YRCW) which is the #1 trucker in the U.S.

Let's see what YRC is saying

• Struggling No. 1 U.S. trucking company YRC Worldwide Inc (YRCW) on Thursday reported a fourth-quarter net loss, citing the impact of the slowing U.S. economy and impairment charges.
• The U.S. trucking sector has suffered from weak volumes since the third quarter of 2006, a slowdown that has been made worse by sliding retail and auto sales, the U.S. housing sector meltdown and the slowing of the overall economy.
• The company reported revenue for the quarter of $1.93 billion, down from $2.35 billion a year earlier.
• The Overland Park, Kansas-based company reported a fourth-quarter net loss of $244.4 million, or $4.14 a share, compared with a net loss of $735.8 million, or $12.99 a share, a year earlier. Excluding impairment charges related to a write-down of goodwill related to the integration last year of two trucking units under a single brand and a write-down of goodwill at its YRC Logistics unit, the company posted a loss of $2.51 a share.
• "Our results reflect the significance of the economic recession that has been longer and deeper than anyone anticipated," (anyone? hmm... someone is not reading certain blogs) Chief Executive Bill Zollars said in a statement. "Although we were not pleased with this level of performance, it was consistent with our internal expectations and those of our banking group."
• YRC is in discussions with its lenders on its debt covenants and Zollars said "discussions with the banks are progressing well, and we are on track to finalize an amendment by mid-February."