|
The United States of China Should American seniors who've been paying taxes their whole lives get stiffed after age 62 – and get nothing in return? That's exactly what could happen. And every dollar could end up in the hands of Chinese bondholders. Powerful political and corporate interests prevent this story from being aired on the nightly news. If you want to know the fate of your money – and how to keep it, please go here.
| Buffett Feasts on Heinz | | by Chad Fraser
2/19/2013 | | On February 14, H.J. Heinz Company (NYSE: HNZ) announced that it is being acquired by Warren Buffett's Berkshire Hathaway (NYSE: BRK.A, BRK.B) and investment firm 3G Capital. The Heinz acquisition is the latest in a string of big buyouts so far this year. It comes on the heels of Comcast's (NasdaqGS: CMCSA) acquisition of the 49% of NBCUniversal that it didn't already own and the takeover of computer maker Dell Inc. (NasdaqGS: DELL) by founder Michael Dell and Silver Lake Partners. In all, these latest deals have powered M&A activity in the U.S. to $182 billion so far this year, up from just $58 billion at this point in 2012, according to CNBC. The Heinz takeover ranks as the biggest single acquisition in the food industry's history. Heinz Takeover Fits Buffett's Value Investing Style … In all, the Heinz deal is valued at $28 billion. Investors will get $72.50 for each share they own, which is a 20% premium on the stock's closing price of $60.48 on February 13, the day before the takeover was announced. Berkshire and 3G will each put in about $4 billion for their 50% stakes in Heinz, with 3G operating the company. In addition, Berkshire will invest in $8 billion of preferred shares thought to be yielding around 9%. In all, Berkshire is spending between $12 billion and $13 billion on the Heinz takeover. The remainder will be funded by a rollover of the company's existing debt, as well as financing from J.P. Morgan (NYSE: JPM) and Wells Fargo (NYSE: WFC). In many ways, the Heinz move is par for the course for Buffett, whose value investing strategy includes buying and holding shares of companies whose businesses are easy to understand and have products that clearly stand out from the competition. He also looks at a number of fundamentals that point to increasing value, such as consistently rising earnings and cash flow; an attractive return on equity; low debt; and high-quality assets. Heinz fits most of these criteria: from 2008 through 2012 (its fiscal year ends on April 30), Heinz's earnings per share rose 8.4%, from $2.63 to $2.85, while sales gained 15.7%, to $11.6 billion, and operating cash flow rose 25.7%. Its long-term debt has held steady between $4.7 and $4.8 billion, but its cash reserves have grown from $617.68 million in 2008 to $1.33 billion in 2012. In the company's latest quarter, which ended October 31, 2012, its sales were flat at around $2.8 billion, though its earnings jumped 23.3%, to $0.90 a share from $0.73 a year earlier. Its gross margin was 35.8%, up from 34.3% a year ago. This performance has come against the backdrop of the global recession, fierce competition from generic products and, more recently, rising ingredient costs, which have put the squeeze on most food makers' profit margins. Throw in the company's well-known products (including Heinz ketchup, Classico pasta sauces and Ore Ida snack foods) and it's not hard to see how Heinz appealed to the Oracle of Omaha, who places a high value on brand names himself: Berkshire's current holdings include an 8.95% stake in arguably the world's most popular brand, Coca-Cola (NYSE: KO), as well as interests in names like IBM (NYSE: IBM), Procter & Gamble (NYSE: PG), Wal-Mart (NYSE: WMT), General Electric (NYSE: GE) and Johnson & Johnson (NYSE: JNJ). … But Did He Overpay? The move does, however, appear to go against Buffett's typical approach in a couple of significant ways. For one, it's hard to argue that Heinz was undervalued: the stock had risen 16.2% in the year leading up to the deal and was trading near 52-week highs before Berkshire and 3G paid an additional 20% premium. The $72.50-a-share purchase price is also a high 23.2 times Heinz's last 12 months of earnings. Plus, the bank debt the partners took out to make the purchase will significantly increase the company's current obligations, adding to its interest costs and making it harder to increase its earnings, which Heinz forecast would grow between 5% and 8% in fiscal 2013 back in October. As well, as Stephen Gandel pointed out in a February 15 Fortune article, Heinz will be on the hook for the 9% payout on Berkshire's preferred shares, or some $720 million annually—though that does give Buffett some insurance on his investment. It's also unusual for Buffett to work with a partner; even more so when that partner will have operational control of the acquisition ("It's their baby from an operational standpoint," he told CNBC). However, 3G, which is backed by Brazilian investors, has a strong track record in finding savings and increasing sales at the companies in which it invests. A good example is Burger King (NYSE: BKW), which the group took over in a $3.3-billion deal in 2010. As the Financial Times reported on February 15, 3G was behind the burger chain's move to a franchise-based model, which is nearly complete. In the fourth quarter, Burger King's net income jumped 94%, to $48.6 million, or $0.14 a share, from $25 million, or $0.07 a share, a year earlier. Buffett Is "Ready for Another Elephant" At the end of 2012, Berkshire held $47 billion of cash, which is far higher than the $20 billion or so that Buffett likes to have on hand. Even after the Heinz deal, he should still have around $15 billion to put toward another acquisition and still stay above his threshold—and the company's cash pile keeps growing. The ever-quotable Buffett likens his penchant for acquisitions to elephant hunting. "I'm ready for another elephant," he told CNBC after announcing the Heinz acquisition. "Please, if you see any walking by, just call me." |
Why is Warren Buffett Dumping Blue-Chip Stocks? Buffett's favorite holding period is "forever." So why is he dumping blue-chip kings like Johnson & Johnson, Proctor & Gamble and Intel? George Soros dumped his holding in these stocks, too…along with a bunch of banking giants. These investing gurus are rushing into gold.
But what do the rest of us who can't afford big gold buys do? We play it safe. We go old-school with this group of stocks. They've beaten average stocks NINE times over and paid out a healthy yield. They'll see you through the billionaire's panic. More here.
| The Sweet and Sour Economics of Refining | | by Robert Rapier
2/18/2013 | It's important that investors understand what they are buying. The biggest gains I've made over the years were in companies whose business I understood well. The biggest losses have been in companies that I didn't understand nearly as well.
During the tech stock bubble from 1997 to 2000, a lot of people – including me – made and then lost money on companies we didn't really understand. I wasn't sure exactly what JDS Uniphase (NasdaqGS: JDSU) did, but I did know that the talking heads on CNBC and at MSN Money believed that the sky was the limit.
But I didn't understand its business. Who were the competitors? What were the threats? I didn't really know and over time it became very clear to me that I was simply gambling, not investing. I was taking the advice of people who in many cases didn't understand these businesses themselves, but who had an impressive track record primarily because they had been making their recommendations during a bull market for technology stocks. When the stock price of JDSU started to fall, I was uncertain whether to sell, because I didn't really understand the long-term prospects.
With that in mind, US refiners have been on a hot streak lately. In the past three months the share prices of Valero Energy (NYSE: VLO), Tesoro (NYSE: TSO), and Marathon Petroleum (NYSE: MPC) (all of which have been recommended here) have appreciated by 61%, 44%, and 52% respectively.
But oil refining has historically been a highly cyclical business. Get in at the right time and you can make a lot of money quickly. Get in at the wrong time and you can lose a lot just as quickly. This is why I caution against buying a refiner if you prefer to buy a stock for the next five years. I would have no major concerns about holding a large integrated oil company like Chevron (NYSE: CVX) for that long, but the refiners require much closer monitoring.
So let's examine the refining industry in some detail. Oil refiners convert crude oil into finished products such as gasoline, diesel, jet fuel, fuel oil and asphalt. But there can be significant differences among refiners. Recently we have seen refiners in the Midwest and on the Gulf Coast making record profits, while those on the East Coast are going bankrupt. The separator is generally the type of crude oil the refinery can process, which is a function of logistics and equipment.
When a refinery purchases crude oil the key piece of information, besides price, is what the crude oil assay – or composition analysis – looks like. The assay gives valuable information on the types of products that can be produced from the oil, as well as the degree of difficulty in refining it. You have probably heard terms like "light sweet", or "heavy sour", but how do these qualifiers affect the ability of a refiner to turn these crudes into products?
Let's look at a pair of typical crude oil assays:
In reality this is only a portion of a crude oil assay. The full assay would include metals concentration, salt concentration, vapor pressure and so on.
The graphic compares an assay of light crude (the higher the API gravity – a measure of density – the lighter the crude) with one of heavy crude. The light crude is also sweet (i.e., it has low sulfur content) and the heavy crude is sour. A heavy crude can in fact be sweet and a light crude can be sour. But the refiners equipped to handle heavy crudes are generally also equipped to handle sour crudes, so that's what they buy.
An assay is done by boiling the crude and measuring what's boiled off at various temperatures. This defines the various products and refining stages, also known as cuts. In the sample assay above, when 99°F has been reached, the gas has been boiled off. This is dissolved methane, ethane, propane, some of the butane and some trace higher gases present in the oil. This cut can be further purified for sales or used as fuel gas to help satisfy a refinery's need for steam.
The next cut is straight run, or natural gasoline. Gasoline is a mixture of hydrocarbons that are characterized by the boiling point, and the gasoline you purchase at the gas station will contain many different blending components. One of these will usually be light straight run gasoline. This cut will contain compounds like butane, octane and every manner of branched and cyclic hydrocarbon that boils in that specific range.
Most gasoline has been subjected to additional processing. The straight run gasoline is what can be expected to be distilled from the crude oil with no additional processing. Typically, straight run gasoline is not a highly desirable gasoline blending component, because the octane rating is usually low. (Octane rating is a measure of resistance to preignition; higher octane ratings can withstand higher pressures before they ignite.)
The next cut is naphtha. Naphtha can be blended into gasoline, but the octane rating is even worse than for light straight run. Therefore, naphtha is usually fed to a catalytic reformer, which boosts the octane rating from less than 40 to more than 90.
We then come to kerosene (also called "jet"), which starts to get into the range of diesel components. This cut has a higher energy content than the earlier cuts, but the boiling point is too high for it to be blended into gasoline. Kerosene is used as fuel for jet engines and is also blended into diesel. It is also used in some portable heaters and lamps.
The sulfur components start to become more concentrated in these heavier cuts, so they are often subjected to hydrotreating. In this step, hydrogen is used to convert sulfur components into hydrogen sulfide, which is then removed.
The next cut is distillate (specifically, No. 2 Distillate; kerosene is sometimes called No. 1 Distillate). Like kerosene, this cut contains sulfur and must be treated (as with all of the heavier cuts). Distillate has two major end uses: as diesel fuel and as home heating oil. In fact, as seen in the assays above, a substantial portion of a barrel of oil ends up as heavy distillate. For the light sweet crude assay above, 32.4 percent ended up as distillate, and for the heavy sour crude the proportion was 19.3 percent.
We then come to gas oil, which is also known as fuel oil or heavy gas oil (distillate also being known as light gas oil). This cut is typically processed in a catalytic cracker to make cracked gasoline. Cracking involves breaking heavy, long-chain hydrocarbons down into shorter hydrocarbons that boil in the gasoline range. Cracked gas is then blended into the gasoline pool.
The final cut, residuals, or just plain "resid," is of greatest interest when we talk about the economics of heavy crudes versus light crudes. Note that in the assay above less than 5 percent of the barrel of light crude ends up as resid. Meanwhile, the heavy crude yields over 28 percent resid.
Resid is sold as asphalt and roofing tar and is not a desirable end product from an economic standpoint. So more refiners are installing cokers, which can crack resid into additional gasoline, diesel and gas oils. The economics are usually very attractive given the historical price spread between light oil and heavy oil. A coker can turn over 80 percent of the resid into valuable liquid products.
Heavy sour is cheaper than light sweet for a couple of reasons. The most obvious is that heavy and sour crudes are more difficult to refine, and require more capital investment. Refineries will only make these capital expenditures if the heavy and sour crudes are discounted. But many refineries in the world are not configured to handle heavy and/or sour crudes, which tends to ratchet up the price of light, sweet crude.
The gasoline derived from any type of crude is interchangeable and priced as a single commodity. But thanks to the steep discount, there is more money to be made with heavy sour crudes as long as a refinery is configured to handle them.
Watch That Crack Spread
The crack spread refers to a refinery's profit margin on the fuels it produces. It is, in other words, a gauge of profitability.
Let's compare two hypothetical refineries.
Refinery A has no coker and is thus restricted to either buying light crude or buying heavy crude and selling a lot of low-value asphalt and roofing tar. Refinery A pays $100 a barrel for the generic light, sweet crude illustrated by the graphic. It will convert that barrel into 0.909 barrels of liquid fuel product, which let's say has a value of $120/bbl (in reality, the volume would be slightly greater due to something called refinery processing gain; simply stated the volume "swells" as it is processed). Per the light assay above, 4.4 percent ends up as gas and 4.7 percent as resid.
Refinery A has therefore grossed $120*0.909 – $100, or $9.08 a barrel before we consider the value of the asphalt and the gases. The price of asphalt has risen sharply in recent years as a result of higher oil prices, and also because more refiners are turning their asphalt into higher value products, reducing the asphalt supply. Let's say that our refiner receives $0.25/lb for its asphalt. A barrel of crude weighs around 300 lbs, so with a 4.7 percent asphalt yield, the barrel yielded 300*0.047 = 14.1 lbs of asphalt worth $3.53. Let's value our gases at the value of propane (about $0.20/lb on the spot market), and we get a value of 300*.044*$0.20 = $2.64 for the propane. Our gross profit, or crack spread (before operating costs, taxes, etc. are considered) is then $9.08 + $3.53 + $2.64, or $15.25 per barrel for the light crude.
Now consider Refinery B. Instead of buying light, sweet at $100/bbl, it can obtain a heavy Canadian crude for $70/bbl (the current discount of heavy Canadian crudes to West Texas Intermediate is actually about $40/bbl.) Again, its barrel of oil weighs some 300 lbs, and as we can see from the assay above the resid yield may be in the range of 28 percent. So, of the 300 lbs, 84 lbs ends up as resid. But with a coker, the refinery can convert 80 percent of that resid into high-value products, and only 20 percent (16.8 lbs) ends up as low-value coke (a coal substitute).
Therefore, the overall yield from the heavy crude amounts to the sum of the cuts up to resid (71.6 percent), plus the resid that was turned into products (80 percent of 28 percent, or 22.4 percent), minus the gas cut (3.4 percent), for a total of 90.6 percent. The overall liquid yield is almost the same as for the light crude, and yet the refinery paid much less for its heavy.
So, the economics for Refinery B look like this: For the liquid fuels, it grossed $120*0.906 – $70 = $38.72 a barrel. This is four times Refinery A's liquid fuel profit from the light crude, but Refinery B has slightly less propane yield than the previous example. The value of propane is $2.04. Finally, Refinery B ends up with 16.8 lbs of coke, which is worth only about $0.03/lb (about $0.50 total). The total gross profit then is $48.72 + $2.04 + $0.50 = $51.26.
It should be no surprise that refiners are rushing to install cokers in order to be able to process the discounted crudes. As light sweet supplies deplete, refiners will increasingly turn to heavy sour crude. This also explains why refiners are willing to bring in crude by rail, even though it is more expensive than via pipeline. With discounts this steep on the heavy crudes, the processing economics overwhelm the cost of transportation.
Of course the catch is that a coker is a major capital expense (hundreds of millions of dollars), and it is only part of the equation. I have focused here only on processing heavy crudes, but not on sour crudes. The story is similar to that for the heavy crudes. Sour crudes trade at a discount to sweet crudes, and the refiners need additional processing equipment to handle them.
But the economics currently favor installing the cokers and hydrotreaters to handle the heavy sour crudes, and will continue to do so as long as they trade at a substantial discount to light sweet crudes.
Part of the reason that East Coast refiners have struggled in recent years is that they primarily had access to the lighter grades of crude oil, and were equipped accordingly. As heavy crudes began to trade at a steeper discount, mid-continent and Gulf Coast refiners saw their crack spreads soar. Many of these refineries had been processing heavy Canadian crudes for years, but East Coast refiners don't have easy access to these crudes. Nor do they have good access to the discounted mid-continent crudes coming from the Bakken, although some Bakken crude is starting to be moved to East Coast refineries by rail.
As an investor, you want to own shares in refiners that are configured to run the heavy, sour crudes – as long as these crudes continue to trade at a significant discount to Brent crude. If that discount starts to meaningfully shrink, that will serve as a warning signal for investors in refineries.
This article originally appeared in the The Energy Letter column. Never miss an issue. Sign up to receive The Energy Letter by email. |
Best One-Two Punch in the Oil-Service Industry Big Oil is moving offshore. Today's biggest finds are deep underwater. One company has pioneered an "MRI" for the ocean floor. It produces the most accurate images of what's below the ocean floor, making oil finds a breeze. The stock trades at 15 times earnings. It should be at 25. It's a bargain.
A second company is a deepwater driller. It charges $635,000 a day for oil companies to use its rigs. It has 24 of them – the best rigs in the business. More contracts are signed almost daily. You can expect a solid profit margin for years to come. Go here to pump up your portfolio.
| Secondary Offerings Put MLPs in the Bargain Bin | | by Ari Charney
2/17/2013 | | After enduring a disappointing fourth quarter, the master limited partnership (MLP) space is leading the market so far this year. Indeed, on a price basis, the Alerian MLP Index is beating the S&P 500 by 5 percentage points year to date. And when you include the reinvestment of dividends for both indexes, that advantage widens to more than 6 percentage points. As such, among the MLPs in our coverage universe that have buy targets--as opposed to "hold" or "sell" ratings--roughly half are trading above these recommended thresholds. That greatly narrows the number of MLPs that not only trade below our buy targets, but also have a Safety Rating of 3 or higher, as well as the prospect of ample distribution growth. But first, a proprietary aside: Our MLP Profits Safety Rating System focuses on those factors that are indicative of both the safety of a distribution, as well as its potential for future growth. The highest possible Safety Rating is a 4. One of the more intriguing names that satisfies the aforementioned criteria is Golar LNG Partners LP (NSDQ: GMLP). The limited partnership (LP) was created by its general partner Golar LNG Ltd (NSDQ: GLNG) to own and operate floating storage and regasification units (FSRU) as well as liquefied natural gas (LNG) carriers. Both the LP and GP are owned by World Shipholding Ltd, an entity that's indirectly controlled by Norwegian-born Cypriot shipping magnate John Fredriksen. The billionaire is perhaps best known among investors for his other ventures, including offshore driller Seadrill Ltd (NYSE: SDRL) and oil shipper Frontline Ltd (NYSE: FRO). Although the market for LNG shipping is in relatively tight supply, Golar's unit price has fallen just over 30 percent since hitting an all-time high of $39.05 last year on March 2. Of course, at a recent closing price of $30.01, Golar's units are still up 33.4 percent since the LP's April 2011 initial public offering (IPO). And when you include the reinvestment of distributions, the return is an even more attractive 47 percent, which compares quite favorably to the S&P 500's 14.2 percent gain over that same period. Given the relative strength of the niche in which it operates, it's possible that Golar's units have simply been beaten down in sympathy with other MLPs that specialize in seaborne transportation. But those shippers are operating in markets facing significant challenges, such as dry-bulk shipping, which is suffering slackening demand amid an oversupply of carriers, and crude carriers that are weathering OPEC's production cut. A Trio of Secondaries A more likely explanation could be the MLP's three secondary equity offerings over the past seven months. As Roger Conrad has previously written, investors typically see secondary offerings in a negative light because of concerns about dilution. And that almost always leads to a selloff. In fact, unit prices often fall below the secondary offering price. Golar's first follow-on offering was announced on July 10 in the wake of the previous day's news that it would be acquiring an FSRU from its GP in a $385 million dropdown transaction. Investors must have anticipated that financing would entail a secondary offering because units began selling off with the announcement of the acquisition on July 9. Over the next several days, unit prices fell as much as 11.6 percent (to $30.80) before finally stabilizing. The MLP ultimately issued 6.32 million units at $30.95 each. The same scenario occurred in early November. Golar announced a major acquisition on Nov. 1, followed by a press release the next day detailing another secondary offering. The MLP acquired the Golar Grand, a liquefied natural gas (LNG) carrier, in a $265 million dropdown transaction. However, the timing of the deal also coincided with a selloff in both the MLP space and the broad market. As a result, Golar's units fell 20.5 percent (to $25.52) over the next two weeks before finally rebounding. The MLP ended up issuing 4.3 million units for $30.85 each. And at the end of January, Golar's third follow-on offering came in tandem with its acquisition of the LNG carrier Golar Maria in a $215 million dropdown deal. But this time the effect was somewhat muted since these moves transpired during a period when both the market and MLPs were advancing. Golar's units declined by 5.5 percent (to $29.25) before heading slightly higher again. The MLP issued 3.9 million units at $30.00 each. Dilution or Distribution Growth? While worries about dilution are perfectly reasonable in other sectors of the stock market, MLPs regularly issue additional units to finance growth-oriented capital expenditures and acquisitions. In many cases, acquisitions can involve assets that are already under long-term contracts, so the MLP's management team knows the return to expect from its investment well in advance of making it. In Golar's case, all three of these deals involved assets under long-term charters--the two LNG carriers are effectively under contract for about 5 years, while the FSRU is under contract through the end of 2022. And both of the LNG carrier deals were directly tied to bumps in the quarterly distribution of 3 percent to 5 percent. So what is the potential for further distribution growth? Golar's already boosted its payout by 25 percent since late 2011, and its next quarterly payout should rise at least 3 percent, thanks to its most recent acquisition. Thereafter, it depends on the rate at which its GP offers additional dropdowns. Though a third-party transaction is always possible, in a tight market it would be difficult to engineer such a deal at an attractive price. Management had previously forecast two to three dropdowns in 2013, so that leaves another one to two dropdowns for the remainder of the year. The MLP currently has four FSRUs under contracts ranging from 10 years to 15 years, as well as five LNG carriers with charters ranging from 5 years to 20 years. The GP currently has five LNG carriers, with another 11 newbuildings and two new FSRUs slated to join its fleet through 2015. In terms of contract duration, the GP's vessels are under a variety of charters, but the LP is principally focused on long-term charters. With the abundance of LNG expected to enter the global markets from the US, Canada and Australia over the next decade, the GP should be able to secure long-term charters for its future dropdowns. In fact, based on the industry order book as well as projected LNG supply, the shipping market is structurally short of vessels for long-term charters as well as the spot market. That's expected to remain the case through 2020 in every year except 2015. At the end of the third quarter, the LP had a revenue backlog of USD2.6 billion. Meanwhile, it held USD48 million in cash and cash equivalents on its balance sheet along with USD687 million in long-term debt, including a USD235 million senior unsecured bond due in 2017. Golar's latest quarterly payout is $0.50, which gives its units a current yield of 6.7 percent. Its coverage ratio for the third quarter was 1.12. The MLP is expected to report fourth-quarter earnings on Feb. 21, though that's an estimate based on last year's timing. The bottom line is that as long as the underlying business remains sound, long-term investors can take advantage of such short-term selling to lock in cash flows at attractive rates. And as MLPs acquire productive assets and grow their distributions, unit prices will eventually head higher as well. This article originally appeared in the MLP Investing Insider column. Never miss an issue. Sign up to receive MLP Investing Insider by email. |
Historic Windfall Coming for Certain MLPs True windfall investing opportunities are rare. This is a "big one" – a real millionaire-maker comparable to being among the first to invest in the Bakken. Amazingly, it's tied to the U.S. presidential election – but here's the super-surprise: This post-election announcement is going to trigger a windfall for investors as profits cascade into a select group of Master Limited Partnerships. LEARN MORE.
|
