Dear Investors,
I thought it would be helpful to shed a little bit of light on our thinking and how we look at our current investments. We’ve done this a few times in the past and it has been quite fun and profitable to see how things have turned out. Often you’ll find that things that look like huge issues in the present, are insignificant in the long-term. For instance, remember early 2016 when there was the major selloff in banks due to their exposure to energy companies? That was a massive buying opportunity, which of course we loaded up on. This has been the year of technology and p/e multiple expansion. There have been no major market selloffs. If you project this into the future, you might as well just buy index funds. Needless to say, we see a different future.
Firstly, anything less than a 3-year time horizon is really not much of an investment. Our whole focus is on maximizing risk-adjusted returns over the long-term. We make no effort to outperform each quarter or year, as attempting to do so would almost definitely be detrimental to returns. Our max upsides and downsides are our best estimates of where things would shake out over the full 3 years, but of course stocks can trade higher or lower at various times. With that said, let’s talk about some investments and how we see things progressing over the next 3 years.
S&P 500– Current price 2,578. Max upside over 3 years= 15% Max downside over 3 years=-35%- Valuations are far too expensive. Higher interest rates, geopolitical shock, or a recession would be most likely reasons for a major selloff.
Nasdaq- Current price 6,734. Max upside over 3 years=18% Max downside over 3 years=-45% Valuations are far too expensive. Higher interest rates, geopolitical shock, or a recession would be most likely reasons for a major selloff. I’d also add a bursting of the big cap tech bubble.
AGO- $37.04. Stock trades at a nearly 50% discount to its growing adjusted book value. Max upside $75 or 102% not including dividends, as book value continues to grow via retained earnings and accretive stock buybacks. Resolution of Puerto Rico would be a major catalyst. Max downside is about $35. This would be possible if we see a major recession and multiple other municipal bankruptcies were to occur.
ALLY- $25.70. Stock trades at a discount to tangible book value and at less than 10 times forward earnings. Stock buybacks and book value growth could put the stock at about $35 or 36% higher in 3 years, not including dividends. Downside is probably around $17 if there were a major recession.
BAC- $26.17. Stock trades around book value. Max upside $35 or 34% not including dividends, as book value and earnings continue to grow. Higher interest rates would help net interest margins and assuming no recession. Max downside is about $15 if we were to have a significant recession.
MBI- $9.09. Stock trades at about 33% of my estimated 4th quarter adjusted book value. Management took advantage of the recent selloff in the stock to buy back 25% of its shares outstanding in 1 quarter. Max upside is $20 or 120% as accretive stock buybacks and the resolution of Puerto Rico occurs. Possible upside beyond that if MBIA can monetize its massive net operating losses (NOL). Potential for National subsidiary to be bought out by AGO in a mutually accretive deal. Maximum downside is probably around $6 or $7 if Puerto Rico losses are far worse than anticipated due to some legislative changes that totally alters U.S. bankruptcy laws.
TEVA- $11.58. Stock trades at less than 3 times TTM free cash flow. Max upside is $50 or 331% if the company can pay down debt and return to earnings growth through the introduction of new products. Stock could easily trade up to $30 or 159%, through just materially reducing debt and seeing stabilization in generic drug pricing. Downside is $5 if pricing gets far worse and management doesn’t focus on improving the balance sheet.
CBL- $5.49. Stock trades at less than 3 times FFO (the equivalent to earnings per share for a REIT). The company just reduced its dividend to $.80 per share annually. That is a 14.57% yield and is easily covered by FFO. The company is reducing debt and upgrading its malls with more entertainment and restaurants, as opposed to retail. Max upside is $10 per share or 82% not including dividends. Max downside is probably around $5 if the dividend keeps getting cut.
WPG- $6.98. Stock trades at less than 5 times FFO and has a dividend yield of 14.3%. The stock could trade up to $10 conservatively. Max downside is probably around $5 if the dividend keeps getting cut.
AMBC- $14.03. Stock trades at about 50% of adjusted book value and is really misunderstood. As the company exits its rehabilitation of its segregated account and as Puerto Rico is resolved, the stock could trade up to $30. Downside is limited to about $8-9 due to its net cash position at the holding company. AMBC has huge NOLs, which if it can monetize would provide considerable upside beyond $30.
AIG- $61.46. Stock trades at a material discount to book value and has a potentially good new management team. Business is probably worth about $85 conservatively in 3 years, with downside of about $55.
C- $71.31. Stock trades at a slight premium to tangible book value and a discount to book. Stock buybacks and improved efficiency should allow earnings and book value to grow. Upside is probably about $90 and I’d put downside at about $60 in a recession.
CTL- $14.59. Stock has a 14.8% dividend at current prices, which was just affirmed by management. Company just made a major acquisition of Level 3 Communications, where both businesses will be focused on the Enterprise, as opposed to the consumer. CTL should be able to monetize its net operating losses and create meaningful synergies. Upside is between $25-30 plus the great dividend. Downside is probably to about $10-12 if the business continues to weaken, synergies miss their target, and if the dividend is materially cut.
DAL- $48.87. Stock trades at less than 10 times earnings and should see earnings grow. Airline business is materially better than it used to be due to consolidation. Upside is around $65 if earnings continue to grow and if we see some possible multiple expansion. Downside in a major recession is probably around $35.
AAL- $45.84. Stock trades at less than 10 times earnings and should see earnings grow. Airline business is materially better than it used to be due to consolidation. Upside is around $65 if earnings continue to grow and if we see some possible multiple expansion. Downside in a major recession is probably around $35.
M- $19.50. Stock trades at less than 7 times earnings and has dividend yield of around 8%. If the business just stays afloat and remains profitable, the stock should rally to $30. If they aggressively monetize their real estate, we could see $40. If there is a major recession, earnings go down, and the real estate declines in value, the stock could be worth $13.
FNMAI- $5.30. Preferred stock with a par value of $25. If the government requires Fannie Mae to raise common equity capital, the preferred should go to $25. This issue will be settled either through court, through a settlement, or through legislation. Currently, the government is illegally taking all profits and holding no capital as a reserve for a future recession. If the government is able to continue on this path, the preferred could be worth less than a $1 theoretically. The issue might end up going all the way to the Supreme Court.
I hope that this is a helpful guide and I encourage you to monitor the progress over the years. If you’d like to discuss any of these investments or anything else, please don’t hesitate to give me a call. Remember, we look at the market being very expensive at this moment. Our strategy as articulated in our preview for 2017, was to focus on value and sell long-term puts to manufacture cheaper entry prices, or to generate income if the stocks go up. We will have a mixture of income and extremely attractive long stock positions as we enter 2018, so the return potential is quite attractive for long-term investors.
Thank you very much!
Sincerely,
Tim Travis