SINLetter - November
Welcome to edition 39
of Suria Investment Newsletter (SINLetter), a free monthly
investment newsletter. The objective of this newsletter
is to provide you with unbiased initial research and
basic facts about individual stocks and other financial
instruments so that you can research them further before
deciding to add them to your portfolio or not. If you
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This is one of the busiest times of the year for me
and hence this newsletter is delayed by a couple of
If you do not subscribe
to blog entries by email or in case you missed them,
here are the blog entries for October.
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you can subscribe to receive
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Performance and Other Thoughts:
September felt like a
terrible month, but October took the honor of becoming
the most volatile month in the 80 year history of the
S&P 500. Had the S&P 500 not rebounded 10.49%
in the last week of October, the month would have gone
down as the second worst month in the history of the
S&P 500, topped only by a 29.9% drop in September
1939 as you can see from this
New York Times Table. The SINLetter model portfolio
suffered a similar fate dropping 18.73% for the month
of October despite a small gain in our September pick
Had I acted immediately after posting the "What
Next?" blog entry on October 28th, the performance
of our portfolio would have improved as Sterlite Industries
went on to post a gain of over 50% and Flextronics (FLEX)
posted a gain of 10% in the last four trading sessions
|Since Inception (Aug 2005)
The lows we hit on Monday,
October 27th could very well be the low for this bear
market and stocks appeared to be extremely oversold
in the short-term. Consider the fact that on
Tuesday, October 28th, the U.S. consumer confidence
to an all-time low of 38 from September's reading
of 61.4. The Dow reacted with a nearly 900 point rally,
its second best point gain ever. The Dow held on to
most of these gains the following day and on Thursday
it posted another 190 point gain in the face of news
that the U.S.
GDP dropped by 0.3% in the third quarter, the sharpest
contraction of the economy in seven years. However I
believe that the rally we experienced in the last week
of October does not mark the end of this bear market.
The conditions for a sustainable move up just do not
seem to be in place. Both earnings and economic news
are likely be to be terrible in the next two quarters,
if not longer.
My biggest worry at this
point is a crisis of confidence that appears to be developing
both amongst businesses and consumers. Not only are
large companies like HP, Yahoo and Ebay laying off employees,
profitable and promising start-ups in silicon valley
are also laying off employees by taking preemptive action
against a weak economy that could affect their future
growth. Check out this
chilling PowerPoint presentation consisting of 56
slides that one of Silicon Valley's leading venture
capital firms Sequoia Capital presented at a secret
meeting of its portfolio companies. Consumers who are
already stretched tight are going to be wary of making
purchases when faced with the specter of layoffs. No
wonder car sales have dropped off a cliff and car dealership
companies like Lithia Motors (LAD)
and Penske Automotive Group (PAG)
were trading at multi-year lows in October. With nearly
70% of the economy driven by consumer spending, this
tightening in consumer spending will lead to further
layoffs in other sectors such as retail and keep this
vicious cycle spiraling downwards.
Why then do I continue
to stay invested despite my mostly bearish outlook?
Consider the following paragraphs from Mark Hulbert's
article in The New York Times,
"As the critics
of market timing often point out, the stock market tends
to produce the bulk of its gains in just a few explosive
sessions. Miss those days and your portfolio’s
returns are likely to disappoint you.
Consider someone who was fully invested in stocks
over the last decade — except for the market’s
20 best days, during which he held cash. Despite holding
stocks more than 99 percent of the time, this investor
would have lost 57 percent through the end of October,
as judged by the Dow Jones Wilshire 5000 index, a benchmark
that represents the combined value of all domestic stocks.
That is 70 percentage points worse than the 13 percent
gain he would have achieved had he held stocks mimicking
that index for the entire 10 years, including the market’s
20 best days."
Attempting to accurately call turns in the market is
very difficult, if not impossible, and hence I prefer
to stay invested with some cash around to either hedge
long positions or buy stocks on my watch
list on days when we experience sharp drops. One
such stock that has been on my radar for a long time
is Suburban Propane (SPH)
and I have discussed the company in detail below.
Gold took a hit in October,
falling $146.3 or 4.83% to close the month of October
at $723.70 per troy ounce. Gold miners like Newmont
and Barrick Gold (ABX)
did even worse, falling more than 30% in a single month.
I am making no changes to the model portfolio at this
time. As discussed below, I am adding Suburban Propane
to our watch
With the volatility in
the market making it difficult even for the most experienced
inventors to pick winners, I figured it would be a good
idea to explore new ideas and broad investment themes.
We discussed the importance
of asset allocation in the previous newsletter and
I would like to discuss an investment vehicle called
a Master Limited Partnership (MLP) and then discuss
Suburban Propane, a publicly traded MLP with a distribution
yield of 9.5%. If you are familiar with MLPs, feel free
to skip the next five paragraphs.
What are MLPs?
The reason I used the
word distribution instead of dividend is on account
of the fact that MLPs are not like regular corporations
and do not get taxed on income. Instead they
tend to return most of their income (typically 85 to
90%) to investors or partners through quarterly distributions.
This shifts the tax responsibility to the partners,
who are taxed at their ordinary income rates.
Since ordinary income rates of investors are typically
lower than the income tax rates of corporations, this
proves to be advantageous to the MLPs and hence their
investors. One of our portfolio companies, Marcus (MCS),
paid 39.21% of its fiscal 2008 income in taxes. When
you compare that rate against the rate you paid for
your 2007 personal income, the tax advantages of MLPs
are laid out in sharp relief.
Since distribution income
from MLPs is treated differently from dividend income
from most stocks, at the end of the tax year, MLPs issue
a Schedule K-1 to their investors. If
the MLP pays out distributions in excess of the income
it generates, the distribution is classified as a "return
of capital" and tax deferred until you sell your
shares or units. Please note that income
from MLPs is often taxable even in retirement accounts
like 401Ks and IRAs if the income exceeds $1,000.
Hence investors tend to shy away from MLPs in retirement
accounts and they are also not preferred by institutions.
to own MLPs:
There are certain indirect
methods of investing in MLPs and avoiding the tax complications.
The MLP Kinder Morgan Energy Partners (KMP)
also has a counterpart called Kinder Morgan Management
that holds units of KMP and whose quarterly payout is
treated like a regular dividend instead of a partnership
distribution. Another alternative is closed-end
funds like Kayne Anderson MLP (KYN) and BlackRock
Global Energy and Resources Trust (BGR). KYN is currently
trading at a 15.22% premium to net asset value (NAV)
and a yield of 9.17%. In contrast BGR is trading at a 13.16% discount to NAV and a yield of 8.61%.
Most MLPs tend to be concentrated
in the energy sector but there are always exceptions
such as the private equity firms The Blackstone Group
(BX) and Fortress Investment Group (FIG), which also
happen to be set up as MLPs.
using yield spreads:
One method of analyzing
MLPs is to look at the spread between the average yield
of the MLPs and the 10 year treasury note. A big spread
when compared to historical averages could be construed
as a favorable factor. The current yield on
10 year treasury notes is 3.81%. The yield of the
MLP Select Index, which consists of the 50 most
prominent energy master limited partnerships, was 9.78%
as of October 30. The current spread between the two
is 5.97% give or take a few basis points. Looking
at the data going back to 2000, with the exception of
last month, the spread between the two has never been
this high, making this a great time to consider adding
MLPs to your portfolio.
Propane, a clean burning
and non-toxic gas, is created as a byproduct of oil
and natural gas processing and is used to heat homes,
cooking and sometimes to power vehicles as Liquefied
Petroleum Gas (LPG). According to the National Propane
Gas Association, about 8.1 million households in the
United States use propane to heat their homes as an
inexpensive alternative to electricity. New Jersey based
Suburban Propane services over 1 million residential
and commercial customers in 30 states. Suburban Propane
also provides customers the option to rent large propane
tanks from them and since these tanks are often buried
underground, switching to a different provider
is not an easy option, giving Suburban Propane a "lock"
on certain customers.
Suburban Propane has been
on my radar for over two years since it showed up on
a stock screen I ran in 2005. The stock lost nearly
a third of its value in the second half of 2005 to $24.51
when the price of propane spiked and the company was
not able to immediately pass on this increase to customers.
The stock went on to nearly double from those levels
to $48.83 by 2007 but lost a lot a ground over the last
two months. At one point on October 6, 2008, Suburban
Propane traded as low as $22.64. Since propane is a
byproduct of oil refining, wholesale propane prices
generally tend to follow oil prices. The important difference
between the drop in Suburban's stock in 2005 and right
now is that propane prices were rising back in 2005
but are actually dropping right now along with the price
The company hedges part
of the propane it has in physical inventory by going
short propane futures. When propane prices rose earlier
this year, the company had to take a $14.5 million loss
against its hedges in the fiscal third quarter ended
June 28, 2008. This was right before oil hit its peak
of $147 in July. If the company continued its
hedging activity in its fiscal fourth quarter, which
ended September 2008, the sharp decline in oil and propane
prices during the quarter should prove beneficial to
the company. Even if the company suspended its hedging
program, the decline in propane prices should benefit
the company as I do not see a significant drop in retail
propane prices that Suburban Propane charges its customers.
This is one of the key reasons why I find Suburban
Propane attractive ahead of its fourth quarter conference
call scheduled on Friday, November 14th.
The company also has a
consistent history of raising quarterly distributions
and has done so 19 times since 1999. Distributions in
the recent past have been financed entirely through
operating income and the company has built up its cash
position to $118.6 million, while holding long-term
debt steady at $548 million over the last three years.
If Obama wins the election
(which appears very likely as I write this) and raises
the long-term capital gains rate and dividend taxation
to 20% (for families earning over $250,000), the tax
deferred status of MLPs is going to make them even more
attractive to high net worth or high earning families.
Check out the following links for additional reading
about MLPs and related investments.
Due to the tax implications
of MLPs and the fact that the SINLetter model portfolio
does not take dividends into account, I am going to
add Suburban Propane to our
watchlist instead and most likely leave it there
for some time to come.
Every month we add featured
stocks into a model portfolio started with a cash position
of $100,000 on August 2, 2005. To keep calculations
simple, trading costs and regular dividends are not
Model Portfolio - October 31, 2008
||Number of Shares*
||Number of Units
* Price and number of
shares adjusted for Activision Blizzard (ATVI)
and ICON plc (ICLR)
to reflect splits on September 8, 2008 and August 13,
From the stocks that are currently in the model portfolio,
I own shares of Intel (INTC), Activision Blizzard (ATVI),
Lionsgate Entertainment (LGF),
Tata Motors (TTM),
PowerShares Water Resources (PHO),
Suntech Power (STP),
and Marcus (MCS). I also own $20 Jan 2009 IBN calls (IBNAZ.X)
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