Category: Columns

How will the ECB Handle Europe’s Gas Crisis?

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We’ve all seen the headlines and charts of European electricity prices and gas prices. Each time the Nordstream pipeline is serviced, we brace ourselves for Russia to not bring it back. And we brace ourselves for Germany, Italy and likely all of Europe to fall into a deep recession with no easy way out.

Front Month Netherlands Nat Gas Contract Price

I don’t have much to add to the energy conversation other than to remember optimists usually make the most money in investing. But the situation is so untenable.

Since I have no idea how Germany’s chemical and industrial sector will deal with the loss of gas (I’ve read reports, but I don’t know the long-term solution), I decided to jot down what is happening with the Euro currency and if that’s something to stifle the blow.

Unfortunately I just don’t see it.

Here’s my scratch on what could happen. Happy to hear others thoughts

In a nutshell, the EUR has already weakened considerably against the US$. That may help tourism.

Theoretically it helps exports on paper, but this is an interesting situation. How? In fact, Europe has quickly become the highest cost producer of many chemicals and other products. Note BASF and Yara have cut fertilizer production because of the gas cost. That is likely true for many other products. Instead, Europe will need to import these fertilizers from the US.

So generically, if Europe can import products cheaper than it can make, it will have to. And that’s a lot of things at this point given the disparity in prices. It doesn’t help that commodities are typically priced in US$ either. Europe has become a high cost island.

So what can the ECB do? Raise rates? Drive the currency higher? I guess, but the magnitude likely kills the economy anyway.

Do they raise rates but provide stimulus? Do the governments try to take the whole burden? I could see the merit as this is the equivalent of war time spending. Maybe that helps the currency as investors see Europe is building a sustainable path out.

Do they do nothing? Hmm.

Should the Euro be disbanded? Maybe the countries that have cheaper power may want this. Maybe they wouldn’t.

Will the U.S. benefit? I could see our chemical and industrial sector get a larger boost as the low cost producer. But it will also drive up our energy costs, as we’ve already seen with natural gas hitting $9 again. The U.S. Fed also probably wants a stronger currency as it helps tame our inflation. But it is a bit easier being the reserve currency to strengthen when Europe is in such a troubling situation. It is also hard to imagine the US being unscathed in a major European recession.

Should the US conduct some sort of defense era production act? Drill baby drill, but in our own country? Some sort of Marshall plan? I see the merit, but do US voters?

We shall see!

Veteran Tip: ALWAYS open Friday 8-k’s $BIG

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Alright, I’m no veteran. But in my career I have learned one important tip… ALWAYS open Friday 8-k’s.

Why would a company file a “current report” that represents something “material” at Friday at 5pm? Hmmm. Seems obvious in hindsight, right? They don’t want people to focus on the said material item.

I’ve seen this a few times in my career. 9/10 times it’s benign. But one time it was a company disclosing a large loss on a hedge contract. Another it was an executive departure that gave a hint results would be bad. There’s more I can’t remember.

This time it’s Big Lots with an ominous signal! For future reference. I’m writing this at 5:30pm on a Friday after getting this notification in my inbox. While they are increasing the size of their credit facility by $300mm, to $900mm, they also are suspending the fixed charge covenant for a period of time. Hmmm

Now, Big Lots historically didn’t need a credit facility this large. But they just bought back a bunch of stock and, like other retailers, have bloated inventory now. They actually went from no debt, tons of cash, to $271mm drawn and limited cash.

The working capital is sucking liquidity, which just happened to Bed, Bath and Beyond. And now the latter is questionably solvent.

This could be a nothing burger. Or it could be an obvious sign that BIGs earnings will indeed suck like the rest of the space. That’s why they need to suspend the covenant. Perhaps they’d fail it otherwise.

I still think BIG will make it through this period and the stock will be higher in 5 years. But in the meantime… not a great sign.

Special Situation Follow up: Bayer Glyphosate Liability $BAYN

Reading Time: 2 minutesI did a previous Bayer post back in 2019, as the the market seemed to be implying a massive liability for glyphosate. I know how tough it is to clink a link, but highly encourage readers to look at what the market was / is pricing in for Bayer’s liabilities. It made / makes little sense in comparison to other liabilities in the past and relative to what glyphosate is – a chemical which the EPA basically goes to the mat on saying it is safe.

Specifically, the EPA states:

  • No risks of concern to human health from current uses of glyphosate.
  • No indication that children are more sensitive to glyphosate
  • No evidence that glyphosate causes cancer in humans. And they add: EPA considered a significantly more extensive and relevant dataset than the International Agency on the Research for Cancer (IARC).
  • No indication that glyphosate is an endocrine disruptor

I mean, think about it. Glyphosate is the most widely used chemical out there and one of the most studied. I don’t think the government is some evil entity that would hide whether it caused cancer or not. Nor do I think they’d allow it to continue if there was any doubt.

It is highly concerning that a jury can say that a chemical causes cancer, when in fact the evidence shows it does not. That is a slippery ethical slope.

Since then, Bayer has won 3 other cases determining that glyphosate did not cause cancer. I guess in the future one state can say it does and another says it won’t? Hm.

Maybe not. The Supreme Court may hear Bayer’s case. Or they may not. But given this situation I discuss above, it seems like they should!

If Bayer’s case is heard, they could help resolve about 31,000 cases against it AND a huge overhang on the stock.

If Bayer’s case is NOT heard, I think we’re basically in the same situation where Bayer will slowly but surely have to prove its case one by one. That seems more priced in (dangerous words of course).

Bayer currently trades for 7.4x ’23 EBITDA – this is for a pharma and consumer health giant (that also owns Monsanto and legacy Bayer crop protection which is just 40% of EBITDA). Merck and Bristol Myers Squibb trade for around 10x ’23. Is the market implying Bayer’s crop protection biz is worth, like 4x? That is crazy. Especially for me who is someone who thinks the glyphosate liabilities are overblown. They actually announced they are selling a piece of the business for 12x. Hm, maybe just keep doing that?

Last, we have also seen creative ways for dealing with liabilities, like the talc liability and asbestos. To be clear, I think glyphosate is nothing like those. Those actually caused issues! But I am sure Bayer is running through the options to mitigate risk…

I could see 25-30% upside on Bayer from some sort of resolution and even then I don’t think it’d look expensive.

Stay tuned!

$KAR Gets (Less) Physical with $CVNA Asset Sale: I’ll Sell KAR Stock Too

Reading Time: 3 minutesI wrote up KAR stock back in 2021 when investors were confusing secular issues (auctions are becoming more competitive with online presence) with cyclical ones (there just were no cars to sell!).

Now, KAR is selling it’s physical auction business to Carvana in a $2.2BN transaction ($1.6BN after–taxes). This is great compared to pre-sale market cap of $1.6BN (+$1.9BN of corp debt).

Interestingly, KAR says it will only lose about $100MM of EBITDA (KAR did $481MM in 2021). So they sold the physical auction business for about 22x.

 So Ryan, I believe, from a revenue standpoint, the revenue impact is approximately, I believe, $800 million in the current year. And Eric may correct me if I’m wrong. And the adjusted EBITDA impact in the current year are approximately $100 million. As I mentioned, that $100 million is a combination of 3 numbers, the EBITDA of the business, which is the significant majority of that number, I would say, by far. And then revenue from the commercial service agreement, which is a modest sum in the current year. And stranded costs, which is an even more modest sum in the current year, but obviously, some benefit, we think, over time there as well.

They’ll get about 50% of their EV by selling 25% of their EBITDA. Not bad!

The company has been trying to shift more online, acquiring several online auctions and attending podcasts and hosting an investor day highlighting their focus shift.

Here’s the thing: The core to my thesis was that I thought physical auctions were necessary AND a competitive advantage.

Reminder: I used to buy and sell used cars. I bought a couple lemons online and personally, I swore it off. There are simply too many moving parts on a car to capture it in a picture, especially  those that are coming from a lease.

When a vehicle comes off-lease, if the leaseholder and dealer do not purchase the vehicle, the captive finance company then owns it and sells it. Because finance companies do not have dealerships, they use the wholesale market to sells the cars back to the dealer network. Typically a vehicle will enter an OPENLANE closed online auction (only open to that OEM’s franchise dealer network), if it doesn’t sell there it will move to an OPENLANE open online auction (open to all of KAR’s registered dealer buyers), and if it doesn’t sell there it will be moved to/ sold at physical auction.

So why am I selling?

This sounds like KAR is keeping the great parts? Doesn’t the KAR stock look cheap now with all that cash?

Maybe, but I don’t want to own this anymore. It is against what I firmly believe the industry requires to move volume efficiently. So, so, so many cars actually end up going into physical auction. And I think having this integration is actually valuable. I don’t have the numbers on me, but the last two years are irrelevant anyway.

Online is less capital intensive (theoretically…), but it isn’t clear to me who the “winner” will be long-term. I worry about that. Clearly KAR has acquired several online platforms that weren’t around just a few years ago.

If OPENLANE wasn’t the obvious winner (i.e. they had to acquire other players to augment it), why would it be in the future?

I somewhat doubt that because of this, KAR stock should trade at a structurally higher multiple. Could be totally wrong.

Oh, and last thing, KAR has a pref that converts at 17.75, so share count is going up 29% (my math it goes from 124 to 159-160, could be wrong though). I knew this going in, but given all the moving parts, I am closing out here.

I have the pro forma KAR stock trading at ~9x PF EBITDA ($3bn market cap, $100MM net debt vs. $345MM of EBITDA). That screens somewhat cheap, but I’m not staying along.

Apollo Buying Tenneco $TEN – Highlights Value in Auto Suppliers

Reading Time: < 1 minuteHere’s something you don’t see everyday in efficient markets: A company being acquired for a 100% premium.

Tenneco is being acquired by Apollo private equity for 100% premium to yesterday’s close. It’s not a premium to is 30 day VWAP or the premium 90 days ago before a rumor of a sale came out. 100% overnight. Amazing.

Tenneco was trading at 3.8x 2022 EBITDA coming into today. Tenneco was pretty levered ($5BN of debt compared to $1.5BN of ’22e EBITDA is 3.4x levered for a business trading at 3.8x, so the equity was a stub). So it isn’t like this multiple is crazy.

Similar to many auto suppliers, they often look optically cheap, but in what I highlighted in my prior posts on suppliers, I actually think THEY ARE CHEAP driven by fundamentals and improvements in FCFs, etc. etc..

It gets better.

What does Tenneco do? They serve a lot of internal combustion engine (ICE) parts! Clean air products (for emissions), powertrain parts (pistons, spark plugs, seals and gaskets for engines).

Certainly interesting to see private equity sees value as well!