Category: Columns

Contrarian Corner: Inflation is a Consensus Bet. Look at Deflation $TLT

Reading Time: 5 minutes

I’m thinking of starting a new segment called, “Contrarian Corner.” In these posts, I will try to point out the other side of a company perception, trade, or view that I see as pervasive in the market.

When everyone crowds to one side of the boat, there are typically better opportunities to sit on the other side.

Right now, it seems “inflation is coming” is a pretty consistent view. (Somehow, the people shouting inflation think they are contrarian?) Every report, article, or tweet is talking about it…. I really try to avoid macro talk, but this is too good to pass up.


My favorite example of this is pointing to lumber prices as an indicator of runaway inflation.  This totally ignores prior supply / demand dynamics that led to this surge. To me, its picking a data point to support a view.

I follow lumber prices, so I know why they are up. Canadian lumber is high-cost supply. The crash in prices in 2018 meant many mills to the north were unprofitable and were curtailed. Add in forest fires and impact from the Pine Beetle and supply was constrained. Lastly, Canada implemented caribou protection which curtailed logging activity. Lumber prices were still very low so even mills in the US shut. Now that housing has come back strong, this caught supply off guard and prices surged.

Is that inflation? Or is that a short-term supply demand imbalance? Prices are now at a level where everyone can make money if they can get supply back online. Would you make a bet with me that lumber prices will be higher than where they are right now in 3 years?

There are other examples of this. I’ve discussed oil (prices are up and rig count is at multi-year lows) as well as housing (underinvested post-GFC), and used car prices. Each of these are specific  supply / demand issues or the bullwhip effect.

Is that persistent inflation? Is a one time rise in prices due to a demand shock (COVID lockdown), that resulted in a supply shock, inflation?

The reason why *persistent* inflation matters is because that is what is going to move long-term interest rates.


So Why Deflation vs. Inflation?

First, its that the government’s use of debt to stimulate is suffering from declining marginal returns. Second, its that M2 is NOT what drives inflation. Its also velocity, which continues to decline.

As the National Bureau of Economic Research stated in a 2010 study (my emphasis added):

The median growth of the 20 advanced nations in this study fell by half as their debt levels moved from less than 30 percent of GDP to 90 percent or more. The drop-off was particularly significant at the 90 percent threshold: between 60 and 90 percent of GDP, median growth was still 2.8 percent; above 90 percent it was 1.9 percent. The drop in average growth between countries with debt ratios of 60-90 percent of GDP, and those above 90 percent of GDP, was even greater: 3.4 percent to 1.7 percent

What happens when you go from 100% to 120%? Japan is approaching 200% debt to GDP and we all know the impacts there (their central bank also straight up buys equity ETFs)

Essentially, the marginal benefit we  get from adding a new dollar of debt is going down. And has been for quite some time.

Yes, the coronavirus stimulus was big. But a lot of it also went to plug a big hole in the economy.

We had stimulus checks. That put money directly in the pocket of consumers, but it didn’t create a new income stream for them. Wages didn’t go up and in my view and so the spending will be a 1x boost in some select sectors. Unless all the debt we just used goes to create a new income streams, all we’re doing is exchanging current consumption for future consumption.


Velocity of money is going down.

I’m going to let Dr. Lacy Hunt explain the next bit. For context, he’s a manager on Hoisington bond fund and has been right on bonds for about 40 years (i.e. he’s been long duration). I highly recommend his investor letters. All of these are quotes from his Q1’2020 letter, with my emphasis added:

  • When the Fed buys government or agency securities from the banks, holdings of government debt declines and the banks’ holdings of deposits or reserves at the Fed go up.
  • The bank balance sheet is unchanged except that the banks are selling government paper of longer maturity and they receive an overnight asset at the Fed. Those deposits do not circulate freely within the economy. (Diligent Dollar Note: QE is not just printing money)
  • If the Fed’s purchase of the debt is from non-bank entities, there will be a transitory rise in M2. Further M2 expansion from that new level will depend on the banking industry. The banks high level of reserves at the Fed will result in no further increase in money unless they and their customers make the collective decision for new bank loans to be originated and the loans are used to expand economic output
  • This is what happened in 2010-11. M2 surged transitorily to a nearly 12% rate of growth along with an increase in loans. The money and loans were used to shore up financial conditions rather than channeled into the purchase of new goods and services. As such, the velocity of money fell dramatically, and the Fed’s purchases of securities did not lead to increased economic growth and inflation. After financial conditions were stabilized, the depository institutions held large amounts of excess reserves.

I feel like the first two bullets need re-emphasizing, because a lot of people associate QE with money printing. Joe Weisenthal put it (again, my emphasis added):

When the Fed buys a Treasury, what it’s really doing is replacing one kind of government liability (maybe a 10-year Treasury) with another kind of government liability (an overnight reserve held at the Fed). If you’re a bank that sold a Treasury to the Fed, you’ve given a long-term asset that yields something for a short-term asset that yields something else. No new money has entered the system. The government doesn’t have any less debt. All that’s happened is that the consolidated government balance sheet (the Treasury and Fed combined) has shortened the term structure of its liabilities. After the Fed buys a Treasury there’s less long-term debt outstanding and more short-term debt outstanding. That’s it.

Bottom line: in order to actually get a boost to GDP and inflation, you need the velocity of money to go up.

All these headlines of GDP growth in 2021 tend to be missing the point. If we have 8% growth in GDP following a year where GDP was down 3.5%, then you just have 2% growth on a 2-year basis. That’s not that great considering all the debt taken on. And then you actually need the banks to lend out the capital, but that depends on risk they see in the market, returns, and whether people need the capital for investment.

Add in worsening demographics (and I think its possible we are sitting where Japan and Europe are sitting 5 years from now.

I think what will happen is inflation expectations will continue to rise short-term as the economy re-opens and we have some supply constraints that gives further pseudo-inflation scares, but long-term the writing will be on the wall.

So bottom line: Do I think reflation will happen? Yes. We will be lapping a serious decline in our economy and there are supply constraints. Do I think those supply constraints will be overcome? Yes. And therefore, I think we will continue on the longer-term deflation trend.

WD-40 Stock: Breaking Down the Bull Case and Valuation $WDFC

Reading Time: 10 minutes

Something different today – I’m going to make a counter argument on a battleground stock. WD-40 stock is one of those names that easily is discarded by analysts for trading at too high of a multiple (myself included, typically). But comparing multiples is not valuation.

For context, WD-40 multiple can be defined as high – currently trades at 35x EV / LTM EBITDA and ~52x price to LTM EPS – and it has expanded significantly over time, too.

Again, this is not valuation. In fact, as I try to lay out in this next chart, you could argue that WD-40 stock has been consistently undervalued by the market. Obviously hindsight 20/20 with a share price going up.

But the red line shows the price where you could buy the stock versus the orange dashed line which is where you would need to buy to realize a 10% IRR (ex-dividends).

Therefore, I’m going to try to look at WD-40 stock with fresh eyes.

I do have biases, so I am going to lay those out upfront. However, I will not cling to any of those biases in my model.

Here is my assumptions about WD-40 stock and why it trades so rich:

  • Interest rates are very low. WD-40 is a high quality company, has little debt, and probably grows at GDP+.
  • If I’m a large diversified asset manager, such as a pension fund, and I need to invest in something for 30 years, I can either pick a ~1-2% bond or a high ROIC company that has staying power and will grow earnings above GDP.
    • The choice obviously isn’t that simple, but bear with me.
  • WD-40 stock also has a 0.85% dividend yield at the time of writing, which will probably grow vs. be fixed with a bond
  • As such, as rates have continued to decline over time, the multiple paid for WD-40’s earnings have gone up
  • In essence, this is a classic “bond proxy” stock. And investors will get punished severely if rates rise.

Again, that’s just my bias as I look at WD-40 stock and I think previously, that would have caused me to do zero work.

Here is a waterfall chart outlining the source of WD-40 stock returns. As you can see, most of the shareholder returns come from multiple expansion (used to trade at 20.5x LTM EPS in 2006 and now trades at ~60.0x:

So I’m going to ignore this narrative for now and ignore the valuation and just plug into (i) the business, first and (ii) what management is saying that could drive the stock higher.

First and foremost, here are some of my initial takeaways (some obvious):

  • WD-40’s name comes from “Water Displacement, 40th attempt”. Basically a secretive lubricant.
    • There are some other facts, myths, and legends on their website, including a bus driver used WD-40 to remove a python from their undercarriage.
  • WD-40 is an excellent company.
    • Highly recognizable brand is worth something that is hard to quantify
    • Earn extremely high returns on invested capital (ROIC) – I estimate ~65% pre-tax in TTM
    • High ROIC is also demonstrated by high margins, low capex: they have 24% EBITDA margins and spend 1.5%-2.0% of sales in capex.
  • LT target is to operate under the 55/30/25, which is 55% gross margins, 30% cost of business, and that implies 25% EBITDA margins. They are already pretty close to these metrics.
  • Management is pretty conservative and leverage is consistently low (0.5x net debt to EBITDA)
    • Management lays out their multi-year initiatives and harps on those initiatives. Every… single… call…
    • Management has also been consistent… like, the people themselves. Garry Ridge has been CEO since 1997.

Some other things I learned after further work:

  • I expected WD-40 to be a big emerging markets play. It kinda is, but not the way I thought.
    • Yes, 65% of revenues come from outside the US, but a lot of that is developed or developing Europe, LATAM, or Australia.
    • China is $15MM of sales in the TTM, which is just ~3.5% of total sales. India is also small.
    • If you think they can win emerging Asia – that growth is still on the come. If WD-40 can be as successful there as it is here in the US, then there is a long runway for growth.
    • Over the long run, they expect to grow APAC 10-13% annually.
  • WD-40 sells through distributors in new regions and slowly moves into direct sales model
    • If I were an investor, I’d actually be frustrated with how slow China growth for WD-40 seems to be.
    • One benefit of WD-40 though, as mentioned, is that they’ve had the same CEO for 2 decades and he’s remarkably consistent.
    • Here are his thoughts from a 2006 earnings call when they first entered China:

    • You can actually see this play out in the employee count. However, I wouldn’t really call it a “success” so far. They aren’t really getting better and better leverage on employee costs.
    • Sales per employee (blue line) is consistently going down, which is counter to what I would have thought.

    • Ridge, the CEO, knows China is key as he said in an interview in 2015 and the commentary makes total sense to me.
    • For context, he brings up factories because an average household consumer maybe uses $0.40 of WD-40 per year. Someone in a workshop may use $40-$70 per year.

  • This is a small company. They do just $435MM in revenue and $106MM in EBITDA.
    • Seems like a conscious decision. Whereas Rust-Oleum owner, RPM, uses cash to buy other brands, WD-40 basically said it doesn’t want to do that – it doesn’t want to di-“worse”-ify.
    • Instead, they are focused more on “specialist” brands, such as a silicone lubricant, bike chain lube, or marine grade products, among many others.
    • It is unclear whether that’s really the best approach, but I can’t argue with their shareholder returns so far.
  • Growth has been… just OK. Sales have grown at a 3% CAGR for 14.25 years and EBITDA has grown at 5%. Excluding the run-off products discussed below, sales have grown at a 5% CAGR, too.
    • I will say this is basically all organic. And if we go back to “bond-proxy” status, earnings held up pretty well in the GFC (were down 15% from peak, but snapped back fast) so the reliability of those slow earnings is rock solid.
    • If all companies earned the same ROIC, then growth would be the only differentiating factor between investments. And WD-40 clearly is top quartile for ROIC.
    • But back to China / EM, I feel like management hasn’t pushed growth their enough. They do discuss it a lot on calls, but would expect sales to be much, much higher than current or even projected. They would drive so much more value given their ROIC if they pushed growth here.
  • WD-40 owns some home cleaning brands, but they are essentially in run-off and management expressly says they just harvest the businesses for cash (see how orange bars have shrunk)

  • The company (maybe not too unsurprisingly) spends little in advertising. It spends about the same each year in advertising as it did in 2006, yet gross profit is +60% higher
  • Capital allocation: investor in 2006 would have gotten all his cash back from FCF
    • In 2006, WDFC traded at 11.6x EBITDA, 20.5x EPS and ~23x FCF.
    • Not “cheap” by any means… The market cap was ~$576MM
    • As shown below, an investor then would have received more than the market cap through dividends and share buybacks since then.
    • Obviously left with a much more valuable piece as well

What type of Moat Business is WD-40?

Connor Leonard did a guest post on Saber Capital’s blog back in 2016, (Saber is run by John Huber and I highly recommend you check out his posts or twitter). In that, Connor outlined four different types of businesses: No moat, Legacy Moat, Legacy Moat with “Outsider” Management and Reinvestment Moat.

It seems to me that WD-40 could fall into one of the last three buckets. The brand value of WD-40 is clearly a legacy moat, but the question is whether or not there are really reinvestment opportunities.

I don’t really consider management here to be “outsiders” but it is hard to argue that earnings have been allocated poorly. The CEO also hasn’t succumbed to debt or M&A pressures by the market. So they haven’t been allocating dumb-ly.

As Connor says,

“[It is] the rare company that has all of the benefits of a Legacy Moat along with ample opportunities to deploy incremental capital at high rates within the current business. In my opinion this business is superior to the “Legacy Moat – Outsider Management” because it removes the variable of capital allocation: at the end of each year the profits are simply plowed right back into growing the existing business.”

WD-40 has plenty of opportunity to reinvest in China and India, but I also still think the capital required to grow there will be pretty limited.

And there lies the point of his post – introducing a fifth model of “capital light compounders.” Those that can grow earnings with very little capital. Instead of reinvesting into the business with long-runway, they systematically repurchase shares.

In my view, you are essentially creating a scarce asset. The powerful business is acquiring itself each year, and crowding out other purchasers of the shares each year.

Expectations Investing

I did a deep dive on WDFC and built projections on that. Frankly, I did them a bit more aggressively than I normally do, but I was using mgmt’s LT targets as a guide (they are shooting for $700MM of sales by 2025).

Frankly, that may be pretty hard target and I actually don’t have them hitting their sales target. Just look at their performance pre-COVID. It wasn’t on-track. However, I do have WDFC expanding margins as they leverage their costs better and beating the 25% EBITDA margin target. It seems to me they already have the infrastructure in place to grow Asia significantly.

I have them using their FCF to repurchase shares and pay their dividend.

While capex might look low, they’ve actually been overspending recently (the big bump in 2017 was building a new office building; in 2020 it was building capacity for their Smart Straw product). At the end of the day, that’s essentially what high ROIC means – they can grow FCF with limited incremental capital invested.

They can’t really buyback too much of the market cap each year at these levels.

DCF

I did a DCF which I don’t normally do, because they can be overly precise and subject to wide swings based on small assumption changes, but I wanted to back into a “what do you need to believe” case.

Firms create value when they’re returns on capital are higher than their cost of capital. The cost of capital, or WACC, is the return offered for the risk that the projected cash flows don’t occur as planned. If future cash flows are more uncertain, investors require higher rates of return for the risk.

For example, here’s the value of a firm under different ROIC vs. growth assumptions with a 10% WACC. If the firm earns < 10%, they are destroying value even if they grow. The important thing is that an already high ROIC business gains more value by growing faster, not by increasing ROIC a bit more (though a low ROIC business will do better by increasing ROIC). This furthers my frustration that China growth has been so slow.

WD-40 cash flows are highly certain (implying a low WACC) and given their ROIC is around 65%, there is a huge spread between this cost of capital and ROIC.

As you can see below, we get in the ballpark of the current stock price using a 5.5% discount rate and assuming the stock grows 3% into perpetuity. Cross checking that with the implied terminal EBITDA multiple, pretty interesting to see it is very high (~29x).

If WACC moved higher (to a not-even-high number), the stock could get crushed.

If you are saying this discount rate is too low… theoretically… it isn’t. Just theory and I’ll touch on this at the very end. Again going back to the stability of WD-40 cash flows, it results in a really low cost of equity. Debt is super cheap right now too, but they barely have any.

The other factor where this DCF is weak is the terminal value: the terminal value math implies a company’s ROIC will equal its WACC in the terminal period (because of competition) and growth steps down. It’s interesting that if I just stretch my DCF out 2 more years, I get a $350 share price (assumes 5.5% WACC and 3% LT growth rate) as WD-40 still earns more than their cost of capital.

Bottom line:

I think WD-40 is a great company and they will continue to compound earnings. I think I have a lot more appreciation for why it is valued like it is valued and hope readers do as well.

Will I be adding it to my portfolio? No.

The company is clearly earning high returns on capital… but I care about returns on my capital. And my opportunity cost is higher.

If a business could invest $1,000 in a factory and earn $400 in dividends, that’s a 40% return on capital for the initial investor. But if someone buys those shares for $4,000, they’ll only receive a 10% return on capital. Price matters.

But I will be looking for other names that are viewed as “too expensive” with perhaps faster growth and similar reinvestment runways.

March 28, 2021 Update: It has come to my attention that Greenwald dedicated part of his book to WD-40. Definitely worth a read:

 

Fresh Look at AgroFresh Stock $AGFS

Reading Time: 6 minutes

AgroFresh is a company that sells 1-MCP, a chemical that helps slow down the ripening process of fruit and vegetables. You know how you can eat apples all year long? Did you ever think that’s strange given harvest season is September-October? With 1-MCP, apples can be stored for a year. That’s right – sometimes you are eating year-old apples. I’ve been following AgroFresh for years and there are certain times when the skew on the stock becomes very interesting.


Disclaimer

This is a quick idea today and I need a disclaimer upfront. This is not investment advice and I use this blog as an investment journal. The subject company today is very risky. You should expect that I may invest in this company and then quickly move on if I see a quick return. You should do your own due diligence.


Key Issues

Anyway, back to AgroFresh stock. The issues have always been:

  • They were bought by a SPAC, which raised red flags given SPAC deal dynamics. AgroFresh stock has not been a good performer since then.
  • It was a carve-out from Dow Chemical, who knows a thing or two about chemicals. So their choice to sell a high margin business was odd (Dow later re-invested in the company through the open market).
  • They have a decent amount of debt (recently refinanced, though expensive).
  • This typically was viewed as a 1 product, 1 market company (viewed as only Smartfresh 1-MCP product with apples).
  • One patent had rolled off in 2015 and more were coming in 2019 and 2020. It was unclear whether earnings would collapse or not

Each of these are valid issues  with AgroFresh stock. The last issue is the most important one in my view. As you can see below, the gross margins and EBITDA margins are super high. They do about $71MM in EBITDA, with 42.5% margins, and only have $3MM in capex (less than 2% of sales) so have extremely high FCF conversion.

Excluding the intangibles assets from their buyout and cash, they have $153MM in assets, but do $71MM in EBITDA – that’s a super high ROIC and highlights the intellectual property and high service model is creating a barrier.


So why is this worth a look?

Frankly, I think the risk / reward is getting very compelling. I’ve made a decent amount of money in stocks the rest of the market thinks is going bankrupt, but where I think the odds are more likely it does not.

First of all, they generate a lot of FCF. Despite a new onerous debt restructuring entered into last year (their prior term loan matured in July 2021, so it was about to become “current”), I still think we’re accruing cash to equity at around 20%. As mentioned a lot, I like good companies with bad balance sheets. This may just be an OK company with a bad balance sheet, but thats OK.

Debt Refinancing

The debt deal was entered into because the company had an upcoming maturity. They got a new $275MM term loan at L+625bps with a 1% floor, which foots to about $20MM of interest per year. I think they’ll be able to refinance that at a better rate, but the loan does have 101 hard call protection until July 2021.

More importantly, they have a seriously onerous convertible pref equity that was put in place by Paine Schwartz Partners (PSP). It accrues at 16% (half cash / half PIK in year one). Call protection is determined by a multiple of invested capital, which also seems aggressive:

If they can take this pref out before July 2021, Agrofresh will need to pay 1.5x the pref amount of $150MM, which is ~$225MM (it is actually less than this, because MOIC includes original issue discount + coupons, but you get the idea).

Otherwise, Agrofresh has to pay 16% interest while this thing is outstanding. For me, I’d want that out of here as fast as possible. On the other hand, if AGFS takes it out in year one, it’s basically like paying 50% interest. I guess that’s the cost of capital during a pandemic when you have a maturity coming due.

Here’s how the pref shakes out, assuming they PIK the minimum amount each year (the PIK interest is added to the balance). As you can see, the PSP pref is brutal because the high rate incentivizes a refi, but the make-whole is large too so it is actually better to wait a bit and execute on your business plan.

There are some other green shoots. Agrofresh won an IP lawsuit against UPL, one of the largest ag chemical companies, and was awarded over $30MM. They can actually use this to paydown the preferred at more favorable terms. Obviously there are two good outcomes of this that I don’t need to directly spell out for readers.


Patent Protection

Smartfresh is the flagship product for Agrofresh. Fortunately or unfortunately, the patent that still applies to a bulk in revenue still lasts until 2022. So unfortunately, it is still a wait and see story.

And what does management say about competition, otherwise? It’s not really new. Here’s a quote back from 2016 (by the way, this TruPick product they are talking about it what they won the lawsuit for):


Optionality

The last thing I’ll say is there is other optionality in this investment. Essentially, take this chemical and apply it to other fruits and vegetables that could be preserved. Man, avocados go from too hard to too ripe way before I’m even ready for it.

So far, they’ve actually done a decent job. Back in 2014, the company was 88% apple-related sales. Now it’s just 60%.

It seems like the company wants to aggressively expand here. Part of the management teams bonus is tied to it (25%).


Management Alignment

Speaking of bonuses, I like that mgmt has a decent amount of options that are way out of the money at $2/share. Mgmt was also in the open market in 2019 buying at $2.35/share.

However, I’m not super thrilled that total comp is around $2MM / year for a company doing $71MM in EBITDA with abysmal stock performance so far.


So why now?

AGFS stock has been a value trap to some extent.

  • Refi that expensive preferred capital  and potentially the term loan.
    • Fortunately or unfortunately, the credit market is aggressive right now and many companies will be able to survive this cycle that wouldn’t have survived past ones.
    • In reality, perhaps they should come to market with a 9% unsecured bond. It’d be juicy in this market (and HoldCo PIKs are trading at lower yields)
    • AgroFresh could do a $375MM deal to takeout the pref + TL and still come out with cheaper cost of capital all-in.
    • Doing this would free up capital for the common shareholders
    • I think they may be able to do something by July 2021. But thesis isn’t predicated on that.
  • Sentiment feels bad on it. Stock seems completely washed out. I like that. Slightly positive news would send it higher.
    • I like the skew: If I see patent weakness or too much competitive threat, can likely exit before losing the whole position. If they surprise to the upside, even modestly, the stock will re-rate very quickly (especially with the leverage).
    • Small wins are meaningful: If AGFS gets a $10MM win, that’s much more incremental to them because they are a microcap.

The Market is Now Game $GME $AMC $AMCX $NCMI $BGS

Reading Time: 3 minutesWhen history is written about GameStop, the book will start with Dave Portnoy and Davey Day Trader Global.  Here’s a degenerate sports gambler who is completely bored during a pandemic and discovers speculating on stocks is fun. Add in stimulus payments, boredom, and millennials controlling $5.4 trillion of wealth, and a lot can happen.

A lot has been written as to why GME is ripping higher, so I just want to add in a few of my own observations.

Gamestop’s price action really comes down to high short interest combined with gamma hedging.  When someone is short a stock, or betting against it, they need to borrow the shares and hopefully return them at a lower price. That’s how they make money. However, your downside is theoretically unlimited because the stock can theoretically go up and up and up. As such, when a stock rips higher, shorts typically need to cover their position so they aren’t destroyed.

The second factor is gamma hedging. Reddit users on r/WallstreetBets are buying a lot of call options. The seller of those call options needs to protect their position, so they actually buy some stock as a hedge (selling a call is a bearish position, so to be more neutral, they buy the stock). When the stock rises, they need to buy more stock to continue their hedge (this is really delta hedging).

So as you can see, even if Reddit users or Robinhood investors don’t have a lot of money, they can drive extreme price movements from what others have to do. Just recently, Melvin Capital needed a bailout because its short on GME blew up. In fact, it seems to me that Redditors are going line by line through Melvin Capital’s short book and trying to blow him up.

Even a Blockbuster remnant is surging.

AMC, the movie theater chain, has been issuing equity en masse to stay alive while theaters are shut down. It has completely diluted shareholders. Share count is now 7.5x higher than it was pre-pandemic. They also had to take on more debt. Even if theaters were packed tomorrow, I think returns would be abysmal for shareholders. And yet… the stock has surged.

But what is really  funny is that AMC Networks, the TV network that had Madmen and The Walking Dead, is also ripping in sympathy.

Buyer  beware.


I don’t plan on adding any fuel to the fire on these names. It is funny that some names I have written about previously are being taken up in the rush, like National Cinemedia, Big Lots and B&G foods.

There are some interesting transactions out there. Andrew Walker posted on Twitter about selling puts on GME. When you sell an option, you are really selling volatility. Given GME has been incredibly volatile, you can make some decent trades.

Look at the $0.50 put options. If you sold 1 contracts you could need to set aside $50 as cash to secure the position and you would collect $3. That may not sound like much, but that’s a 6% return. Over 79 days. Annualized that more like a 30% return.

The only way you lose is if GME crashes to less than $0.47 (or 99.8% from here, lol), which is way below where it even traded when its outlook was terrible (it’s worst was around ~$3.50). Look at the interest as well and the volumes. You could sell A LOT of these contracts for your PA.

My thinking is GME will clearly issue equity. And because the price is so high, the dilution will be low and then they’ll have cash. This will raise the floor that the stock used to trade at.

$NXEOW Warrant Recap (& Maybe Post-mortem) $UNVR

Reading Time: 3 minutesIt’s been awhile since I’ve discussed the Nexeo warrants, which are now tied to Univar’s stock performance following the acquisition. At one point, I’m pretty confident this blog was the go-to place for information on the merger and its impact on the warrants.

Unfortunately, none of that matters now. We have 145 days to expiry and the strike price is $27.8034 vs. UNVR currently trading at $20.64. History would tell me that this isn’t unsurmountable, but it may not be likely that UNVR is in the money.

But  I try to be an optimist (especially because I still own a lot of NXEOW), so I do have a couple points on why I think the warrants could possibly make it. To be clear, I’m grasping for straws here because Univar really needs to make it to $30 to get the warrants sufficiently in the money.

UNVR has materially underperformed its peers  

This chart compares returns for a broad set of chemical stocks. UNVR has materially underperformed, but that makes no sense. UNVR distributes these company’s chemicals! If the suppliers are doing well, odds are UNVR should be doing well.

If UNVR had performed in line with the average of these names, it would be at $28.70 right now, not closer to $20.

Macro Data is Suggests Chemicals Should be in Strong Demand

Ok, the last chart was pretty hand wavy. But it makes sense why the chemical stocks have ripped. The underlying data is suggesting a really strong economy.

PMI is “an index of the prevailing direction of economic trends in the manufacturing and service sectors. It consists of a diffusion index that summarizes whether market conditions, as viewed by purchasing managers, are expanding, staying the same, or contracting”

So PMI is a measure of expansionary or declining conditions, with 50 being neutral. Clearly we are expanding in these markets.

This isn’t a perfect comparison, but look at PMI vs. the basic materials index. You can see the correlation in their performance. The only thing to remember is that XLB is a basket of stocks that should build value over time whereas PMI can only bounce between 0-100.


In my view, there’s no reason why UNVR shouldn’t be performing better. Commodity prices have improved, industries such as autos and housing (which consume a lot of chemicals) are doing much better. And all of UNVR’s suppliers are doing much better. I guess we’ll find out if they can close the gap.


Post Mortem

Since this may not pan out, I’ll go ahead and write my brief post mortem. I DON’T have regrets investing in these warrants. I say that despite the fact that I stand to lose a decent chunk of change on them.

I had strong conviction Nexeo was being underappreciated by the market and the warrants were a levered bet on that view. Nexeo was indeed taken out, despite tons of pushback from people saying Univar wouldn’t ever do it. I saw the opportunity to possibly 6x my money with downside being the ticket to play the game.

Once people digested what the acquisition meant, the warrants basically doubled in a day. But there are some real lessons here.

  • First, try to avoid warrants in companies that play in commodities. Commodities can swing to the upside putting you quickly in the money, but it can obviously go the other way too.
  • Second, pigs get slaughtered. When you’re up a lot on a warrant or call option, just get out. I should have sold all my warrants and just bought UNVR’s stock if I thought it was still good (even though in hindsight I know it has underperformed now).
  • Third, don’t be duped by a long time to expiry. “I have so much time until these warrants expire… a lot can happen”. Yes, a lot CAN happen. Including a global pandemic.  I should have instead said, “you know what, I think Nexeo / Univar will build a lot of value over 3 years and I should just ride the equity”