Big Picture Synopsis:
Stocks:
Stable Vix Pattern (bullish)
Short Term: Expecting a 10%+ Correction
Intermediate and Long Term: Bullish
In an interview found at YF's Daily Ticker, published last Monday, Barry Ritholz stated that he had trimmed his clients exposure to U.S. stocks and used the proceeds to buy European and emerging market equities. He assets that emerging markets have been "shellacked" as the U.S. stock market has moved to all time highs. The Vanguard Emerging Markets ETF closed at $39.28 on 8/16, down from the $43.87 closing price on 12/31/12. Since closing at $35.2 on 10/3/11, VWO has risen only 11.59% through 8/16/13 while the S & P 500 has gained more than 50% over the same period.
While I would agree that emerging markets are undervalued, they remain under downside pressure now due to an economic slowdown, particularly in Asia, and the decline in their currencies against the USD caused by the rise in U.S. interest rates.
I am nibbling in this stock sector, but treading lightly. Two of recent nibbles, the CEF IR and the ETF EWM, are already in the red. Investors appear to be overreacting to news, as shown by the 5.6% decline in the Indonesian stock market last Monday noted below in the "Recent Economic Reports" section. At the moment, I am underweighted in emerging market stocks.
Bonds:
Short to Long Term: Slightly Bearish Based on Interest Rate Normalization: The Difficult Path to Interest Rate Normalization)
The Chief Income strategist for Janney Montgomery Scott believes that the bond selloff is overdone. As summarized in Barrons, that analyst believes that fair value for the 10 year treasury is between 2.71% to 2.77%. That estimate is based on a weak forecast for both the economy and inflation. The analyst uses personal consumption expenditure inflation and estimates only a 1.2% average annualized rise and assumes no further FED influence in interest rate markets other than a continuation of ZIRP.
I noted last week that the market has traditionally priced the ten year at 2.6% higher than the Y-O-Y core inflation number which would exclude energy and food. That historical number comes from J.P. Morgan, and I would assume that it is a correct average number. JPMorgan Barrons.com The core inflation number was 1.7% for the twelve months ending in July 2013, Consumer Price Index Summary, and has been moving up some.
The correct approach is to assess what a normal ten year rate would be now without QE. We know that QE will end and the market has already started to adjust to that eventuality.
We know that investors price bonds by demanding a return over and above an average annual inflation forecast for each maturity.
That inflation forecast is embodied in the break-even spread, the difference in yield for a TIP and a non-inflation protected treasury with the same maturity. The treasury sells TIPs maturing in 5, 7, 10, 20 and 30 years. The break-even spread can be calculated for each of those maturities.
The inflation forecast embodied in the market's pricing of a 10 year TIP is currently 2.13%, not the 1.2% used by Janney Montgomery Scott. And, traditionally, investors have demanded at least a real return of 2% in addition to the inflation protection.
One possible factor that may restrain the move of the 10 year yield to normal levels is ZIRP. It is certainly possible that a number of buyers will emerge who borrow at the short end, using leverage, to buy the ten year.
Yesterday, Barclays' strategists predicted that the 10 year will rise to 3.15% by year-end and to 3.75% by the 2014 third quarter. Their prediction for the 30 year is 4% this year and 4.4% by the 2014 third quarter. Those kind of estimates are attempting to predict normalized rates as QE winds downs and eventually ends during the 2014 second or third quarter.
I suspect that the rates will reach higher normalized levels quicker than the forecast made by Barclays. The market will front run the FED once tapering starts and QE gradually winds down later this year and into 2014.
I resisted the temptation to buy a bond CEF last week. Bonds did rally on Friday, as prices rose and yields declined some. Daily Treasury Yield Curve Rates. I suspect that the reason was the awful new home sales number for July. The economy really needs new home construction to pick up a lot more (see discussion below)
As of 8/23/13, the break-even spread for the 10 year treasury was 2.13%, the market's forecast for the average annual rate of inflation over the next ten years.
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Recent Economic Reports:
The Federal Reserve released the minutes of their July meeting last Wednesday. FRB: FOMC Minutes, July 30-31, 2013 I do not find it helpful to read that the voting members can not agree on anything important. As to when the FED will start to taper, a "few" members argued that "it might soon be time to slow somewhat", while a "few" others argued for more patience.
There was general agreement that tapering could begin later this year and conclude in the middle of 2014 "if economic conditions continued to develop broadly as expected". The "as expected" path for ending QE would be unemployment in the vicinity of 7 percent and inflation moving toward the Committee's 2 per cent objective. So, that amounts to a confirmation that the FED intends to taper but does not provide guidance as to when.
In my view, it does not matter whether the FED starts to taper in September or November, or decides to end QE in the 2014 second, third or fourth quarter. It is only important that QE will soon end, and intermediate and long term rates will normalize to market levels.
Participants did "generally continued to anticipate that the growth of real GDP would pick up somewhat in the second half of 2013 and strengthen further thereafter". A number of participants cautioned that they were less confident about a near term pick up in growth than they had been in June.
There was an interesting split in the member's views about future inflation:
If inflation expectations fall from current levels, that will ease the transition to market based interest rates.
QE first started in March 2009 and will be in its fifth year during 2014. The balance sheet is already well over $3 trillion and growing. System Open Market Account Holdings - Federal Reserve Bank of New York If asset purchases continue into the 2014 second half, could anyone at the FED argue with a straight face that QE is not debt monetization?
The SF Federal Reserve recently released a research paper that QE2 did not add much to growth. Federal Reserve Bank San Francisco | Research; Bloomberg The conclusion reached by the SF Federal Reserve economists was that the $600B in QE2 asset purchases added about .13% to real GDP growth which faded after two years.
Existing home sales rose 6.5% in July from June and 17.2% above the July 2012 rate. realtor.org
New homes sales plunged in July, falling 13.4% below the revised June reading, and at an anemic annual rate of only 394,000. census.gov.pdf The long term chart of new home sales highlights the devastation of the housing bubble:
New One Family Houses Sold: United States - St. Louis Fed
That is one ugly looking chart.
HSBC's flash PMI for China's manufacturing rose to 50.1, up from 47.7 in July. markiteconomics The consensus estimate was for a 48 reading.
Markit reported encouraging PMI numbers for Europe. markiteconomics The Eurozone Services PMI activity index was reported at 51, a 24 month high, and up from 49.8 in July. The Eurozone Manufacturing PMI was reported at 51.3, a 26 month high, and up from 50.3 in July.
Germany's national statistics office reported that GDP increased at an annualized rate of 2.9% during the 2013 second quarter. The German government reported the central and local governments reported a budget surplus of .6% of GDP.
There was general agreement that tapering could begin later this year and conclude in the middle of 2014 "if economic conditions continued to develop broadly as expected". The "as expected" path for ending QE would be unemployment in the vicinity of 7 percent and inflation moving toward the Committee's 2 per cent objective. So, that amounts to a confirmation that the FED intends to taper but does not provide guidance as to when.
In my view, it does not matter whether the FED starts to taper in September or November, or decides to end QE in the 2014 second, third or fourth quarter. It is only important that QE will soon end, and intermediate and long term rates will normalize to market levels.
Participants did "generally continued to anticipate that the growth of real GDP would pick up somewhat in the second half of 2013 and strengthen further thereafter". A number of participants cautioned that they were less confident about a near term pick up in growth than they had been in June.
There was an interesting split in the member's views about future inflation:
 |
| Inflation Expectations |
QE first started in March 2009 and will be in its fifth year during 2014. The balance sheet is already well over $3 trillion and growing. System Open Market Account Holdings - Federal Reserve Bank of New York If asset purchases continue into the 2014 second half, could anyone at the FED argue with a straight face that QE is not debt monetization?
The SF Federal Reserve recently released a research paper that QE2 did not add much to growth. Federal Reserve Bank San Francisco | Research; Bloomberg The conclusion reached by the SF Federal Reserve economists was that the $600B in QE2 asset purchases added about .13% to real GDP growth which faded after two years.
Existing home sales rose 6.5% in July from June and 17.2% above the July 2012 rate. realtor.org
New homes sales plunged in July, falling 13.4% below the revised June reading, and at an anemic annual rate of only 394,000. census.gov.pdf The long term chart of new home sales highlights the devastation of the housing bubble:
New One Family Houses Sold: United States - St. Louis Fed
That is one ugly looking chart.
HSBC's flash PMI for China's manufacturing rose to 50.1, up from 47.7 in July. markiteconomics The consensus estimate was for a 48 reading.
Markit reported encouraging PMI numbers for Europe. markiteconomics The Eurozone Services PMI activity index was reported at 51, a 24 month high, and up from 49.8 in July. The Eurozone Manufacturing PMI was reported at 51.3, a 26 month high, and up from 50.3 in July.
Germany's national statistics office reported that GDP increased at an annualized rate of 2.9% during the 2013 second quarter. The German government reported the central and local governments reported a budget surplus of .6% of GDP.
The Indonesian current account deficit was reported to be $9.8B for the second quarter, up from $5.8B in the first quarter. Foreign investors were notable sellers as the rupiah sank to its lowest level against the dollar since 2009. Foreign investors are also concerned that growth in Indonesia slowed to less than 6% during the last quarter. Bloomberg Exports of coal, tin and palm oil to China have slowed down.
The central bank of Thailand recently trimmed its 2013 GDP growth forecast to 4.2% from 5.1% and its 2014 forecast to 5%. Thai Central Bank Last Monday, GDP for the second quarter was reported at -.3%, compared to the prior quarter, and the growth forecast for the year was lowered to 3.8% to 4.3%. WSJ
The central bank of Thailand recently trimmed its 2013 GDP growth forecast to 4.2% from 5.1% and its 2014 forecast to 5%. Thai Central Bank Last Monday, GDP for the second quarter was reported at -.3%, compared to the prior quarter, and the growth forecast for the year was lowered to 3.8% to 4.3%. WSJ
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Siegel And Shiller:
I recently discussed the Shiller P/E, including the many criticisms leveled at that formula primarily by those who are predisposed to bullishness now.
The Shiller CAPE ratio had the S & P 500 P/E at 23.57 last Monday, a problematic level for stock market bulls based on historical precedent, as I noted in my prior post.
Jeremy Siegel is one of the near perpetual bulls who find fault with Shiller's formula. His criticisms are not unique to him and are summarized in this MarketWatch article. Siegel's criticism of the CAPE formula was published in a Financial Times article available only with a subscription.
I generally agree with the criticisms leveled at Shiller's Cape ratio. I also recognize that the market has traditionally performed in lackluster fashion for several years when the CAPE ratio is over 20 as now. I will pay attention to historical precedent too.
I have repeatedly criticized Siegel's stocks for the long term thesis. My criticism revolves around a few simple facts that are generally applicable to most individual investors. Stocks, Bonds & Politics: To Professor Siegel: Time for a Re-Think (May 2009 Post); Item # 2 WSJ Article on Jeremy Siegel's Use of Data (and see also Barry Ritholtz column about Siegel in his Big Picture blog)
If I could have invested in 1951 the money that I currently have in the S & P 500, Siegel's thesis would work out just fine.
Unfortunately, most investors do not accumulate serious money until later in life, when the kids are hopefully supporting themselves, college is out of the way, and the mortgage is paid off.
The window for accumulating significant sums is relatively short for most investors before retirement. Throughout the period for accumulating savings, a very large number of situational risks will arise that require dipping into savings, including such items as the unexpected loss of a job, college tuition, and the need to contribute both time and money to a parent having difficulty making ends meet. Whatever the drain on savings may turn out to be, the issue is the relatively short period for accumulating savings.
Once that fact is understood and recognized, it is not particularly helpful to point out how stocks have outperformed bonds since 1871 or since 1949. Instead, there has to be a recognition that there are prolonged periods when stocks will provide negative real rates of return. Even young investors have such a period fresh in their minds (2000 to March 2009). That was a relatively short period of negative returns, only nine years and a few months, compared to 1/1/1966 to August 1982, when an investment in the S & P 500, with dividends reinvested, would have resulted in an annualized loss of more than 1% adjusted for inflation. If the long term secular bear market in stocks occurs during the money accumulation phase, then the likelihood of stocks producing the desired result are nil. And, that just needs to be understood as an important caveat to Siegel's thesis.
I have also mentioned and discussed Robert Arnott's criticism of Siegel's stock for the long run thesis. Siegel v. Arnott: Both Have Winning and Losing Arguments for Me in my Dynamic Asset Allocation
Arnott wrote an article in April 2009, "Bonds: Why Bother?", that simply pointed out that an investor could have beaten the S & P 500 over a 40 year period, starting in 1969, by simply buying 20 year treasury bonds, reinvesting the income, and rolling them over at maturity. That period included the robust long term secular bull market in stocks that started in August 1982.
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Prospect Capital (PSEC)
As noted in this Seeking Alpha article, PSEC significantly beat the consensus estimate by 8 cents per share, reporting income of $.38 cents per share for its 4th fiscal year quarter. The net income was lower than the 2012 F/Y 4th quarter due to a gain from the disposition of Gas Solutions. Book value only budged one cent to $10.72 per share from the prior quarter's $10.71. SEC Filed Earnings Press Release
F4Q 2013 Earnings Call Transcript - Seeking Alpha
I am reinvesting the dividend received for the shares owned in a taxable account, but will stop doing that when the market price exceeds book value per share by 5% (5% of $10.72 is $.536 + $10.72=$11.256).
This is a snapshot of my last dividend reinvestment:
I have not sold any shares held in that taxable account.
I will flip shares purchased in the ROTH IRA, where my primary investment consideration, given my financial situation, is preservation of capital, with income generation being a distant second and capital appreciation being even a more distant third objective.
I have added some shares in that taxable account recently: Item # 6 Added 100 PSEC at $10.85 (8/10/13 Post); Item # 2 Added 50 PSEC at $10.15 (June 2013)
My last purchase in the ROTH IRA occurred during one of the periodic dips in PSEC's price. I made what I called a paired trade at the time, selling Prospect's exchange traded bond PRY at $25.51 and using the proceeds to buy the higher yielding common stock. Item # 3 Paired Trade: Sold 50 PRY @ $25.51 & Bought 100 PSEC @ $10.2-Roth IRA (November 2012 Post)
Since that exchange, PRY has slid some in price while the higher yielding PSEC has gained in value:
Prospect Capital Corp. 6.95% Senior Notes Due 2022 (PRY)
Siegel And Shiller:
I recently discussed the Shiller P/E, including the many criticisms leveled at that formula primarily by those who are predisposed to bullishness now.
The Shiller CAPE ratio had the S & P 500 P/E at 23.57 last Monday, a problematic level for stock market bulls based on historical precedent, as I noted in my prior post.
Jeremy Siegel is one of the near perpetual bulls who find fault with Shiller's formula. His criticisms are not unique to him and are summarized in this MarketWatch article. Siegel's criticism of the CAPE formula was published in a Financial Times article available only with a subscription.
I generally agree with the criticisms leveled at Shiller's Cape ratio. I also recognize that the market has traditionally performed in lackluster fashion for several years when the CAPE ratio is over 20 as now. I will pay attention to historical precedent too.
I have repeatedly criticized Siegel's stocks for the long term thesis. My criticism revolves around a few simple facts that are generally applicable to most individual investors. Stocks, Bonds & Politics: To Professor Siegel: Time for a Re-Think (May 2009 Post); Item # 2 WSJ Article on Jeremy Siegel's Use of Data (and see also Barry Ritholtz column about Siegel in his Big Picture blog)
If I could have invested in 1951 the money that I currently have in the S & P 500, Siegel's thesis would work out just fine.
Unfortunately, most investors do not accumulate serious money until later in life, when the kids are hopefully supporting themselves, college is out of the way, and the mortgage is paid off.
The window for accumulating significant sums is relatively short for most investors before retirement. Throughout the period for accumulating savings, a very large number of situational risks will arise that require dipping into savings, including such items as the unexpected loss of a job, college tuition, and the need to contribute both time and money to a parent having difficulty making ends meet. Whatever the drain on savings may turn out to be, the issue is the relatively short period for accumulating savings.
Once that fact is understood and recognized, it is not particularly helpful to point out how stocks have outperformed bonds since 1871 or since 1949. Instead, there has to be a recognition that there are prolonged periods when stocks will provide negative real rates of return. Even young investors have such a period fresh in their minds (2000 to March 2009). That was a relatively short period of negative returns, only nine years and a few months, compared to 1/1/1966 to August 1982, when an investment in the S & P 500, with dividends reinvested, would have resulted in an annualized loss of more than 1% adjusted for inflation. If the long term secular bear market in stocks occurs during the money accumulation phase, then the likelihood of stocks producing the desired result are nil. And, that just needs to be understood as an important caveat to Siegel's thesis.
I have also mentioned and discussed Robert Arnott's criticism of Siegel's stock for the long run thesis. Siegel v. Arnott: Both Have Winning and Losing Arguments for Me in my Dynamic Asset Allocation
Arnott wrote an article in April 2009, "Bonds: Why Bother?", that simply pointed out that an investor could have beaten the S & P 500 over a 40 year period, starting in 1969, by simply buying 20 year treasury bonds, reinvesting the income, and rolling them over at maturity. That period included the robust long term secular bull market in stocks that started in August 1982.
*******************
Prospect Capital (PSEC)
As noted in this Seeking Alpha article, PSEC significantly beat the consensus estimate by 8 cents per share, reporting income of $.38 cents per share for its 4th fiscal year quarter. The net income was lower than the 2012 F/Y 4th quarter due to a gain from the disposition of Gas Solutions. Book value only budged one cent to $10.72 per share from the prior quarter's $10.71. SEC Filed Earnings Press Release
F4Q 2013 Earnings Call Transcript - Seeking Alpha
I am reinvesting the dividend received for the shares owned in a taxable account, but will stop doing that when the market price exceeds book value per share by 5% (5% of $10.72 is $.536 + $10.72=$11.256).
This is a snapshot of my last dividend reinvestment:
 |
| August Dividend Reinvestment =$10.987 per share |
I will flip shares purchased in the ROTH IRA, where my primary investment consideration, given my financial situation, is preservation of capital, with income generation being a distant second and capital appreciation being even a more distant third objective.
I have added some shares in that taxable account recently: Item # 6 Added 100 PSEC at $10.85 (8/10/13 Post); Item # 2 Added 50 PSEC at $10.15 (June 2013)
My last purchase in the ROTH IRA occurred during one of the periodic dips in PSEC's price. I made what I called a paired trade at the time, selling Prospect's exchange traded bond PRY at $25.51 and using the proceeds to buy the higher yielding common stock. Item # 3 Paired Trade: Sold 50 PRY @ $25.51 & Bought 100 PSEC @ $10.2-Roth IRA (November 2012 Post)
Since that exchange, PRY has slid some in price while the higher yielding PSEC has gained in value:
Prospect Capital Corp. 6.95% Senior Notes Due 2022 (PRY)
Prospect Capital (PSEC)
I will generally hold PSEC shares for a year or so in an IRA and then sell the shares, generally bought at less than $10.5, somewhere between $11 to $12.25. I have generated $242.82 in profits between 2010-2012 with 50 share lots bought in the IRA accounts while collecting the generous dividends. I include snapshots of those trades, and links to the posts discussing them, in Item # 3 Bought 100 PSEC @ $10.2-Roth IRA. That 100 share lot is in my sell zone for shares held in the IRA.
I may at some point buy the senior bond back in a retirement account, but I will need at least a 5% discount to its $25 par value.
Friday's Closing Price: PSEC $11.38 +.13 (1.16%)
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I will generally hold PSEC shares for a year or so in an IRA and then sell the shares, generally bought at less than $10.5, somewhere between $11 to $12.25. I have generated $242.82 in profits between 2010-2012 with 50 share lots bought in the IRA accounts while collecting the generous dividends. I include snapshots of those trades, and links to the posts discussing them, in Item # 3 Bought 100 PSEC @ $10.2-Roth IRA. That 100 share lot is in my sell zone for shares held in the IRA.
I may at some point buy the senior bond back in a retirement account, but I will need at least a 5% discount to its $25 par value.
Friday's Closing Price: PSEC $11.38 +.13 (1.16%)
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1. Sold Remaining IGR at $7.89+ (see Disclaimer):
Snapshot of Trade:
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| 2013 Sold 283 IGR at $7.893 |
Snapshot of Profit on 333 Shares in 2013:
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| 2013 IGR 333 Shares +$77.62 |
Security Description: The CBRE Clarion Global Real Estate Income Fund (IGR) is a leveraged closed end fund that owns common and preferred shares issued by real estate companies worldwide.
The fund is currently paying a monthly dividend of $.045 per share. At that rate, the yield is about 6.84% at a total cost of $7.89.
The fund is currently paying a monthly dividend of $.045 per share. At that rate, the yield is about 6.84% at a total cost of $7.89.
CEFConnect Page for IGR
Rationale: I simply wanted to sell this one while I still had a profit. I intend to use the proceeds to buy individual REIT common stocks.
Future Buys and Sells: Not likely. I am transitioning to direct ownership of REIT stocks as they plummet in price.
2. Bought 50 DRE at $14.5 Roth IRA (see Disclaimer): Equity REITs have turned into one of the falling knives.
Snapshot of Trade:
The shares had just gone ex dividend three days prior to this last purchase. I caught the shares near the close after a significant daily decline:
Closing Price on 8/16/13: DRE: $14.50 -0.62 (-4.10%)
The shares closed at $17.48 on 7/23/13, DRE Historical Prices. The closing price on 8/16/13 was $14.5, representing a 17% decline from the 7/23/13 closing price.
Snapshot of Prior Trades in Roth IRA:
Item # 1 Sold 100 DRE at 17.24-Roth IRA (April 2013)-Bought 50 DRE at $13.79-ROTH IRA (November 2012). I apparently did not discuss the other 50 share purchase.
Bought 50 DRE @ 13.45-ROTH IRA (February 2011)-Sold DRE at $15.31 (5/5/11 Post):
Security Description: Duke Realty Corp (DRE) is an equity REIT that owns, develops and manages industrial and medical properties.
Company Website: Home - Duke Realty
I have been familiar with this REIT for a long time since it operates in Nashville, and has several properties near HQ. Nashville - Duke Realty
Property List: Pages 15-17, 2012 10-K
Recent Earnings Report: For the 2013 second quarter, DRE reported core FFO of $.27 per share and an overall occupancy near a historic high at 93.1%. Same property net operating income grew 2.7% for the 12 months ending 6/30/13 and was up 3.4% compared to the 2012 second quarter. Adjusted funds from operations was $.24, representing a payout ratio below 71%. Duke Realty Reports Second Quarter 2013 Results
In-service occupancy in DRE's bulk distribution portfolio was 94.4%; 86.5% in its suburban office portfolio and 92.7% in its medical office buildings.
During the second quarter, the company acquired for $405M several "high-quality bulk industrial facilities located in key distribution markets" containing 5.9M square feet. All of those properties were 100% leased as of 6/30/13. Two of those facilities, totaling 950,000 square feet, are located in Cranbury, NJ and are 100% leased to Crate and Barrel through 2020. Another 4.9M square feet is a geographically diversified "portfolio of eight modern bulk industrial buildings" that are 100% leased to major retail tenants including Home Depot, Kimberly Clark, Sears and JoAnn Stores.
Q2 2013 Results - Earnings Call Transcript - Seeking Alpha (CEO acknowledges that some analysts have questioned "our acquisition of 100% leased facilities in the value creation opportunities", page 3, and that appears to be a legitimate concern)
SEC Form 10-Q for Q/E 6/30/13 (net real estate investments=$6.891+B; debt at $4.396+B with secured debt at $1.241B of that amount; equity preferred shares=$447.683M)
The 2014 F.F.O. estimate is $1.14. DRE Analyst Estimates The forward multiple on that estimate is 12.72.
Rationale: DRE shares have declined 15.9% since I sold shares at $17.24 last April until I bought the 50 shares lot at $14.5.
The decline from recent high, hit on 5/15 at $18.71, would be 22.5%. That decline does not appear to be warranted to me, even with the recent interest rate rise that makes long treasury bonds competitive in yield to DRE's current dividend yield.
With DRE, there is a reasonable possibility that the dividend will be increased over time, unlike the fixed coupon treasury, and the common share owner has an equity interest in a large real estate company.
DRE's share price went over a waterfall during the recent Near Depression. DRE Interactive Chart As shown in a long term chart, the shares were trading near $3 per share, split-adjusted, in 1991 and topped out near $41 in 2007. The shares then did a swan dive before hitting a hard place near $5.5 back in March 2009. Since that bottom was made, the shares have been moving up in choppy up and down action.
While I do not expect a recovery to $41 this decade, it would be reasonable to anticipate a gradual share price appreciation that will provide a decent total return when combined with the dividend.
The dividend yield at the current quarterly rate of $.17 is about 4.69% at a total cost of $14.5 per share. Hopefully, DRE will find the cash to start raising that dividend starting next year and will return to its former dividend growth path. Even if the start is slow, something like a rise to $.175 or $.18 per share during 2014, I would be satisfied provided the dividend was raised again in 2015. The important point here is to start investors thinking again about dividend raises, rather than that really nasty dividend cut discussed below.
Risks: (1) Share Price Destruction: The carnage in the share price suggests that this REIT made a large number of mistakes leading up to the recent recession, and possibly continuing thereafter, that led to a massive destruction in shareholder value and a decline back to 1996 levels. DRE Interactive Chart Many other REITs are still below their 2006-2007 peak prices, though nowhere near levels prevailing in the 1990s even after the recent correction, while others have exceeded their 2007 peaks earlier this year.
Boston Properties | BXP Interactive Chart
SL Green Realty | SLG Interactive Chart
HCP| HCP Interactive Chart
Health Care REIT| HCN Interactive Chart
AvalonBay Communities | AVB Interactive Chart
Equity Residential | EQR Interactive Chart
Alexandria Real Estate Equities | ARE Interactive Chart
Simon Property Group | SPG Interactive Chart
Sovran Self Storage| SSS Interactive Chart
EastGroup Properties| EGP Interactive Chart
A company similar in many respects to Duke Realty is First Industrial Realty (FR), whose stock chart looks similar to DRE. The closing price for FR was $15.09 on 8/16/13 and topped out at $50.25 late in 2006 before doing its tailspin to $2 and change.
(2) Dividend Slash: Duke shareholders also suffered a major slash in their quarterly dividend rates. The quarterly rate was $.485 per share in the 2008 4th quarter, and was then first slashed to $.25 for one quarter before the company adopted the current rate of just $.17 per share. Dividend History | Investor Relations | Duke Realty
There are two major negatives reflected in that dividend history. Both cause me to pause and to adopt a trading strategy for this security.
The first is the size of the dividend slash, a stunning 65%.
The second major negative is that the dividend has been kept constant for 18 quarters as the company proudly acknowledged a near record occupancy rate for the past quarter.
While my memory may be foggy or incorrect, I remember that both DRE and FR supported their dividends in part, prior to the Near Depression, by developing and selling new properties.
{FR was bought and sold as part of the Lottery Ticket strategy, Lottery Ticket Strategy. FRPRK was bought and sold twice successfully, both 50 share lots, and was called at its $25 par value last July. REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & disadvantages.}
(3) Debt Load: Another issue is the sheer amount of debt. While I would not anticipate in rolling over the notes as they mature, there is interest rate risk involved in having to refinance at higher rates. Most commercial mortgages are relatively short term.
The last quarterly report does not list all of the maturity schedules, pages 14-15. Slightly more detail is given in the 2012 Annual Report at pp. 86-88: 2012 10-K
(4) Competition and Lack of Significant Barriers to Entry: Another issue is that bulk distribution facilities are subject to competitive pressures. It is not like owning a nice office building in downtown SF, NYC or Boston. Another real estate operator could build one of those facilities nearby without any trouble acquiring the necessary buildings permits or vacant land. Many of these facilities are located near airports and ports or in suburban or outlying areas near interstate entry/exit ramps.
Other risk factors are discussed in the 2012 Annual Report starting at page 7 and continuing to page 14: 2012 10K
Future Buys-Sells: I will probably average down by buying another 50 shares somewhere south of $14.
Friday's Closing Price: $14.91 +.26 (1.77%)
3. Bought 100 PFE at $28.7 (see Disclaimer): Given Pfizer's problems, this was at best a marginal buy. The price has drifted down since this recent purchase.
Snapshot of Trade:
Security Description: Pfizer (PFE)
In November 2012, Pfizer completed the sale of its nutrition business to Nestle for $11.85B and recognized a gain of approximately $4.8B.
In February 2013, Pfizer sold 99.015M shares of Zoetis, its animal health subsidiary, which represented 19.8% of its total ownership interest. The company recently launched an exchange of Pfizer shares for its remaining Zoetis interest. In its last earnings report, Pfizer stated that it had accepted 405.1 million Pfizer shares, valued at approximately $11.4B, for its remaining 80.2% stake in Zoetis.
Pfizer's consumer products division was sold to JNJ for $16.6B in 2006. NYT; note 4 Pfizer Inc. 1 Q 2007 Form 10-Q.
Pfizer sold its Capsugel pill unit to KKR for $2.38B. Bloomberg
This is a link to a graph showing Pfizer's Product Pipeline.
Pfizer Profile Page at Reuters
2012 Annual Report: PFE-12.31.2012-10K (patent expirations by drug at page 9)
SEC Filed Financial Report: PFE-12.31.2012
This purchase is a marginal one based on the negative impacts from patent expirations as shown in this table:
Page 3: PFE-12.31.2012 That table certainly was discouraging.
The loss of exclusivity on Lipitor is a major negative of course.
Prior Trades: My last trade was a 50 share flip in 2006:
Recent Earnings Report: For the second quarter of 2013, Pfizer reported an adjusted E.P.S. of $.56, down from $.59, on a 7% decline in revenues. SEC Filed Press Release The company gave its 2013 adjusted E.P.S. forecast as $2.1 to $2.2. The GAAP number will be much higher due to the gain on the full disposition of Zoetis.
The company is using proceeds from its dispositions to buy back stock. Through 6/30/13, Pfizer had purchased $8.7B of its common stock. Of that amount, $3.3B was purchased in the second quarter.
Once I own a drug company stock, I will want to look at revenues per drug. It took two snapshots to capture Pfizer's breakdown:
Pages 47-48 PFE - 6/30/2013 - 10Q
Rationale: I have been concerned about Pfizer's patent expirations. After reviewing the recent product introductions, and the pipeline, I became sufficiently comfortable to make a 100 share nibble based on those considerations, along with a low forward P/E multiple and a dividend yield in excess of 3%. The current quarterly dividend is $.24 per share. At that rate, the yield would be about 3.34% at a total cost of $28.7 per share.
The current consensus E.P.S. estimate for 2014 is $2.30, up from $2.16 in 2013. PFE Analyst Estimates
The two new drugs are called Xeljanz for rheumatoid arthritis and Eliquis for cardiovascular disease.
XELJANZ® (tofacitinib citrate)
ELIQUIS® (apixaban) | Official Site
Once Pfizer obtains initial approval for one indication, it will generally have several other trials in progress for other indications. Product Pipeline | Pfizer (Xeljanz in stage 3 trials for psoriasis).
I have read several reports that Eliquis sales have been disappointing through the 2013 second quarter since that blood thinning drug was launched, but I would give it more time. It is basically a replacement drug for Warfarin. It was approved by the FDA last December. That drug is co-marketed with BMY who reported worldwide Eliquis sales of only $12M in the 2013 second quarter: Bristol-Myers Squibb Reports Second Quarter 2013 Financial Results Initially, analysts had forecasted peak annual sales of $3B, with some as high as $5B, but now the estimate is closer to $600M. Two other Warfarin replacements hit the market earlier, Pradaxa and Xarelto, and may have become entrenched with doctors. Eliquis has been approved for use in Europe, Canada and Japan.
Xeljanz, which is approved for rheumatoid arthritis patients who fail to respond to first line treatment, has also had disappointing sales going up against Humira. Analysts have reduced their peak annual sales forecast by 2016 to $1.6B from $3B.
Two newer cancer drugs are Inlyta for advanced renal cell carcinoma and Xalkori (Crizotinib) for advanced non-small cell lung cancer. Oncology product sales did increase 24% in the 2013 second quarter to $399, with revenues from Inlyta hitting $71M and Xalkori almost tripling to $67M. Inlyta (Axitinib) was developed internally by Pfizer, while Xalkori was developed by researchers at Agouron Pharmaceuticals which was acquired by Warner-Lambert (WL) in 1999, NYT, and WL was acquired later by Pfizer. FDA Approval for Crizotinib - National Cancer Institute
Pfizer's experimental cancer drug, Palbociclib PD-991, has been granted fast track status by the FDA. Pfizer’s Palbociclib (PD-0332991) Receives Food And Drug Administration Breakthrough Therapy Designation For Potential Treatment Of Patients With Breast Cancer Phase II clinical trials found progression-free survival for more than two years among breast cancer patients when paired with an older drug Femara. Bloomberg This drug has the potential to reach blockbuster status, provided the Phase III trials confirm the Phase II results. This product was developed in collaboration with Onyx: Palbociclib | Onyx Pharmaceuticals.
Ultimately, the success or failure of this investment will depend on Pfizer's success in successfully developing future blockbuster drugs, and I certainly have my doubts about the ability of this company to deliver.
Risks: (1) Patent Expirations and Drug Approvals: Pfizer has lost exclusivity to several major drugs and a few more will be lost within the next two years. I have not been impressed overall with the new drugs developed internally, which have so far received FDA approval, to replace those expiring. Many of the Pfizer's successful products were acquired through acquisitions of other firms that invented them. It remains to be seen whether Pfizer can successfully bring new drugs, currently in the pipeline, to market.
Europe has not approved Xeljanz, as just one example of regulatory risks (see page 5 of earnings release and article Pfizer's Xeljanz)
(2) Disposition of Stable Revenue Businesses: While the company has raised a lot of cash with recent asset dispositions, those businesses had more stable revenue streams. I would actually prefer that Pfizer still own all of those businesses including the consumer product division that was sold to JNJ several years ago for $16.6B. The company in its current configuration will have higher profit margins but will be dependent on discovering new drugs to replace ones losing exclusivity and then successfully bringing those drugs to market after expensive and time consuming trials. I believe that business model adds risks and uncertain potential rewards, particularly given the overall prior success rate of Pfizer's own research and development.
On the flip side, assuming Pfizer is able to successfully develop new major blockbuster drugs in house, per share profits would then accelerate at a faster pace without being dragged down by the slower growing stable businesses that have been divested by the company. I would give Pfizer a "D+" for in house development of blockbuster drugs taking into account the money spent in that endeavor. Novartis is a more innovative company.
(3) Other Risks: The company describes risks starting at page 22 of the 2012 Annual Report. I would highlight two kinds of risks with recent news developments. PFE agreed to pay $491M after pleading guilty to a federal charge that it illegally marketed the kidney transplant drug Rapmune for use in other transplants. Bloomberg Another type of risk arises from drug side effects. A district court judge recently leveled $1.8 million in punitive damages against PFE after a woman allegedly developed breast cancer after taking PFE's Prempro menopause drug. Bloomberg PFE has set aside about $1.6 billion to cover those types of claims after a 2002 study highlighted the cancer risk.
It takes several pages for Pfizer to briefly describe ongoing litigation: Pages 30-42, PFE - 6/30/2013 - 10Q
(4) Dividend Slash After 2009 Wyeth Acquisition: This $68B acquisition brought Enbrel (co-marketed with Amgen) and Prevnar into Pfizer's fold, but also caused Pfizer to slash its dividend by 50%. Reuters The quarterly dividend was reduced from $.32 per share to $.16 in the 2009 second quarter. Investors | Pfizer That is another reason why I have avoided the stock for years.
(5) Not Invented Here Syndrome: This is a major negative from my perspective and is one of the main reasons why I have stayed away from Pfizer for a long time. Many of the well known PFE drugs were not discovered in PFE's labs but by other companies that were acquired by Pfizer. Lipitor was developed by Parke-Davis, part of Warner Lambert that was acquired by Pfizer in 2000. Pfizer History Other drugs were acquired via Pfizer's acquisition of Pharmacia in 2003 and Wyeth in 2009 (e.g. Enbrel , Premarin, Effexor, Protonix, Prevnar) One of Pfizer's major current drugs, which still has patent protection, is Sutent that was discovered by SUGEN, which was acquired by Pharmacia in 1999, and Pfizer later acquired Pharmacia. Another one of the current blockbuster drugs, Lyrica, was invented by a chemist at Northwestern, Richard Bruce Silverman.
As I recall, and my memory is not what it use to be, Viagra was for a long time the only in-house discovered blockbuster drug. As noted above, I give PFE an "D+" for drug discovery.
Future Buys: Conceivably, I could buy up to another 100 shares. I am not likely to add until I see significantly better sales for both Xeljanz and Eliquis as well as more FDA approvals of drugs in the pipeline. The company is still facing headwinds in patent expirations.
Friday's Closing Price $28.34 +$.18 (.64%)
4. Bought 100 OSM at $23.12 (see Disclaimer):
Snapshot of Trade:
Security Description: SLM Corp. CPI-Linked Medium Term Notes Series A 2017 (OSM) is a senior unsecured note issued by SLM, also known as Sallie Mae, that pays monthly interest payments based on a 2% spread to a CPI calculation on a $25 par value. The note matures on 3/15/2017.
OSM Prospectus (poorly written with some hieroglyphics that make no sense)
The OSM prospectus only refers to the security as a medium term note, and then references another prospectus:
SLM Prospectus for Medium Term Notes
The prospectus identifies notes issued under that prospectus as senior unsecured:
The monthly interest payment is calculated using the non-seasonally adjusted CPI numbers. research.stlouisfed.org For each monthly BLS report on CPI, the data can also be found in first line of Table 1: Table 1. Consumer Price Index for All Urban Consumers (CPI-U)
This is how the calculation would be made using the most recent CPI number for July 2013. This will be the monthly payment calculation for November 15, 2013. The Y-O-Y CPI increase between 7/2012 to 7/2013 is used in the calculation for the monthly period ending on 11/15/13.
July 2013: 233.596
July 2012: 229.104
Difference: 4.492
Divide 4.492 by 229.104= .0196% Annual Increase
Add Spread of .02%= .0396%
Multiply .00396 x. $25 par value=$.99 (annually)
Multiply $.99 by 31/365= $.08408 per share (31 days in coupon period)
The coupon payment will of course be variable for each month depending on the 12 month percentage change in CPI, with a 3 month lag.
The payment made in September 2013 was $.071385
May 2013: 232.945
May 2013: 229.815
Difference: 3.13
Divide 3.13 by 229.815= .01362
Add .02 Spread= .03362
Multiply .03362 x. $25 par value=$.8405
Multiply $.8405 x. 31/365=$.071385
All of the foregoing is just to highlight that LB is a Nerd Machine.
Prior Trades: I have bought and sold OSM several times. The largest gain was realized last year on a 100 share lot:
The first 50 share lot was purchased in August 2008, prior to starting this blog. The other 50 share lot was purchased in March 2010:
Sold 100 OSM at $23.34 (March 2012)-Item # 9 Bought 50 OSM at $15.74
I have clipped several smaller gains:
Item # 4 Bought 100 OSM at 15.75-Regular IRA (June 2010)- Item # 4 Sold 100 OSM at $16.87 (July 2010); Item # 3 Bought 50 OSM at $11.8 (June 2009)- Item # 3 Sold 50 OSM at $16.01 (January 2010)
The shares were bought on 7/31/2008, prior to the commencement of this blog, and were sold 10/22/2010: SOLD 100 of 200 OSM at $18.18
Snapshot of Trade:
 |
| 2013 Roth IRA Bought 50 DRE at $14.5 |
Closing Price on 8/16/13: DRE: $14.50 -0.62 (-4.10%)
The shares closed at $17.48 on 7/23/13, DRE Historical Prices. The closing price on 8/16/13 was $14.5, representing a 17% decline from the 7/23/13 closing price.
Snapshot of Prior Trades in Roth IRA:
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| 2013 Roth IRA DRE 100 Shares +$309.69 |
Bought 50 DRE @ 13.45-ROTH IRA (February 2011)-Sold DRE at $15.31 (5/5/11 Post):
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| 2011 Roth IRA 50 DRE +$78.98 |
Company Website: Home - Duke Realty
I have been familiar with this REIT for a long time since it operates in Nashville, and has several properties near HQ. Nashville - Duke Realty
Property List: Pages 15-17, 2012 10-K
Recent Earnings Report: For the 2013 second quarter, DRE reported core FFO of $.27 per share and an overall occupancy near a historic high at 93.1%. Same property net operating income grew 2.7% for the 12 months ending 6/30/13 and was up 3.4% compared to the 2012 second quarter. Adjusted funds from operations was $.24, representing a payout ratio below 71%. Duke Realty Reports Second Quarter 2013 Results
This REIT will develop its own properties. During the second quarter, it started construction on one 206,000 square foot suburban office development and three medical office buildings totaling 114,000 square feet. This brings the total developments in progress to 3.3M square feet, with an estimated cost of $513M, and DRE has 90% of those projects pre-leased in aggregate.
During the second quarter, the company acquired for $405M several "high-quality bulk industrial facilities located in key distribution markets" containing 5.9M square feet. All of those properties were 100% leased as of 6/30/13. Two of those facilities, totaling 950,000 square feet, are located in Cranbury, NJ and are 100% leased to Crate and Barrel through 2020. Another 4.9M square feet is a geographically diversified "portfolio of eight modern bulk industrial buildings" that are 100% leased to major retail tenants including Home Depot, Kimberly Clark, Sears and JoAnn Stores.
Q2 2013 Results - Earnings Call Transcript - Seeking Alpha (CEO acknowledges that some analysts have questioned "our acquisition of 100% leased facilities in the value creation opportunities", page 3, and that appears to be a legitimate concern)
SEC Form 10-Q for Q/E 6/30/13 (net real estate investments=$6.891+B; debt at $4.396+B with secured debt at $1.241B of that amount; equity preferred shares=$447.683M)
The 2014 F.F.O. estimate is $1.14. DRE Analyst Estimates The forward multiple on that estimate is 12.72.
Rationale: DRE shares have declined 15.9% since I sold shares at $17.24 last April until I bought the 50 shares lot at $14.5.
The decline from recent high, hit on 5/15 at $18.71, would be 22.5%. That decline does not appear to be warranted to me, even with the recent interest rate rise that makes long treasury bonds competitive in yield to DRE's current dividend yield.
With DRE, there is a reasonable possibility that the dividend will be increased over time, unlike the fixed coupon treasury, and the common share owner has an equity interest in a large real estate company.
DRE's share price went over a waterfall during the recent Near Depression. DRE Interactive Chart As shown in a long term chart, the shares were trading near $3 per share, split-adjusted, in 1991 and topped out near $41 in 2007. The shares then did a swan dive before hitting a hard place near $5.5 back in March 2009. Since that bottom was made, the shares have been moving up in choppy up and down action.
While I do not expect a recovery to $41 this decade, it would be reasonable to anticipate a gradual share price appreciation that will provide a decent total return when combined with the dividend.
The dividend yield at the current quarterly rate of $.17 is about 4.69% at a total cost of $14.5 per share. Hopefully, DRE will find the cash to start raising that dividend starting next year and will return to its former dividend growth path. Even if the start is slow, something like a rise to $.175 or $.18 per share during 2014, I would be satisfied provided the dividend was raised again in 2015. The important point here is to start investors thinking again about dividend raises, rather than that really nasty dividend cut discussed below.
Risks: (1) Share Price Destruction: The carnage in the share price suggests that this REIT made a large number of mistakes leading up to the recent recession, and possibly continuing thereafter, that led to a massive destruction in shareholder value and a decline back to 1996 levels. DRE Interactive Chart Many other REITs are still below their 2006-2007 peak prices, though nowhere near levels prevailing in the 1990s even after the recent correction, while others have exceeded their 2007 peaks earlier this year.
Boston Properties | BXP Interactive Chart
SL Green Realty | SLG Interactive Chart
HCP| HCP Interactive Chart
Health Care REIT| HCN Interactive Chart
AvalonBay Communities | AVB Interactive Chart
Equity Residential | EQR Interactive Chart
Alexandria Real Estate Equities | ARE Interactive Chart
Simon Property Group | SPG Interactive Chart
Sovran Self Storage| SSS Interactive Chart
EastGroup Properties| EGP Interactive Chart
A company similar in many respects to Duke Realty is First Industrial Realty (FR), whose stock chart looks similar to DRE. The closing price for FR was $15.09 on 8/16/13 and topped out at $50.25 late in 2006 before doing its tailspin to $2 and change.
(2) Dividend Slash: Duke shareholders also suffered a major slash in their quarterly dividend rates. The quarterly rate was $.485 per share in the 2008 4th quarter, and was then first slashed to $.25 for one quarter before the company adopted the current rate of just $.17 per share. Dividend History | Investor Relations | Duke Realty
There are two major negatives reflected in that dividend history. Both cause me to pause and to adopt a trading strategy for this security.
The first is the size of the dividend slash, a stunning 65%.
The second major negative is that the dividend has been kept constant for 18 quarters as the company proudly acknowledged a near record occupancy rate for the past quarter.
While my memory may be foggy or incorrect, I remember that both DRE and FR supported their dividends in part, prior to the Near Depression, by developing and selling new properties.
{FR was bought and sold as part of the Lottery Ticket strategy, Lottery Ticket Strategy. FRPRK was bought and sold twice successfully, both 50 share lots, and was called at its $25 par value last July. REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & disadvantages.}
(3) Debt Load: Another issue is the sheer amount of debt. While I would not anticipate in rolling over the notes as they mature, there is interest rate risk involved in having to refinance at higher rates. Most commercial mortgages are relatively short term.
The last quarterly report does not list all of the maturity schedules, pages 14-15. Slightly more detail is given in the 2012 Annual Report at pp. 86-88: 2012 10-K
(4) Competition and Lack of Significant Barriers to Entry: Another issue is that bulk distribution facilities are subject to competitive pressures. It is not like owning a nice office building in downtown SF, NYC or Boston. Another real estate operator could build one of those facilities nearby without any trouble acquiring the necessary buildings permits or vacant land. Many of these facilities are located near airports and ports or in suburban or outlying areas near interstate entry/exit ramps.
Other risk factors are discussed in the 2012 Annual Report starting at page 7 and continuing to page 14: 2012 10K
Future Buys-Sells: I will probably average down by buying another 50 shares somewhere south of $14.
Friday's Closing Price: $14.91 +.26 (1.77%)
3. Bought 100 PFE at $28.7 (see Disclaimer): Given Pfizer's problems, this was at best a marginal buy. The price has drifted down since this recent purchase.
Snapshot of Trade:
Security Description: Pfizer (PFE)
In November 2012, Pfizer completed the sale of its nutrition business to Nestle for $11.85B and recognized a gain of approximately $4.8B.
In February 2013, Pfizer sold 99.015M shares of Zoetis, its animal health subsidiary, which represented 19.8% of its total ownership interest. The company recently launched an exchange of Pfizer shares for its remaining Zoetis interest. In its last earnings report, Pfizer stated that it had accepted 405.1 million Pfizer shares, valued at approximately $11.4B, for its remaining 80.2% stake in Zoetis.
Pfizer's consumer products division was sold to JNJ for $16.6B in 2006. NYT; note 4 Pfizer Inc. 1 Q 2007 Form 10-Q.
Pfizer sold its Capsugel pill unit to KKR for $2.38B. Bloomberg
This is a link to a graph showing Pfizer's Product Pipeline.
Pfizer Profile Page at Reuters
2012 Annual Report: PFE-12.31.2012-10K (patent expirations by drug at page 9)
SEC Filed Financial Report: PFE-12.31.2012
This purchase is a marginal one based on the negative impacts from patent expirations as shown in this table:
Page 3: PFE-12.31.2012 That table certainly was discouraging.
The loss of exclusivity on Lipitor is a major negative of course.
Prior Trades: My last trade was a 50 share flip in 2006:
 |
| 2006 PFE 50 Shares +$146.6 |
The company is using proceeds from its dispositions to buy back stock. Through 6/30/13, Pfizer had purchased $8.7B of its common stock. Of that amount, $3.3B was purchased in the second quarter.
Once I own a drug company stock, I will want to look at revenues per drug. It took two snapshots to capture Pfizer's breakdown:
Pages 47-48 PFE - 6/30/2013 - 10Q
Rationale: I have been concerned about Pfizer's patent expirations. After reviewing the recent product introductions, and the pipeline, I became sufficiently comfortable to make a 100 share nibble based on those considerations, along with a low forward P/E multiple and a dividend yield in excess of 3%. The current quarterly dividend is $.24 per share. At that rate, the yield would be about 3.34% at a total cost of $28.7 per share.
The current consensus E.P.S. estimate for 2014 is $2.30, up from $2.16 in 2013. PFE Analyst Estimates
The two new drugs are called Xeljanz for rheumatoid arthritis and Eliquis for cardiovascular disease.
XELJANZ® (tofacitinib citrate)
ELIQUIS® (apixaban) | Official Site
Once Pfizer obtains initial approval for one indication, it will generally have several other trials in progress for other indications. Product Pipeline | Pfizer (Xeljanz in stage 3 trials for psoriasis).
I have read several reports that Eliquis sales have been disappointing through the 2013 second quarter since that blood thinning drug was launched, but I would give it more time. It is basically a replacement drug for Warfarin. It was approved by the FDA last December. That drug is co-marketed with BMY who reported worldwide Eliquis sales of only $12M in the 2013 second quarter: Bristol-Myers Squibb Reports Second Quarter 2013 Financial Results Initially, analysts had forecasted peak annual sales of $3B, with some as high as $5B, but now the estimate is closer to $600M. Two other Warfarin replacements hit the market earlier, Pradaxa and Xarelto, and may have become entrenched with doctors. Eliquis has been approved for use in Europe, Canada and Japan.
Xeljanz, which is approved for rheumatoid arthritis patients who fail to respond to first line treatment, has also had disappointing sales going up against Humira. Analysts have reduced their peak annual sales forecast by 2016 to $1.6B from $3B.
Two newer cancer drugs are Inlyta for advanced renal cell carcinoma and Xalkori (Crizotinib) for advanced non-small cell lung cancer. Oncology product sales did increase 24% in the 2013 second quarter to $399, with revenues from Inlyta hitting $71M and Xalkori almost tripling to $67M. Inlyta (Axitinib) was developed internally by Pfizer, while Xalkori was developed by researchers at Agouron Pharmaceuticals which was acquired by Warner-Lambert (WL) in 1999, NYT, and WL was acquired later by Pfizer. FDA Approval for Crizotinib - National Cancer Institute
Pfizer's experimental cancer drug, Palbociclib PD-991, has been granted fast track status by the FDA. Pfizer’s Palbociclib (PD-0332991) Receives Food And Drug Administration Breakthrough Therapy Designation For Potential Treatment Of Patients With Breast Cancer Phase II clinical trials found progression-free survival for more than two years among breast cancer patients when paired with an older drug Femara. Bloomberg This drug has the potential to reach blockbuster status, provided the Phase III trials confirm the Phase II results. This product was developed in collaboration with Onyx: Palbociclib | Onyx Pharmaceuticals.
Ultimately, the success or failure of this investment will depend on Pfizer's success in successfully developing future blockbuster drugs, and I certainly have my doubts about the ability of this company to deliver.
Risks: (1) Patent Expirations and Drug Approvals: Pfizer has lost exclusivity to several major drugs and a few more will be lost within the next two years. I have not been impressed overall with the new drugs developed internally, which have so far received FDA approval, to replace those expiring. Many of the Pfizer's successful products were acquired through acquisitions of other firms that invented them. It remains to be seen whether Pfizer can successfully bring new drugs, currently in the pipeline, to market.
Europe has not approved Xeljanz, as just one example of regulatory risks (see page 5 of earnings release and article Pfizer's Xeljanz)
(2) Disposition of Stable Revenue Businesses: While the company has raised a lot of cash with recent asset dispositions, those businesses had more stable revenue streams. I would actually prefer that Pfizer still own all of those businesses including the consumer product division that was sold to JNJ several years ago for $16.6B. The company in its current configuration will have higher profit margins but will be dependent on discovering new drugs to replace ones losing exclusivity and then successfully bringing those drugs to market after expensive and time consuming trials. I believe that business model adds risks and uncertain potential rewards, particularly given the overall prior success rate of Pfizer's own research and development.
On the flip side, assuming Pfizer is able to successfully develop new major blockbuster drugs in house, per share profits would then accelerate at a faster pace without being dragged down by the slower growing stable businesses that have been divested by the company. I would give Pfizer a "D+" for in house development of blockbuster drugs taking into account the money spent in that endeavor. Novartis is a more innovative company.
(3) Other Risks: The company describes risks starting at page 22 of the 2012 Annual Report. I would highlight two kinds of risks with recent news developments. PFE agreed to pay $491M after pleading guilty to a federal charge that it illegally marketed the kidney transplant drug Rapmune for use in other transplants. Bloomberg Another type of risk arises from drug side effects. A district court judge recently leveled $1.8 million in punitive damages against PFE after a woman allegedly developed breast cancer after taking PFE's Prempro menopause drug. Bloomberg PFE has set aside about $1.6 billion to cover those types of claims after a 2002 study highlighted the cancer risk.
It takes several pages for Pfizer to briefly describe ongoing litigation: Pages 30-42, PFE - 6/30/2013 - 10Q
(4) Dividend Slash After 2009 Wyeth Acquisition: This $68B acquisition brought Enbrel (co-marketed with Amgen) and Prevnar into Pfizer's fold, but also caused Pfizer to slash its dividend by 50%. Reuters The quarterly dividend was reduced from $.32 per share to $.16 in the 2009 second quarter. Investors | Pfizer That is another reason why I have avoided the stock for years.
(5) Not Invented Here Syndrome: This is a major negative from my perspective and is one of the main reasons why I have stayed away from Pfizer for a long time. Many of the well known PFE drugs were not discovered in PFE's labs but by other companies that were acquired by Pfizer. Lipitor was developed by Parke-Davis, part of Warner Lambert that was acquired by Pfizer in 2000. Pfizer History Other drugs were acquired via Pfizer's acquisition of Pharmacia in 2003 and Wyeth in 2009 (e.g. Enbrel , Premarin, Effexor, Protonix, Prevnar) One of Pfizer's major current drugs, which still has patent protection, is Sutent that was discovered by SUGEN, which was acquired by Pharmacia in 1999, and Pfizer later acquired Pharmacia. Another one of the current blockbuster drugs, Lyrica, was invented by a chemist at Northwestern, Richard Bruce Silverman.
As I recall, and my memory is not what it use to be, Viagra was for a long time the only in-house discovered blockbuster drug. As noted above, I give PFE an "D+" for drug discovery.
Future Buys: Conceivably, I could buy up to another 100 shares. I am not likely to add until I see significantly better sales for both Xeljanz and Eliquis as well as more FDA approvals of drugs in the pipeline. The company is still facing headwinds in patent expirations.
Friday's Closing Price $28.34 +$.18 (.64%)
4. Bought 100 OSM at $23.12 (see Disclaimer):
Snapshot of Trade:
 |
| 2013 Roth Bought 100 OSM at $23.12 |
Security Description: SLM Corp. CPI-Linked Medium Term Notes Series A 2017 (OSM) is a senior unsecured note issued by SLM, also known as Sallie Mae, that pays monthly interest payments based on a 2% spread to a CPI calculation on a $25 par value. The note matures on 3/15/2017.
OSM Prospectus (poorly written with some hieroglyphics that make no sense)
The OSM prospectus only refers to the security as a medium term note, and then references another prospectus:
SLM Prospectus for Medium Term Notes
The prospectus identifies notes issued under that prospectus as senior unsecured:
The monthly interest payment is calculated using the non-seasonally adjusted CPI numbers. research.stlouisfed.org For each monthly BLS report on CPI, the data can also be found in first line of Table 1: Table 1. Consumer Price Index for All Urban Consumers (CPI-U)
This is how the calculation would be made using the most recent CPI number for July 2013. This will be the monthly payment calculation for November 15, 2013. The Y-O-Y CPI increase between 7/2012 to 7/2013 is used in the calculation for the monthly period ending on 11/15/13.
July 2013: 233.596
July 2012: 229.104
Difference: 4.492
Divide 4.492 by 229.104= .0196% Annual Increase
Add Spread of .02%= .0396%
Multiply .00396 x. $25 par value=$.99 (annually)
Multiply $.99 by 31/365= $.08408 per share (31 days in coupon period)
The coupon payment will of course be variable for each month depending on the 12 month percentage change in CPI, with a 3 month lag.
The payment made in September 2013 was $.071385
May 2013: 232.945
May 2013: 229.815
Difference: 3.13
Divide 3.13 by 229.815= .01362
Add .02 Spread= .03362
Multiply .03362 x. $25 par value=$.8405
Multiply $.8405 x. 31/365=$.071385
All of the foregoing is just to highlight that LB is a Nerd Machine.
Prior Trades: I have bought and sold OSM several times. The largest gain was realized last year on a 100 share lot:
 |
| 2012 OSM 100 Shares +$733.05 |
Sold 100 OSM at $23.34 (March 2012)-Item # 9 Bought 50 OSM at $15.74
I have clipped several smaller gains:
 |
| 2010 Regular IRA +$290.54 |
 |
| 2010 OSM 100 Shares +$117.01 |
 |
| 2011 OSM 50 Shares +$109.6 |
Item # 1 Sold 50 OSM at $21.06 (March 2011)-Added to OSM at $18.47 (December 2010).
Stocks, Bonds & Politics: Floaters: Links in One Post
Recent Earnings Release: For the 2013 second quarter, SLM reported GAAP net income of $503M or $1.2 per share. Core earnings were reported at $1.02 per share. Core earnings included a $257M gain from the sale of residual interest in FFELP (Federally Guaranteed Student Loans) loan securitization trusts, a $38M after tax gain from the sale of SLM's Campus Solutions business, a $42M decline in loan losses and an increase in net interest income before provisions for loan losses of $19M. In its private education loan portfolio, SLM originated $368M in loans, up 15% and had a core net interest margin of 4.12%. Delinquencies of 90 days or more declined to 3.6% from 4.5%. The FFELP segment reported $237M in core earnings, up from $44M, primarily due to a $257M gain from the sale of residual interests in FFELP loan securitization trusts. As of 6/30,13, SLM had 108B of FFELP loans compared to $133B as of 6/30/12. In SLM's third business segment, called business services, the core earnings were $166B, which included the $38M after tax gain referenced above. This segment includes fees from servicing, collections and college savings businesses. SEC Filed News Release
Form 10-Q
Rationale: (1) Decent YTM Based on an Average CPI of 2%: Since this security pays a spread to CPI, and matures in less than 4 years, I am not assuming much, if any, interest rate risk.
Assuming SLM survives to pay the principal at maturity, I will receive a $181 profit on the shares in less than 4 years or about a 7.8% return (almost 2% per year)
In addition, I will receive monthly interest payments at a 2% spread to the aforementioned annual CPI calculation. A 2% annual CPI rate would be a reasonable forecast for the next 4 years in my opinion. Assuming an average coupon of 4% from now until the maturity date, the annualized current yield would be about 4.33% at a total cost per share of $23.12. At that total cost number, and assuming a 4.33% average coupon, the YTM would be about 6.71% using Fidelity's calculator. Price/Yield Calculator That YTM calculation will vary with actual future CPI numbers. It could be higher or lower.
By buying this security in the ROTH IRA, I convert a bond that pays taxable interest into a tax free bond.
I am just trying to make a ballpark type rational guess as to the potential annualized return.
For comparison purposes, I found several SLM unsecured senior fixed rate coupon bonds maturing in 2017:
2.043% 2/1/2017
5.15% 3/15/17 (same maturity date as OSM)
4.45% 12/15/17
5.1% 6/15/17
4.8% 6/15/17
(2) Interest Rate Risk is Minimal Due to Short Maturity (less than 4 years) and the CPI Float. In this connection, a rise in interest rates due to interest rate normalization, rather than an increase in inflation, will not be captured by a CPI floater. A rise in rates caused by an increase in CPI from 2% to 3% would be captured by an increase in the coupon.
Risks: (1) Credit risk is the main risk. While SLM appears to be doing fine now, the landscape for student loans has changed with the government ending it guarantees for privately funding loans. SLM is a heavily indebted company that has to constantly refinance maturing debt. (bonds listed at FINRA, a very long list)
FINRA shows that the senior unsecured debt is currently rate junk by both Moody's at Ba1 and Fitch at BB+. S & P has a BBB- grade. I would go with the junk ratings.
Future Buys/Sells: I may buy up to 100 more shares at a lower price, but only in a taxable account. I am full with my exposure to SLM in a retirement account with just 100 shares of OSM. I will not risk more IRA funds on any junk bond.
Friday's Closing Price: $23.21 +$.01 (.045%)
5. Bought 50 AEB at $20 (see Disclaimer):
Snapshot of Trade (satellite taxable account):
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| 2013 Taxable Account Bought 50 AEB at $20 |
Security Description: The AEGON Floating Perpetual Capital Security (AEB) is one of Aegon's hybrid securities. AEB was issued by the Dutch insurance company Aegon and pays quarterly qualified dividends at the greater of 4% or .875% above the 3 month Libor rate on a $25 par value.
Aegon is primarily a life insurance company, headquartered in the Netherlands, that has operations worldwide, including the U.S., where it owns Transamerica (acquired by Aegon in 1999). AEG Key Statistics | AEGON N.V. Common Stock
AEB Prospectus
I summarize the advantages and disadvantages of Aegon hybrids in Aegon Hybrids: Gateway Post.
A list of Aegon hybrids can be found at QuantumOnline.com; or at Capital Securities - Aegon Group (AEG periodically changes the link to that page)
According to Quantumonline, AEB is currently rated Baa1 by Moody's and BBB by S & P, both investment grade ratings.
AEB is a junior bond for balance sheet purposes and is part of Aegon's equity capital capital for regulatory purposes. That dual classification, debt and equity, explains why this security is called a hybrid.
For U.S. taxpayers, distributions have been in the past treated as qualified dividends rather than interest payments.
AEG is a perpetual security, which is an equity characteristic. Aegon has the right to call this security now at par plus accrued dividends but does not have the obligation to ever redeem it.
This security can be volatile, with a strong downside bias in times of market stress.
On 5/28/13, AEB closed at $25.21 and had slid 20.66% until I made my purchase at $20. AEB Interactive Chart
Many investors would find that kind of movement unsettling. I would call it normal behavior for this security under the circumstances.
The price movement during the Near Depression was far greater. I noted in one post that several of my AEG and ING hybrids had increased 80% to 90% in a week's time, Bungee Jumping Aegon and ING Preferred Stocks/ BlackJack and Stock Investing: Lessons Learned & Applied. Of course, the previous declines were awesome too.
There was no news development from Aegon that would account for that slide.
Instead, the slide was likely precipitated by the rise in U.S. interest rates and a realization that the minimum 4% coupon would likely remain in effect for several more years due to the FED continuing ZIRP well into 2015 and possibly longer.
Prior Trades: AEB has generated good profits so far on relatively small positions, but has given me more than one case of heartburn due to its volatility. Most of the gains, however, originated from small lot purchases during the Dark Period. Needless to say, I do not expect that this security will be dropping back down to single digits again anytime soon.
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| 2010 Regular IRA 50 Shares +$81.11 |
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| 2010 AEB 150 Shares +$772.04 |
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| 2011 Roth IRA 100 Shares +$1,213.76 |
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| 2011 Taxable 100 AEB +$1,142.51 |
Even though AEB is a junior bond, I include it as one of my equity preferred floating rate securities due to its qualified dividend income tax treatment for U.S. taxpayers. Stocks, Bonds & Politics: Advantages and Disadvantages of Equity Preferred Floating Rate Securities (snapshots of trades at the end of that post: total realized gains for this category $10,911.76)
Recent Earnings Report: For the 2013 second quarter, Aegon reported that underlying earnings increased to EUR 478 million. Form 6-K Excess capital increased to EUR 1.9 billion. The Board declared an interim dividend of EUR .11.
I also own the common as part of my Flyer's Basket Strategy: ADDED 70 AEG at $5.28 (October 2012); Bought 50 AEG at $6.36 (December 2009). I am reinvesting the dividend to buy more shares.
Mandatory Payment Event Issue: For as long as Aegon pays a common dividend in cash, it has to pay the distributions owed to the hybrid owners, a more senior security than common or equity preferred stocks.
Back in 2009, I had several posts that discussed how long Aegon had to legally continue paying the hybrid owners after eliminating its common share dividend. That was a hot topic at the time, since AEG had eliminated its dividend and many hybrid owners were concerned about receiving their dividends.
I will just link one of those posts and hope the issue does not become relevant again. I concluded after much wrangling back and forth that Aegon would have to make 4 quarterly hybrid payments after making a cash distribution to the common shareholders. Nail on the Head for Aegon Mandatory Payment Event?
Rationale: (1) I am playing with the house's money on this one which has a way of drawing back into a security previously sold.
(2) Investment Grade with Deflation/Inflation Play: AEB is an investment grade quality security that combines some deflation/low inflation and problematic inflation protection in the same security.
The low inflation/deflation scenario is addressed by the minimum 4% coupon while the Libor float provides some protection in the problematic inflation scenario.
This makes this kind of security desirable for a long term hold, provided I can buy it at a significant discount to par value.
No one knows the future for certain. A security that can swing both ways has a place in a diversified income portfolio since the future is after all unknown and has a tendency to surprise even the best informed investors.
(3) Qualified Dividend: I know that the minimum yield is 5% based on a total cost of $20 per share.
There is no cap on the maximum possible yield. If the 3 month LIBOR looks like it is going to make a sustained move to high levels, Aegon might choose to redeem the issue. I do not see that happening anytime soon, and probably not within the next five years.
At a 6% 3 month Libor rate during the relevant computation period, the coupon would become 6.875% which is in effect a 8.59% yield at a total average cost of $20 per share. (.06875 x. $25 par value=$1.71875 dividend by $20 cost=8.59%)
Risks: (1) Volatile Market Pricing: The market has a tendency to price this security with only short term considerations. The recent rise in interest rates renders a 4% coupon on a $25 par value less valuable when the price is $25. By marking AEB down over 20% in price, the effective current yield increases to 5%, which is fine with me. There is nothing to prevent the market from continuing that price correction, however.
I view this kind of price adjustment as understandable over the short term. The security becomes more attractive for both the short and long term due to that price correction. The current yield at the 4% minimum coupon goes up as the price goes down. Importantly, the potential value of the LIBOR float also goes up as the market price goes down.
(2) Aegon Credit Risk: All of the Aegon hybrids were hammered during the Near Depression period and its immediate aftermath. It was possible to pick them up in the single digits. My lowest prior purchase for AEB were $5.5 and $4.9. AEB AND JQC (10/8/08 Post); Buy of 50 AEB at $4.8 (February 2009). I passed up an opportunity to buy closer to $3, as that price decline just unnerved the OG.
Aegon never missed or delayed a distribution on its hybrid securities. Next time, if there is a next time, I would anticipate that Aegon will be required to defer payments as a precondition to any acceptance of state aid. The rules have changed in that regard.
I am not currently concerned about AEG's credit risk.
Future Buys/Sells: I am not likely to hold onto AEB on a move over $23, and I am likely to buy another 50 shares on a decline below $18.
Friday's Closing Price: $20.4 +$.26 (1.29%)
