Tuesday, February 17, 2015

Sold 100 of 200 DPG at $20.74/Sold Roth IRA: 100 PNNT at $9.53 and 70 ARCC at $16.87-Balancing Risks and Rewards/Bought 50 RHHBY at $32.99/Bailed on SD 2020 Bond-Sold at 74.69-Bought at 65

Stable Vix Pattern (Bullish):
Links to SeekingAlpha Instablog, Articles and Comments:

South Gent's Instablog | Seeking Alpha

South Gent's Articles | Seeking Alpha

South Gent's Comments | Seeking Alpha

Recent Developments:

As explained in this Bloomberg article, it may be several more months before U.S. crude oil production starts to decline.

The EIA reports weekly field U.S. crude oil production. For the week ending 2/6/15, production hit an all time record of 9.226 million barrels per day.  Weekly U.S. Field Production of Crude Oil (Thousand Barrels per Day)

Individual tax receipts are moving higher, suggesting that employees are starting to see more wage increases.

The German central bank released last Monday an upbeat report on the German economy. Their analysis can be found starting at page 7: Monthly_Report The report is summarized in a MarketWatch article.

Singapore’s economy grew at a 4.9% annualized rate in the 2014 4th quarter. My primary exposure to Singapore's stock market is my 200 share position in iShares MSCI Singapore ETF (EWS). I recently added 100 shares. Item # 3 Added 100 of the Stock ETF EWS at $12.8 (1/19/15 Post)

Zurich Financial (ZURVY) reported somewhat disappointing results. Zurich released its annual results 2014

In response to that earnings' release, the ADR price declined $1.29 to close at $32.49 (2/12/15). One ADR equals .1 ordinary shares priced in CHFs. The ordinary shares closed at CHF303.2, down 9.7 or 3.1%. Zurich stock information and share price | Zurich Insurance

The Zurich Board proposed a 17CHF per share annual dividend to be paid out of capital reserves. In the past, the sourcing of payment from capital reserves has avoided the Swiss withholding tax due to the dividend being classified as a return of capital.  So that will be 1.7CHF for my ZURVY shares. The actual value will be determined when the CHFs are converted into USDs. If that was done today, which of course will not be the case, the value would be $1.8264:

If I am right about this dividend being treated as a ROC due to its sourcing, then my cost basis will be reduced again by the amount of the dividend, which will bring the total adjusted cost per share near $17, even though I bought shares in 2012 at $24.72. BOUGHT 100 ZFSVY at $24.72 (symbol later changed to ZURVY) I took a snapshot of my adjusted cost basis, which is currently $19.21, in the introduction section to this post: ZURVY


1. Sold 100 DPG at $20.74  (see Disclaimer):

Snapshot of Trade:

2015 Sold 100 DPG at $20.74

Selected Highest Cost Shares for Disposition: 

Snapshot of Profit:

2015 DPG 100 Shares +$200.07
Item # 7 Added 100 DPG at $18.58 (2/3/14 Post)

There was a ROC adjustment to the cost basis primarily due to DPG's ownership of MLPs.

4 Quarterly Dividends ($.35 per share) Received: $140

Total Return = $340.07 or 18.23% (holding period 12+ months)

I still own 100 shares in a taxable account: Item # 1 Bought 100 of the CEF DPG at $17.3 (12/29/12 Post);

Total Realizing Share Profits (excluding dividends)= $603.14

Security Description: The Duff & Phelps Global Utility Income Fund  (DPG) is a leveraged closed end stock fund that invests in electric, gas and water utilities, telecommunication companies and MLPs.

CEFConnect for DPG

Last SEC Filed Shareholder Report:  Duff & Phelps Global Utility Income Fund

DPG Page at Morningstar (currently rated 3 stars; leveraged at 22.5%; ROC support for the dividend originating mostly from ROC MLP distributions)

Quarterly dividends have paid recently at $.35 per share. Duff & Phelps Global Utility Income Fund Inc. (DPG) Dividend Date & History

The risks are fairly typical for a leveraged stock closed end sector fund that buys securities worldwide. There will be some currency risks, the normal CEF risks (e.g. expansion of discount after purchase), price risk due to valuations of owned securities, interest rate risks to the prices of bond substitute securities, and the risks associated with leverage (e.g. borrowing costs, buying assets which decline in price with borrowed money adding to the woes, etc.)

Rationale: The paring of this position is consistent with three themes: (1) a concern about the negative impact on bond substitutes flowing from a rise in interest rates; (2) the likelihood of increases in the federal funds rate over the next several years that will raise the borrowing costs of leveraged closed end funds; and (3) what I regard as a significant overvaluation in utility stocks.

As of 2/13/15, the Utilities Select Sector SPDR ETF (XLU) had a forward estimated P/E of 17.4 and a dividend yield of only 3.32%. The estimated 3 to 5 year E.P.S. growth rate was 4.86%. The P.E.G. ratio is elevated due to the low growth rate and high P/E.

This sector is vulnerable to a correction precipitated by even a modest rise in rates that diminishes the allure of a 3.32% yield and further calls into question such a high P/E for a sector growing earnings only in the low single digits.

A P.E.G. of 2  to 2.5 would be closer to a fair value range with rates rising, an estimated 3 to 5 E.P.S. growth rate of 4% to 5%, provided the rise in rates ebbs below the average historical norms.

I go into more detail about the rationale in a recent SA Instablog: A Word Of Caution About New Purchases In The Utility Sector - South Gent | Seeking Alpha

The Vanguard Utilities ETF (VPU) has another set of data that is even more concerning than the XLU valuation information:

As of 1/31/15,  this Vanguard fund owned 78 stocks, with a P/E of 20.8 times and a 2% growth rate. Portfolio & Management That P/E and growth rate simply does not compute for the LB who views it to be at best irrational, a description used whenever it decides to be pleasant about something viewed as nutty.

2. Downsized BDC Exposure in Roth IRA after Reassessing Risks and Rewards: Sold 100 PNNT at $9.535 and 70 ARCC at $16.87 (see Disclaimer):

Snapshot of Trades:

Snapshot of Gains:

Total +$117.74

Rationale: I have repeatedly said that externally managed BDCs exist to enrich the managers rather than to benefit the mostly individual investors who are lured into buying shares. The honey used to attract investors is a high dividend yield in a world without risk free yield.

After the recent dividend slashes at both PSEC and FSC, I decided to start lowering my overall exposure to BDCs in the retirement accounts.  I am going to assign any new purchases to the lowly lottery ticket category for BDCs that are not presently owned. I may elect to average down with a few small odd lot buys in PSEC and FSC only, unmindful of the First Law of Holes which I referenced in a recent SA comment involving the horrific actions of that BDC. Time To Accumulate Fifth Street Finance Shares? - Fifth Street Finance (NASDAQ:FSC) | Seeking Alpha I have not yet averaged down on FSC due to the most recent price carnage inflicted on shareholders by Fifth Street's managers. Individual investors reading recent SA articles might be blinded by the current discount to net asset value and ignore or lightly regard the reasons for that lowly status.

3. Bought 50 Roche (RHHBY) at $32.99 (see Disclaimer):

Snapshot of Trade:

The ordinary shares closed at CHF 245 -.80. on the day of my purchase.


1 ADR = .125 Ordinary Shares

RHHBY Roche Holding

.125 Ordinary Shares=  CHF 30.625

Conversion Value for 1 ADR: $33.0474

Company Description: Roche Holding AG ADS (RHHBY) is one of the world's largest pharmaceutical and diagnostic companies. The company is based in Switzerland with a significant presence in the U.S. through its U.S. wholly owned subsidiary Genentech.

Roche will be adversely impacted in its reported revenues and sales due to the rise in the Swiss Franc. About 18% of Roche's costs are in CHFs, and the company has no plans to move existing operations to lower cost countries. Reuters A continuation of the CHF at its current level is anticipated to reduce core earnings by 9%.

Roche shares have declined over the past year in part due to several pipeline drug failures. New drug treatments for Alzheimer's disease, schizophrenia and two other drug candidates (ALECARDIO aleglitazar  and the lung cancer drug Onartuzumab) due to safety and/or efficacy issues. As noted in the prior link regarding the lung cancer drug, the unexpected Phase III may be reflect a poor trial study design.

In 2009, Roche made an important acquisition by agreeing to acquire the remaining 44% of Genentech shares that it did not own for $95 per share or $46.8 B. Roche had acquired majority control of Genentech in 1990 for $2.1B. Genentech is now a wholly owned Roche subsidiary. Bloomberg

Some of the important Genentech drug discoveries include the following cancer drugs, many of which are well known to non-stock investors:

Avastin: metastatic colorectal cancermetastatic kidney cancerlung cancer,

Gazya:  chronic lymphocytic leukemia,

Herceptin: breast cancer,

Rituxan: Non-Hodgkin’s Lymphoma And Chronic Lymphocytic Leukemia,

Tarceva: Non-Small Cell Lung Cancer and

Zelboraf: (metastatic melanoma)

Other Genentech discoveries include Lucentis (wet macular degeneration), Tamiflu, and Xolair (allergies)

Lucentis is sometimes to referred to as a cosmetic version of the Avastin molecule.  Lucentis is about 50 times more expensive and both drugs cost about the same to manufacture. Eye doctors will often use avastin off-label to treat wet macular degeneration rather than Lucentis. It may be more profitable for the doctors to use Lucentis however. As noted in the preceding linked article published by the Washington Post, Medicare has to pay for both drugs. Lucentis has been approved for the treatment of wet macular while the company has refused  the FDA's entreaties to seek approval for Avastin's use in that treatment. While I do not remember the details, Avastin was approved as a cancer treatment by the FDA, and its effectiveness was due to cutting off the blood supply growth to tumors. Patients who were taking the drug for cancer noted an improvement in their vision. Some eye doctors started to inject Avastin directly into the eye to shut down or reduce abnormal blood vessel bleeding that was destroying the macular (the center of the retina) and causing loss of eyesight.

A new drug for wet macular degeneration, Eylea, has been approved by the FDA.

Roche currently does not expect biosimilar competition for its Herceptin product before 2017.

I took a snapshot of drug sales by product to highlight Genentech's importance to Roche:

Page 12:  Roche 2014 Financial Report.pdf

As shown in the preceding table, two recently approved cancer drugs, Perjeta 2012) and Kadclya   (2013) are rapidly increasing sales. Both are breast cancer drugs.

FDA approves Perjeta for type of late-stage breast cancer (2012)

FDA approves new treatment for late-stage breast cancer (2013)

FDA approves Perjeta for neoadjuvant breast cancer treatment (2013)

Sales of Pegasys, an approved treatment for hepatitis B and C, are declining due to competition from new treatments.

About 75% of Roche's revenues come from biologics which are less susceptible to traditional generic competition.

Roche's in vitro diagnostic business has about a 20% global market share.

2014 Annual Report.pdf

The annualized total return for the ADR shares was 13.63% starting on 8/20/2003 through 2/14/15. Total Return

RHHBY currently has a 4 star rating by Morningstar with a fair value estimate of $35. Zacks has an underperform rating and a $31 price target.

I also read several recent press releases including the  following, with the first probably being the most important:

U.S. FDA grants Breakthrough Therapy Designation for Roche's investigational cancer immunotherapy MPDL3280A (anti-PDL1) in non-small cell lung cancer

FDA approves Roche's Lucentis for treatment of diabetic retinopathy in people with diabetic macular edema

Roche's Phase III study of Gazyva/Gazyvaro showed significant benefit in refractory indolent non-Hodgkin's lymphoma

Chart: RHHBY is currently selling below its 50, 100 and 200 day simple moving average lines. RHHBY Interactive Stock Chart 

As shown in that chart, the shares have been in dive mode since closing at $37.92 (12/1/14). The USD priced shares received a lift when the Swiss National Bank ended its Euro peg that immediately caused the CHF to rise in value against the Euro and the USD. The rise in the value of the CHF flows through into the pricing of the USD priced ADR. However, due to the decline in the ordinary shares, this currency related gain was muted and short lived, as the ordinary shares priced in CHFs declined in value as shown in this one year comparison chart:

One Year Comparison Chart CH:ROG (Blue Line) vs. RHHBY

The Swiss stock market declined significantly in value when the Swiss National Bank ended its Euro peg. The stronger Swiss Franc will have a negative impact on reported earnings. That decision was announced on 1/15/15. The currency related rise in the ADR shares was higher than the percentage decline in the ordinary shares which is why the RHHBY line chart goes up that day as the ordinary share price plunged in value.

Dividend History: I could only find at Roche's website a chart depicting its dividend history since 2002:

I consequently do not know the dividend amounts prior to 2002.

In its "Investor Update" dated 1/28/15,  Roche states that is board approved a 3% dividend increase to 8 Swiss Francs, the "28th consecutive year of dividend growth".

The chart does, however, show a significant slowing in the dividend growth rate. It looks like about 1.5CHF per share was paid in 2002. The percentage increase to 8 CHFs would be huge at 433.33% over a 13 year period, Calculate Percent Increase, but the last increase was only 3%.

Like many European companies, Roche pays its dividend annually.

The 8 Swiss France for the ordinary shares translates in a dividend of 1 CHF per ADR share.

The value of that dividend will be determined when the actual conversion from CHFs to USDs takes place. If the conversion occurred on 2/10/15, the date of my share purchase, the value would be about $1.0815. For purposes of illustration only, that dividend value would result in a dividend yield of about 3.28% at a total cost of $32.99 per share.

Switzerland's Withholding Tax: 

Switzerland will withhold a 15% tax on that amount. When held in a taxable account, a U.S. taxpayer can recover all or part of a foreign dividend tax as explained in this Schwab article.

A taxpayer may run into a problem recovering all of the foreign taxes when the amount of foreign tax paid exceeds $300 for a single person and $600 for a married couple. A credit can be claimed up to those amounts without filing out a somewhat complex IRS form 1116. Accountants may not mind filling out that form since it just adds to the bill. It gives me a headache.

That form has to be filled out when claiming more than those limits as a credit. The form will limit the foreign tax credit "to the lesser of the amount of foreign tax paid or the U.S. tax liability on the same income". This would become relevant for a taxpayer who wants to claim more than the foregoing limits, but who is in a marginal tax rate of less than 15% when the foreign dividend income tax rate was 15%. I would emphasize that I am just giving a common sense explanation of the material contained in that Schwab document. I am certainly not a tax expert, and I am not giving anyone tax advice here. It is important, however, to at least grasp the essential elements explained in that Schwab article to make an informed investment decision when buying dividend paying foreign stocks.

Recent Earnings Report: I would generally describe the recent earnings report as unimpressive, which partly explains my relatively small initial purchase. For the full year, Roche reported core E.P.S. of CHF 14.29, missing the consensus estimate of CHF 14.7. On a constant currency basis, core E.P.S. and revenues advanced about 5% Y-O-Y. That number is expressed in the abbreviation CER (constant currency rates) in the following table:

Page 5 Finance Report.pdf

Free cash flow decreased about -1% in 2014 to CHF5.322B. (pages 10 and 33)

Roche expects 2014 revenues to grow in the low-to-mid single digits based on constant exchange rates. Core earnings per share are targeted to grow faster at CER. Roche Press Release-"Roche delivers solid results in 2014"

Rationale: I would not be buying Roche stock without Genentech being in the fold. I simply have more confidence in the ability of Genentech researchers to discover new drugs, and the value of a drug company long term will be driven by internal innovation rather than the Pfizer approach to drug discovery.

I also want more exposure to assets priced in Swiss Francs without having to convert my USDs into CHFs. I may pursue that option in a few years, but I am content now in expanding my ownership of U.S. traded Swiss stocks whose value will be determined in part by the value of the CHF/USD exchange rate.  I have far more confidence in the CHF as a store of value long term than the USD.

While Roche's dividend growth has slowed some, the company does have a long track of raising its dividend. The pace of future dividend increases will depend on drug discoveries rather than existing products.

There is a fairly robust pipeline of new drugs currently in trials or new use FDA filings for existing drugs: Roche-Pipeline and Pipeline Summary.pdf (new molecular entities at pages 79-81). However, I did not see a number of potential near term catalysts in the pipeline.

Risks: Based on the 2015 E.P.S. estimate of CHF 14.02, Bloomberg, the forward P/E is about 17.37 based on last Friday's closing price of CHF243.6. I view that number as being in the upper end of my fair value range for Roche. I would therefore anticipate slower capital appreciation unless the E.P.S. growth rate accelerates. Without the CER adjustment, the 2014 E.P.S. was CHF 14.29, virtually unchanged from the CHF14.27 reported in 2014.

I will focus on earnings and revenues expressed in constant currencies. Core E.P.S. grew only 5% in 2014 based on the constant exchange rate.

The recent pipeline failures calls into question Roche's ability to successfully discover new treatments that have both efficacy and safety.

Future Buys and Sells: Until I see better results in CER, I am not likely to buy more shares unless there is a price drop to below $30 without any material adverse event causing the decline.

I have a larger position in Novartis and have a far more favorable opinion of NVS than of Roche, though I do not find NVS shares attractive at over $100 per share. Dividend Growth Strategy: Novartis - South Gent | Seeking Alpha

Novartis owns about 53.3+M Roche shares:  Roche - Major Shareholders

4. Sold 1 Sandridge 8.75% Senior Unsecured Bond at 74.69 (see Disclaimer):

Snapshot of Profit:

2015 Sold 1 SD Bond +$73.68 
Bought 1 Extremely High Risk Sandridge Energy 8.75% Senior Bond Maturing 1/15/2020 at 65 (12/17/14 Post)

Net Interest: $14.58

Total Return: $88.27

Security Description: This is an unsecured senior bond issued by the E & P company SandRidge Energy (SD), whose common shares are hovering near $2 after rallying substantially in percentage terms from a mid-January 2015 low around $1.18.

FINRA Page for SD 2020 Bond: Bonds Detail

Rationale: When I bought this bond, it made me uncomfortable. I referred to this buy as analogous to playing a hand of blackjack for $650, which is actually beyond the OG's limit of $300.

To relieve the anxiety, which needs to be lessened for senior citizens like the OG who has barely recovered from the angst permeated Near Depression period, LB decided to harvest the 10%+ annualized total return rather than listen to more moaning and groaning from the OG.

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