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HOlmes Osborne

    First Quarter 2017—Lucky Number 13!

  This is the thirteenth year that we’ve been in business. We started off managing the money of just people in California and Missouri but now have clients from all over. Our first custodian was Fidelity but not we work with Charles Schwab and Interactive Brokers.

We’ve seen the markets collapse and great firms like Bear Stearns and Lehmann Brothers go under. Interest rates have been at record lows and the stock market at record highs. Inflation didn’t quite lead to higher consumer prices but has lead to approximately half of the country not making enough money to survive. It also probably led to a once-in-a-lifetime political leader— Donald Trump.

The industry has gotten away from advisors utilizing their own ideas. Now, most consultants use some variation of index funds. We’ve gone the other way and are totally focused on research. We research about one company a day. Sometimes we look at existing companies and sometimes explore new ideas. It will be interesting to see if and when these financial markets ever come down. It does not seem like the industry (nor country) is prepared.

   Majority of 401K Money Parked in Bonds and Cash

In our 401Ks we have convinced many participants to move their money to safer investments. Many 401K participants do not pay close attention to how their retirement funds are doing. We put together model portfolios for our clients based upon their risk tolerance. If a participant shows a fear of volatility in financial markets, they get moved to a conservative portfolio. It’s surprising to see the number of participants in 401Ks who have all their money invested in stocks.
 First Quarter Activity

The first investment that we purchased at the beginning of the year is Canadian uranium miner Cameco. Cameco is the largest uranium miner in the world. The stock was on the way down until the Presidential election. Since then, it turned up but has since cooled off.

Uranium is not liked by many countries. The price is down from $136 a pound ten years ago to $23. It bottomed (or so we think) at $18 back in October.

This is the time to buy a commodity—when it’s hated and counted out. Not when everyone is lined up to buy at the pawn shop (this doesn’t work for uranium but you get the point).

The second stock is a highflyer that is constantly in the news-Valeant. Valeant is a pharmaceutical company that was growing leaps in bounds. Management was on an acquisition binge buying companies like Bausch & Lomb. Hedge funds and five-star mutual funds loved the stock—that is, until the company jacked up the prices of off-patent drugs and gouged customers. Then, the press turned on Valeant.

The stock was over $250 two years ago. Now, it’s $10.64. The collapse hit a few funds pretty hard. The famous Sequoia Fund and renowned Wall Street hedge fund manager Bill Ackman both lost billions.

We were buying before Ackman sold his shares. His selling has probably been putting downward pressure on the stock price. That’s ok, we’ll hold for a long time. The company has good products like contact lenses and needed pharmaceuticals. The stock is worth much more than where it is trading.

The next holding was a short term trade of an old friend of ours— Harmony Gold. Harmony is a South African gold miner that has a huge amount of mineral resources. The stock is down because of issues in South Africa. We got in at $2.32, watched the stock rise to $3, and then sold at $2.54. It dropped further to $2.18 but has since recovered.

Last year, we made a small fortune in Harmony. We even bought it again at the end of the quarter. At this point, we are again at a profit. We are not married to this investment and will bale out at a moment’s notice.

We sold out of Munich RE, one of the largest reinsurance companies in the world. The stock has a nice dividend but the price didn’t seem to be going anywhere. The reinsurance market has become competitive. Investors can even buy “CAT” bonds, which offer reinsurance in case of catastrophes. We lost a little money on Munich but not much.

The Annual Report on Swiss generic drug maker Siegfried Holdings came out recently. The company’s sales increased dramatically with the purchase of BASF’s pharmaceutical ingredient division. The stock is up about 38% since we purchased it in late 2015.

We finally unloaded Weatherford International, a real dog. Weatherford produces oil drilling equipment and has had nothing but problems—accounting issues, lost sales with the drop in energy prices, they even moved their headquarters to Europe to avoid U.S. taxes. We need those taxes to pay down our $20 trillion debt. We lost between 20% and 65% on Weatherford. What a horrible investment!

 U.S. Corporate Debt

The amount of debt that U.S. corporations carry on their balance sheets will at some point come to haunt the economy. We will discuss several corporations and potential problems that could form.

The first is AT&T. AT&T has $5.8 billion in cash and $16.8 billion in receivables. Sounds like a lot, until you see what’s on the balance sheet— $40.7 billion in payables and $124 billion in debt. That’s incredible. Much of the company’s cash flows goes to pay the dividend and not pay down debt.

The company even has $55 billion in liabilities in something called “other”. The amount of whatever “other” is is so large, it could be a third world country. I don’t know why anyone would invest in AT&T.

Furthermore, AT&T’s business is technology. People change phone providers like they change tee-shirts. You can own a cell and hook up to a Wi-Fi network and make calls for free. Not a business I’d want to invest in. There are offenders in this category—Verizon and Centurylink to name just a few. Standard & Poor’s lists AT&T’s debt as investment grade. Now you know why we don’t pay much attention to bond rating agencies.

The retailers are dying with increased competition from the internet and Amazon. JC Penney carries $183 million in cash and $208 million in receivables to a whopping $2.6 billion in payables and $4.5 billion in debt. Sears carries $286 million in cash and $466 million in receivables to $339 million in payables and $5.7 billion in debt. The principal shareholder has stripped off the best parts of Sears and liquidated a lot of the real estate. Still, the company struggles.

For the last several years, Wall Street has been mesmerized by oil pipelines. These pipelines are organized as limited partnerships so they pay out principal and earnings. They also carry huge amounts of debt. Canadian pipeline Enbridge carries $286 million in cash and $145 million in receivables to $1 billion in payables and $7.8 billion in debt. No thanks. Almost every company in the pipeline industry looks like this. That’s why their stocks were hit when oil and natural gas fell in price.

To discuss what we look at, the first is cash, which explains itself. The second is accounts receivables, the money owed by customers. The next is payables, the money the firm owes in bills and for other goods. The last of course is debt. Cash flow is income plus write-offs like depreciation minus capital expenditures (such as money spent on new equipment and updating property). What’s left over can be used to pay dividends, buy other companies, and pay down debt.

All of the firm mentioned are relying upon cash flows to pay down debt. Cash flows of course are cyclical and can be reduced with poor economic activity. At some point, cash flows will recede and these companies will be stuck with the debt.

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