About Credit Trends

December 21st, 2010 Comments off
Credit Trends was established to manage equity portfolios based upon

1- Free Cash Flow-the maximum amount of cash an entity could distribute to shareholders from operations, includes an analysis of discretionary expenditures, both over- and under spending as well as those liabilities which should have been reflected on the primary financial statements. It also includes classification errors in the statement of cash flows

2-Return on Invested Capital-presents us with a real cash on cash return management has been able to earn on invested capital. It begins with our proprietary definition of free cash flow, not operating earnings

3-Cost of Capital-our models capture the true operating and financial risk of the entity and form the important discount rate from which fair value is derived. It captures everything from sales, input  and tax stability to litigation, yield spreads and sovereign risk. It is a true measure of the risk to prospective free cash flows.

CT Capital’s proprietary definition of cost of capital was developed using sophisticated modeling and analytic techniques supported by a decade of research. Its models consist of over 70 factors which result in a superior discounting mechanism from which to discount an entity’s free cash flows.
CT Capital’s free cash flows result from converting to a quasi-cash accounting thru eliminating many of the accounting conventions companies utilize which can help create an “artificial” result. We also add to this result by incorporating enhancements such as evaluating unnecessary and exaggerated discretionary areas which could be used to enhance free cash flows.
To learn more, please contact us:
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To Know Free Cash Flows, Deep Dive into Reporting is Essential

October 22nd, 2024 Comments off

For our complete study, your firm must be a CT Capital Research or advisory client.

A half-century in all phases of security analysis, global M&A for largest firms, academia, taxation (including foreign codes), and credit.

For instance, if a firm repurchases shares at the end of a reporting period for settlement in the upcoming period, the cash impact will appear in “Other accrued liabilities.” This would likely cause a cash flow error for most analysts should they not adjust the period.

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Unquestionably Secular Trend: CT Capital Unveils New Portfolio

August 20th, 2024 Comments off

CT Capital today introduced a new portfolio strategy—the only one in existence–using our proprietary and most comprehensive cash flow and credit worksheets based on 50 years in all phases of finance—to an exclusive portfolio in which all firms are fully capable of taking advantage of the declining trend and aging of the world’s population.

Currently, lower inflation-adjusted interest rates have provided a large boost to valuation multiples, as firms can earn a lower cash yield to maintain a constant spread with the cost of equity.

Unfortunately, interest rates eventually rise, and therefore, secular trends are a more powerful long-term contributor to the investment performance of firms and their investors.

It is a diversified portfolio in which the firms are able to overcome not only the population trend, which is further impacting consumer spending, such as housing but also VP Harris’s higher proposed tax rate.

Please get in touch with CT Capital for complete details of this institutional portfolio ($10M minimum)

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This will be copied-so let’s be No.1

August 8th, 2024 Comments off
Proposal for investors

PRODUCTIVITY ETF

 

Labor productivity refers to the overall amount of output, measured in terms of revenues that are produced per unit of dollar cost of labor, number of employees and other such metrics.

The framework presented here is a consequence of the global decline or virtual stagnation in population in industrialized nations. Estimates by various think tanks, such as the World Bank, UN, INED, and others, all confirm the current and continuing population declines.[1][2]

This secular falloff in the consumer base, the first in centuries, would value an investment strategy capable of taking advantage of firms whose primary business is directed at improving the productivity of clients or have a strong history of such for themselves.

The reach of such firms runs across a spectrum of economic sectors.

We are therefore proposing an ETF (exchange traded fund) in which the portfolio is comprised of firms engaged in such businesses or implementing such a strategy.

FACT: The populations of developed nations worldwide are either declining or on a declining trend, which is an indisputable fact.
FACT #2: Insufficient labor forces require higher levels of productivity to sustain or expand production.

FACT #3: The challenge of fewer consumers can be addressed by reducing costs and increasing efficiencies to increase profit margins. Cost cutting can only go so far and has proven to backfire.

Our objective is to manage the only globally diversified Exchange-Traded Fund (ETF) that focuses entirely on investing in firms that improve productivity measures, either for their own benefit or for others.
.

This fund has a broad emphasis and does not exclusively target technology. However, it is expected that a substantial portion of the portfolio, ranging from 30% to 60%, would be invested in technology companies. The exact allocation will depend on factors such as portfolio risk, allocation strategy, and values.

The portfolio will be composed of firms possessing stronger than benchmark financial structures, access to credit, and an adjusted free cash yield in excess of their cost of equity using our proprietary financial adjustments of both a quantitative and qualitative nature.

I anticipate that the financial media, both in written and televised form, will be inclined to offer a platform for a fund of this nature, as there is now no similar option available.

 

Write to us with interest.

info@ctcapllc.com

 

 

 

 

 

[1] See https://data.worldbank.org/indicator/SP.POP.GROW?most_recent_value_desc=false

[2] See https://www.ined.fr/en/everything_about_population/data/world-projections/projections-by-countries/

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June 30, 2024—AI and the Jobs Act—see our full report sent to clients

August 4th, 2024 Comments off

COMMENT ON AI AND THE JOBS ACT

Potential changes brought about by the Jobs Act’s sunsetting provisions are considerably more significant financially than recent trends in microprocessors designed towards artificial intelligence and so have a considerably greater impact on the US economy and stock values. Jobs Act cash-impacting changes could pose a risk to technology shares, as tax credits, the actual tax rate, research, and depreciation allowances could be altered. Individual rates will also rise, necessitating a cautious approach to our investment strategies.

 

After reading through scores of financial filings, our position on AI is that it will take a long time, if ever, for promised benefits to be felt via impacting shareholder value in the 99%+ of firms outside the microprocessor, software, and consulting firms that sell those services. Eventually, those firms will succumb to customer reality.

 

Many firms, from Boeing to UPS, had no comment on the matter of AI, while others, like Honeywell, mentioned it just in passing, without any specific application to how it would lift cash flows or other financial metrics.

 

Firms commenting on AI include benefits to compliance risks, the timing of reports, including legal and accounting, repairing design flaws (such software has existed for years), and some labor savings. Consulting firms like Accenture claimed costs would rise, at least in the short term.

 

We do not see general economy-wide advantages capable of lifting valuation multiples due to AI revenue enhancement. Stability metrics could improve. Increasing competitive risks, cyberattacks, or penetrating competitive advantages may harm metrics.

 

GE’s comments on cybersecurity should extend to AI: “As a result, we may be unable to promptly or effectively detect, investigate, remediate or recover from cybersecurity attacks, which may result in material harm to our systems, information or business.”

 

If benefits occur, they will be equally available sector-wide, making firms equally competitive. Some firms warned that competitive threats from AI might infringe on their business, a particular risk of the advancement.

 

Should a higher unemployment rate be seen as technology replacing labor, that could well have a negative impact. Years ago, we heard how large-scale supercomputer competition capable of trillions of calculations a second would also change the world, including weather forecasts. I’m still waiting

.

Until we see a tangible impact capable of improving shareholder valuations across the board, we will be content to watch others invest in and comment on this world-altering technology, as we did with EVs. This was the correct decision, as time has proven, and it will likely be again. If not, we will watch the losers fold and place capital into those most benefiting.

 

 

 

 

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How to Properly Measure Stability Metrics of a Public Entity

July 23rd, 2024 Comments off

How to Properly Measure Stability Metrics of a Public Entity

 

Our meticulous approach to conducting a separate analysis of historical stability for each key metric is not just essential; it’s the bedrock of our analysis. This approach ensures the reliability of our analysis and provides a solid foundation for our conclusions, even when new factors such as a new accounting standard, tax law, or other events alter historical stability.

We are now engaged in a presidential election cycle, sure to play a pivotal role in corporate stability running through all decisions-operating, financing, and investment.

Stability is a crucial component of valuation. It plays a significant role in estimating the cost of capital, which is the discount rate of future cash flows from all sources.

 

FULL 11 PAGE REPORT- A MUST FOR ALL SECURITY ANALYSTS-SENT TO CT CAPITAL CLIENTS

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Defense–Plenty of Room to Match Fair Valuation

July 23rd, 2024 Comments off

 

Investors are lacking in their understanding of defense shares, and the values presented therein.

Our defense sector investments have continued to outperform diversified indexes, such as the Russell 1000, while continuing to replace money-losing fixed-price contracts with cost-plus.[1]. Subsequently, free cash will rise dramatically—a development that most investors are unaware of.

FULL REPORT ON DEFENSE SHARES AND SECTOR SENT TO CT CAPITAL CLIENTS

 

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LEARN HOW TO MAKE PROPER FINANCIAL ADJUSTMENTS—BECOME A CLIENT TODAY!

May 20th, 2024 Comments off

LEARN HOW TO MAKE PROPER FINANCIAL ADJUSTMENTS—BECOME A CLIENT TODAY!

 

Example: If a firm repurchases shares at the end of a reporting period for settlement in the upcoming period, the cash impact will appear in “Other accrued liabilities.” This would likely cause a cash flow error for most analysts should they not adjust the period.

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Is The S&P 500 Useful As a Comparative Benchmark?

March 3rd, 2024 Comments off
CT Capital llc Research

The S&P 500 has lost its utility as a value benchmark for assessing portfolio performance since it cannot match the broad sector composition, volatility of key financial metrics, cost of capital, employment, and its volatility, and other characteristics of measuring value-type equities.

The S&P 500 may be more accurately and currently characterized as a well-known quasi-technological benchmark. The US Bureau of Economic Analysis (Figure 1) shows the technology sector accounts for just 8.8% of GDP, yet the top 6 stocks in the index, all being technology, account for 27% of its portfolio importance.

Comparatively, during year-end 2017, the top 10 S&P 500 stocks were a diversified group accounting for 17% of the entire index value—today, the top ten securities for about one-third and is composed of a single sector–technology firms.

The current faster growth in many technology firms does not warrant its weighting. As we saw with Tesla shares, a top 5 S&P 500 firm only a few years ago, these shares can halve in value even though, as economic growth remains strong,  shares are generally rising.

Example: Nvidia’s stock price increase of only one day this quarter was about equal to the combined performance of two hundred S&P stocks!

Figure 1 Technology Sector in S&P 500 Gives Misleading Impression of US Economic Activity

 (figure sent to CT Capital Clients)

Because of the greater cost of equity (risk to adjusted cash flows) associated with technological companies, anticipated returns should consider a large depreciation of principle. Extreme volatility is inherent in the sector.

However, our diverse large capitalization value portfolios and the Russell 1000 Value Index have longer track performance records over a broader range of economic conditions and shifting industry trends, making them less vulnerable to the notable price volatility linked to a single sector. Conversely, as its complexion changed in very recent years, the S&P 500 became a general index oddity.

We display two large-cap value portfolios below (Tables 1 and 2). Their makeup differs significantly from that of the S&P 500 benchmark. Notably, those top heavy currently ruling the index are absent, except Microsoft, which logically has a more extended history.

 

Table 1 Wilshire 1000 Large Cap Value Portfolio Characteristics

(Table sent to CT Capital Clients)

Table 2 Russell 1000 TR Characteristics

(Table sent to CT Capital Clients)

Always remember that short-term financial results have a minimal impact on long-term value. In contrast, the consistency of multi-cycle growth in inflation-adjusted metrics found in a value portfolio such as CT Capital has a considerable influence and investor reward. That is the essence of a value-type portfolio and one not present in the current construction of the S&P 500 as has long been perceived.

 

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Cost of Capital Having Large Impact on Prices of Financial Assets

January 17th, 2024 Comments off

Our company has a unique approach to estimating the cost of capital. We believe that we have delved deeper into this matter than any other advisor. To make sure, feel free to ask other advisors about their precise method of calculating the equity cost of capital, including worksheets. While academia has also touched upon this topic, most focus has been on naive GAAP data and relatively simple approaches. It is essential to understand that even a one percentage point difference in the cost of capital can lead to a fair value variation of fifteen to thirty percent, depending on the current price of capital. Therefore, we must consider this aspect when determining a reasonable value estimate.

Become a CT Capital client today and understand our history of outperformance of benchmarks with considerably lower risk

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Special Year-End Review Now Available to Clients

December 5th, 2023 Comments off

As security analysts, we conduct year-end assessments and profound financial modifications to reported results. The quantity and quality of the information initially disclosed at the commencement of the reporting period are typically limited in scope.

First, financial releases are frequently scant; thus, our methods for obtaining information become more varied. In addition to the company information that may have been available, we gather and use a variety of sources to broaden our base, including official government data, conferences, managerial approaches and remarks, competitor and supplier information, and other pertinent channels like state requirements.
Our primary objective is to understand the allocation and origins of cash flows comprehensively.
To that end, it is essential to conduct a thorough examination and analysis of all sources of revenue to gain a comprehensive understanding of the inflows related to cash flow. This includes examining all revenue categories, whether through cash receipts on earn-outs, product and service sales, or any other means of obtaining cash, such as insurance proceeds. We will make the necessary adjustments if we uncover any unusual cash production information.

 

TO VIEW THIS MOST IMPORTANT TEN-PAGE REPORT, YOU MUST BE A CLIENT OF CT CAPITAL LLC

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Quips From Our June 30, 2023, Client Investment Review and Outlook

July 5th, 2023 Comments off

…….

Investors typically raise risk levels when normal cyclical events stare them in the face when they should have accounted for it all along, including current happenings in China.

The most significant such issue is in fact the expected dramatic population drop in China.

Japan was viewed as the world’s economic engine (Figure 1) and now China could well be on a similar track. Increasing sovereign risk further clouds their economic outlook, especially with the EU recognizing its threat to world stability. This month, Astra Zeneca announced it was spinning off its Chinese division for this reason.

 FIGURE AVAILABLE HERE ON CLIENT REPORT ONLY

 

 Figure 1– Stock Performance Tied to Population Growth as Seen in Japan

Firms with heavy customer/supplier exposure in China must cut operating costs and find new outlets and innovations to maintain or capture larger market shares

….

All our metrics are converted to real (inflation-adjusted) terms, offering insight in both inflationary and deflationary periods.

As with our Lockheed Martin, we fully expect quite a few of our holdings to continue closing out portions of their pension liabilities. Pension transfers doubled over the past year as premiums dropped as interest rates rose. Such actions improve credit, cost of capital, and valuation if key metrics remain constant or improve.

For lower credits whose asset quality (collateral) drops during periods of sector weakness, additional borrowings come at a high cost, often unable to be captured by the shrinking operating margins.

With world economies embarking on years, if not decades, of slowing nominal (relative to post-war) growth, our proprietary financial adjustments carry important significance in estimating fair value.

Example. The purchase or sale of a futures contract is listed as an investing activity in the statement of cash flows, even though the contract is intended as a hedge of a firm commitment to purchase inventory. Thusly, we would adjust to an operating cash flow. This would not be picked up by almost all analysts, if any.[1]

Starting with the following year, firms must disclose where and when derivative instruments and their related gains and losses are reported in the statement of cash flows. To the extent we derive additional information, it will be incorporated into our restatements.

It amazes us that the geniuses at the Federal Reserve do not recognize that the more they raise short-term rates from current levels, the greater long-term rates drop since the US is already experiencing a slowdown. Should such actions occur, cost of debt capital, assuming constant spreads, drops, defeating the Fed’s agenda for inflation restraint.

Any bank restraint will likely be supplanted by the “shadow banking system,” only a portion of which is regulated and could lead to future hard-to-control issues for financial regulators

[1] Ask other advisors the various adjustments they make to the published financial statements on derivative positions.

TAXATION

The 15% alternative minimum tax should result in unexpected consequences for many investors. Because the change is based on a rolling average three-year $1B back-test, firms may be required to pay higher taxes even though profits and cash flows drop.

In addition, an upcoming accounting standard on taxation can be expected to have a weighty impact on valuations, providing investors with essential breakouts of foreign, local, and federal tax (subject to a 5% threshold). The standard will allow for greater introspection of risk in which the various countries’ firms operate, with the result, our worksheets will have a closer margin to the estimate of fair value.

As generative AI moves up the curve, it will allow firms to prepare tax reports and insights either not possible now due to time constraints or records being held across a wide range of locations, customers, and suppliers.

When instituted, Pillar 2 requirements are complex and will cause investor havoc, but one which we will be fully prepared for. Pillar 2 has already been adopted by a large number of countries.

The 2017 Tax Cut and Jobs Act rewards our higher-than-benchmark credit portfolio, as it limits the amount of interest that may be deductible to 30% of taxable income. However, it permits depreciation and amortization to be deducted from the taxable income calculation.

Capital-intensive industries will be vulnerable to higher taxation as they can no longer fully deduct equipment expenses in the year purchased. This residual will lower valuation multiples for affected firms.

STOCK-BASED COMPENSATION

Investors tend to downplay the real cost of stock-based compensation.

As investors read the statement of cash flows, under operating activities, stock-based compensation is added, it being a non-cash item over that reported in the income statement.

But does this provide investors with all the tools they need to evaluate firms worth?

Stock-based compensation is far from a small cost, even considering the beneficial tax effect. The employer generally is eligible for a tax deduction equal to the full amount of the stock minus the exercise price when the employee vests in the restricted stock or the intrinsic value of the stock when the option is exercised

 

When a restricted stock vests or a nonqualified option is exercised, the amount of the employer’s corporate tax deduction is fixed.

 

Equity issuance, even for firms in our portfolio, given their valuations and credit profile, is costly and should be recognized as such.

We are not advocating firms not providing this incentive to current and future employees, but to generally recognize the cost into valuation when making the decision. Equity can help lower cost of debt capital when used judiciously in debt instruments.

Furthermore:

  • Equity dilutes current shareholders, so additional cash flows could be required to maintain current valuation levels.
  • If the tax deduction is less than the book compensation cost, the employer has a “tax shortfall.”
  • BALANCE OF THIS SECTION SENT TO CLIENTS ONLY

 

HOW WE ADJUST OUR ESTIMATE OF FAIR VALUE WHEN A COMPANY REPORTS A SHORTFALL

Our fair value estimate may be altered when an investee reports a shortfall in their normalized key financial metrics. Under normal circumstances, a shortfall, either during a short-term period or cycle, has a quantifiable and limited impact in our investment process, as it has already been considered thru the cost of capital (see Commentary), or via our normalization restatements.

Such may be cause for an outright sale or, as written in our “Commentary” which follows, be already factored into our cost of equity. Each case must be tailored to the firm and issues involved, both quantitative and qualitative. As our firms are expected to see real growth from cycle to cycle, normal cycle or temporary issues of cost or revenue wash out over time, despite what investors believe at the time to be atypical.

The primary relevant factors are:

  1. How does the shortfall impact our expected normalized real free cash flows and growth rate? What is the timing of any likely recapture of revenues delayed, discounted to current and fair value?

Identify the causes and whether they can be assumed to be of a longer-term duration. If so, for how many periods? If the shortfall was due to a significant client, supplier, geography, or external factor, is it……………………BALANCE OF THIS SECTION SENT TO CLIENTS ONLY

 

 

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Equity Market Comment-Oct 11, 2022

October 13th, 2022 Comments off

 

We know bear markets are no fun.

 

Such is why we devote as much time studying risk as we do to the ability of a firm’s managers to generate cash from assets, all the while placing the firm(s) on course for future growth in normalized and adjusted cash-based return on capital.

 

Our firms have strong corporate identities (market share) with sound financial structures, and financial back-up (calls on credit) should such ever be required. Their alliances with the debt community are deep.

 

Bear markets, whether financially or otherwise induced, test the mettle of not just corporate managers but us as well in the delineation of our cost of equity. And on that score, you should feel very much at ease, as almost a half-century of analysis can attest.

 

Our firms will (not might or should) bounce back to new highs when the current period is over, a forecast that cannot be made about so many other firms whose share prices in the bull market were exaggerated and are now facing a period of rising interest costs and tax rates.

 

For example, many firms have counted on the bull market and contributed lower cash payments to their pension plans. Such maneuvers artificially raised GAAP-based cash from operations, an activity for which we adjust. Higher tax rates will also be in the cards for many firms due to changes in tax laws; a topic addressed in our last report.

 

Unfortunately, investors have not yet distinguished between firms like ours and other firms, even those benefitting from tax credits under the Inflation Act.

 

KH

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IMPAIRMENTS – A CT CAPITAL ADVANTAGE

October 7th, 2022 Comments off

IMPAIRMENTS – A CT CAPITAL ADVANTAGE

Impairment occurs when fair value is below amortized cost. Some business decisions, including the sale of assets, could well result in an impairment charge.

Our cash-based return on capital model is excellent at catching future impairment charges under GAAP, especially as one of the tests in the Standard is a drop of total firm market value below book. We concern ourselves with impairments likely to reduce cash flows, as most impairments are recorded as non-cash GAAP events. The impact on future cash flows is to be determined.

Impairments may also lead to covenant violations due to cash flows or collateral impacts.

You recall the worldwide credit crisis was exacerbated by FAS 157 and its fair value provision, which forced firms to mark inactive securities to market. This was later replaced with other conditions, including the income approach used by our firms with no need to sell portfolio holdings to supplant cash and whose portfolio consists of non-active fixed income instruments. Assets for sale are shown in OCI (other comprehensive income), and currently show, for our portfolio, no deviation from normal.

Though the impairment-related Standard calls for an annual review, a change to interim reporting may be called for, especially for firms with inflated inventory and goodwill, the latter which may not be amortized or deducted for tax purposes. Impairments are normally set at the individual unit level.

Taxable M&A goodwill may result in tax-deductibility and needs to be studied, including the impact on future taxation.

Our cash flow-based models already incorporate fair asset values into our value estimate. Assets reported below their ability to produce cash are thus late to the game. The same is true for assets such as PP&E, which may be near the end of their useful life for accounting purposes yet are fully capable of producing goods for years to come.

The Inflation Reduction Act may prove to be the most important new legislation impacting cash flows and valuation, requiring a comprehensive understanding of firm accounting (both global and domestic) and actual cash tax. Tax credits and incentives have sway over taxes due otherwise.

The alternative tax provision for a minimum 15% based on a firm’s book income must be evaluated in conjunction with the many offsets;[1] as far as the 1% tax on buybacks is concerned, it is of minor influence, and could be overcome if the firm is to issue stock or to repurchase other securities. CT Capital has the abilities necessary to dissect the data in an appropriate form, which is then plugged into our valuation models.

Free cash flow estimates require getting the fingernails dirty and normalizing results, transactions, accruals, and estimates within the line entries, and, later, tax credits. Most analysts use simplistically lazy models.

[1] In this provision the Act generally establishes the 15% tax liability for firms having a $1B average annual adjusted financial statement income. It is an alternative minimum tax to the extent that its “tentative minimum tax” exceeds its regular US federal income tax liability plus its liability for the base erosion anti-abuse tax (BEAT). Impacted firms do receive a credit against future liability.

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A STORY AND LESSON FOR THE WEEKEND

October 22nd, 2021 Comments off

Subject: FROM CT CAPITAL-A STORY AND LESSON FOR THE WEEKEND

 

Hi,

 

Quite a few years ago, the law firm I used was the same as Carl Icahn, where his personal attorney was a partner.

 

My attorney knew of my M&A client, who was vastly more well-known than Icahn for his takeover antics, including “greenmail,’ which at the time, while not illegal, had no additional costs to the threatened firm, as was later the case. My client bought a few leading firms and hence became one of the wealthiest men in the US.

 

In fact, I had several meetings with Icahn’s attorney for no reason other than an introduction.

 

When the news broke of his buying TWA, I was told he ran around his office singing: We bought an airline. We bought an airline.

 

I called my then attorney to tell him it was a big mistake, from unions to pensions to cyclicality, and other negative risks are thrown in, like fuel costs.

 

I thought of this and am happy Mr. Icahn learned a lesson he has wisely put to use since, as we see the historic rise in valuation multiples of firms with strong growing real cash returns over its cost of equity. This metric was undoubtedly not the case with TWA, later to file bankruptcy proceedings.

 

We see our owned firms, from the mega-cap Accenture to the small firms like Watts Water and Quanta rise a multiple of their cost. Yet had they been handed a large merger premium at the time of our cost would have been hailed by investors, and no more so than institutional investors.

 

Investors and firm executives who do not get the lesson here will always be doomed for underperformance, despite hitting the hot industry or trend from time to time. Investment advisors will see lots of journalistic coverage in the process, and the institutional money will flow, just as it did for the Paulson’s and other hedge fund managers post the credit crisis. Such is now the case with private equity, despite many risks for those firms, including size and transparency.

 

As the saying goes, all that glitter is not gold, and why our firms rise over multiple cycles without the benefit of fads or large cyclicality.

 

 

Ken

Categories: General Tags:

Campaign Promises Backfire

September 28th, 2021 Comments off

Politicians were so adamant to get the hell out of fossil fuels they neglected to consider the unintended co of doing so as quickly as their campaign promises.

 

See our important report in which we discuss the impact to financial assets, which sectors and names stand to benefit, and more importantly, and in combination with stepped-up sovereign risks and changes to tax codes worldwide, those sectors and names which will almost certainly see their valuation multiples compress.

 

Kenneth Hackel, CFA

 

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Elon Musk Making Grievous Operational Errors

June 2nd, 2021 Comments off

Tesla remains our favorite short position, only enhanced by Musk actions the past few weeks. Comments this morning to be followed by updated review out this weekend.

 

 

KH

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Non-GAAP Presentations Most Often Misleading

June 2nd, 2021 Comments off

With non-GAAP presentations rampant, the importance of our making financial statement adjustments is a critical component of our analysis. The energy sector is far from alone in this regard. Classification error in the statement of cash flows, where firm leeway is often permissible under GAAP, requires such adjustments and results in large ranges in free cash flow estimates for analysts not making proper adjustments, such as leaving activities as financing or investment cash flows instead of movement to operating. The unadjusted analysis would result in incorrect conclusions of target price and risk.

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Moody’s Stealing Our Name !!!!!!!!

October 24th, 2020 Comments off

Some 25 or so years ago we took the name Credit Trends and in 2002 took the website you see here.

Some years ago I called someone at Moody’s and asked them to refrain from using our name, and assumed they would do so, as they started using the name in 2007, as seen by the Wayback Machine web site.

I see they continue to use the name and as a result of their size, are shown on top of search sites like Google.  The USPTO  granted Moody’s a trademark for Credit Trends many years after we began usage

When applying for a trademark they were required to undergo a search to see if the name was being used for a similar purpose. For example, they could be granted a trademark for a Credit Trends dog food or funeral home but NOT for credit information or related business.

Obviously, both they and the US Patent and Trademark failed in this regard.

We are now asking the USPTO to have Moody’s trademark removed and that Moody’s stop using the name Credit Trends of Moody’s Credit Trends, and if not intend to file a lawsuit against Moody’s

 

Kenneth Hackel, CFA

President

Credit Trends

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June 30, 2020 Investment Review and Outlook

July 9th, 2020 Comments off

June 30, 2020, Investment Review

A WING AND A PRAYER

Beginning Comment

If a (bat)wing triggered the health and financial crisis, it might take prayer to get us out, as a vaccine is no sure thing given flu shots have been around for 75 years, yet upwards of 60,000 Americans still die of it each year[1].  In the sang-froid world where CT Capital operates, invocation may follow the process, not be an integral aspect of it. Financial decisions must ground on the skills of firm executives and the attendant response of the buying public.

So, given we have a slim idea as to when an effective COVID vaccine might become available, we operate under the condition that normality will be restored. Since a timeline is a guessing game we do not play, we must heavily weight the natural ability of the firms in the portfolio absent governmental aid until the recovery ensues. The April thru mid-June period in which the account showed outperformance against both indexes for the year—after a healthy 2019— shows how quickly events can turn.

 

 

For entire Outlook and analysis, contact CT Capital LLC

 

 

[1] McKinsey writes the number of reported COVID deaths to be well underestimated. See https://www.mckinsey.com/business-functions/risk/our-insights/covid-19-implications-for-business?cid=other-eml-alt-mip-mck&hlkid=29f0e15f26f24962b86688c0f90319c7&hctky=2672065&hdpid=0a24bf6c-15ec-4e50-9709-381e0f5b160a

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CT Capital LLC-Q1 Review–Gen. Dist Ed

April 20th, 2020 Comments off
 
CT CAPITAL LLC
 
 

 

 

 

Investment report

Q1  2020

 

 

REVIEW AND OUTLOOK

“Faith in the future, out of the now”

–John Lennon

INTRODUCTION

Professionally, I have seen a very wide, often deep, and diverse set of financial circumstances in my almost half-century in this industry, both micro and macro. I have seen firms with seemingly high rates of stable growth decades into the future fail and firms emerge from bankruptcy into market leaders.

The current period ranks as the most difficult from a financially analytical perspective, as the protagonist was not borne out of a financial event and so needs to be solved by the non-financial sector.

The great lesson from the ranks of economic history, regardless of trigger, is the current dark period will end, yet the financial and related impacts will not be known for some time. And so there will be winners and large losers, commensurate with periods of large pricing volatility reflective of the new, higher cost of equity capital.

Firms with abundant credit resources will have an easier time to the other side while others will have a long road back, if at all.

One of the hallmarks of the rise in cost of equity capital is a small change in perception often leads to outsized changes in market value.

The current period requires a deep dive on credit, regardless of the time horizon of salvation. Many firms will, a result of breaking through negative covenants, be prohibited from various actions, including dividend payments, additional borrowings, acquisitions, or asset sales without a bank waiver.

Our assessment commences with the current liquidity profile, sources of potential capital with associated costs, expected loss of revenues and updated cash flow, legal commitments, potential asset sales, and as always, litigation. Smaller supplier firms might find relief at reasonable cost from their larger, stronger capitalized customers for part of their capital needs, both of a monetary and non-monetary nature. Others will look to non-banks or typical lending institutions, depending on their equity access.

Our strong credit firms should be able to capitalize on others weakness as Air Products did this past week in its $530M acquisition of 5 hydrogen plants having assured customer sales.

Where trans-ocean shipping is required, ports might be closed or on slowdown which too would require cash and efficient inventory and operational management.

Our holdings share the important strength of abundant calls on credit; a few have been wise having entered forward equity sales instituted when shares were considerably higher. Most firms have begun to utilize financial options as well as cuts to operations, share repurchases and dividends, capital spending, hiring and other measures. Crisis management teams are in full force.

We are hopeful firms will finally recognize the real cost of share buybacks and dividend payments and carefully weigh that cost when the crisis ends. As many firms that participated in such activities are now in dire need of cash.

We review the impact on employees and key suppliers and any potential fallout, including related alterations to the landscape such as cost and productivity. Contingency plans need to be established and clearly communicated to creditors and shareholders.

President Trump is the de-facto majority owner of firms like General Motors and others relying on federal aid, without which they could well fail. If the President “asks” such firms to switch production to a health-related item, they will feel enormous pressure to follow the directive. This too has a cost and must be considered in the analysis, including any lost market share and related impact going forward, vis-a-vis competitors.

We must not lose sight of the crisis moderating; of understanding where the  firms stand on the credit front (liquidity profile, including that of customers and suppliers) and if changed, the new level and sourcing of sales, supply chain, divisional count, plans for implementation of improved and reliable technologies including robotics (don’t get viruses) and of understanding the firm’s plans going forward, including debt reduction, marketing strategy, margins for segments under expected growth rates, asset impairments, change to valuation allowance,  taxes, employees working in new locations (i.e. home) and updated costs related to insurance, leases, travel, closings, pension, health, and productivity.

We believe our cost of capital model covers most to all risk elements our firms may confront, from sovereign to insurance, litigation, natural disasters, or elsewhere. While our model includes risk of natural disasters, such as the penalty we place on Japan and elsewhere, it did not previously include health related risk.

That is why we scoff at recent comments “the cost of capital is low enough,” as they are evidently looking only at the cost of debt, not equity which is based on the risk to the free cash flows.

We feel we can never repeat enough the vast preponderance of a firm’s estimate of fair value is composed of their free cash flows many years out, even should the next few prove disappointing. It is why stocks rise over time, as investors typically overweight nearby cash flows.

In fact, for a hypothetical firm currently selling at a free cash flow multiple (that maximum cash that can be distributed each year to the equity owners without impairing the firm’s optimal future rate of growth) of 15 or a free cash yield of 6.7%, and whose real free cash flows are expected to grow by 0% per share for the coming 3 years, then 5%, 87% of the current value of the firm is composed of those cash flows 5 years and out. Not next quarter or even the next 4 years.

We believe our firms have the ability to ride out a period of deep stress (we own no energy, airlines or firms currently requiring federal assistance) and while estimates of fair value are now lower for all firms in the portfolio given we have cut expected growth rates across the board and raised cost of equity, we also believe there are no firms in the portfolio that could be bought out for cash at a lower price than were at the end of 2019. Certain stock transactions (such as if xxxx bought xxxxx) could make sense near that valuation. Next line omitted from general distribution edxition

So, even though our invested firms generate, over the normal cycle, more cash per investment dollar than benchmark commensurate with higher interest rate coverage, more stable and consistent key metrics such as stronger calls on credit, and lower cost of capital, their investment performance still suffered.

Banks are facing a crucial period, given the term structure of interest rates and negative interest rates around the world. That backdrop and required reserves alters the landscape for the sector, especially when pricing loans and deposits. Treasury help will continue to be essential in keeping the system sound, liquid and dependable.

ANALYSIS

And so, we must view the current dislocations–operating and financial, micro to macro, capitalistic states to communist—as ranking near the top distress points in financial market history.

The analytical process for us begins, at the operating level, at the collection of receivables, and the level of uncertainty associated therewith. Are there likely credit losses? Or are collections merely slower?  What is the likelihood and magnitude of orders slowing both during and post-crisis? To what extent can expenses be slashed or eliminated? What is the degree of tax offsets including those resulting out of the new stimulus law; will there be follow-up legislation including reimplementation of the tax-loss carryback? To what extent can the firm operate at all, and to what extent are clients impacted with the approximate shape of the snap-back period?

Credit analysis must be tailored to both the individual firm and its competition. The stronger possess the ability to raise external financing at levels that allow value-adding deals regardless of the level of stress.

It must also include means to boost service or other income, cost of hedging and counterparty risk; potential renegotiations leading to cost savings such as leases; strength of banking relations and other such relationships; yield curve impact; customer and supplier impact, impact of stock options (as a provider of funds and tax implications) ability to retain executives, regulatory reporting and requirements, and updated credit rating.

Other areas of inspection include impairment to goodwill, tax valuation allowance and impairment of equity method investments.

Then there are analysis, estimates, and possibilities related to additional uncertainty related to prospective Fed and Congressional actions, consumer response, insurance costs, tax (many factors here), employee benefit costs related to pension and other benefits and perks, executive compensation, possibilities of timely acquisitions and joint ventures, cost sharing, sovereign risk and, lest we forget, the ongoing trade issues with China and Europe, US election cycle, and so on.

Cash flow hedges may be moved to earnings though may still be included in AOCI.

We have, as would be expected, re-normalized rates of growth of 2020 and 2021 sales and free cash flow—hence return on capital. Many firms will not generate free cash flows this and possibly next year, while quite a few will be within normal bounds followed by large bounce-backs as the health issue is under control.

We feel our methodologies are appropriate given how the world economies and especially our holdings were operating prior to the health crisis and prospects for growth in newer technologies, notably 5G.

Even considering large cuts to our 2020 and 2021 outlook, we conclude our portfolio is worth holding, while if the health issue is resolved or moderates prior to that time, our holdings would see very large rises in financial metrics and coincident expansion in valuation multiples within short duration.

THE OPTIMAL COURSE OF ACTION

I have seen corporate executive officers take advantage of past crises in making strong value-adding deals while others acted in haste making acquisitions of declining businesses; some get “gun shy” or make other poor cash decisions such as failure to recognize a change in marketplace.

Well-managed firms with a history of making appropriate use of capital and strongly defined acquisition criteria will again benefit when the current period subsides.

Survivability and debt negotiations are the chief concern for firms facing s cash commitments and should lead to a large rise in default rate. Many firms rated BBB- will now fall into junk territory forcing certain investors to sell (or not buy) their securities placing additional pressure on their ability to finance the business at a reasonable cost.  In my almost 50 years in this business, a firm owned on behalf of clients has never filed under the laws of protection.

Many firms, in preparation for, and in reaction to the spike in yields, are drawing complete lines while others are preparing filings—-requests for new CUSIPS have surged. These additional incremental costs are significant on top of the revenue issue and should prod investors away from riskier assets.

Pension liabilities will soar for the over half of the S&P 500 firms which, over the past decade, have been severely underfunding (and more so in relation to that reported under GAAP) their liabilities in hopes of greater investment returns. Several of our firms have been impacted, but not to the degree that would cause us to alter those position given their long-term cash flow stability. Congressional offsets could be of help here and is being discussed for multi-employer and single employer plans.

Even with the current barrage of news, our deep scrub analysis will be of enormous help when the current health issue is, if not completely resolved, at least lowered. We expect many of our holdings to make use of their deep pool of resources to acquire assets and world-class talent, which will lead their shares to new high ground over time.

The stark reality is whoever thinks “Corona” is a six month or even a 2-year event is kidding themselves. There is currently much work to be done by our Government, our corporations, and our citizenry. Expenses will need to be realigned, having profound impact on many sectors; a few will benefit as firms move more to virtual, robotics, lower lease expense, and significant costs re-optimized, including right-sizing of facilities, labor, and supply chain. Share buybacks and dividend growth will slow or stop, boosting credit.

All firms in our universe have seen their cost of equity capital raised by 15-40 basis points minimum. Over time, our expectation is the reduction in expected free cash flows will aid in reversing said rise.

Aside from credit, the main current issue facing valuation is the new long-term expected rate of growth of free cash flows, not the size of the of cut to the current year’s adjusted and normalized free cash flows. We already pointed out the preponderance of current valuation is due to cash flow years out, meaning the ability of the firm to provide excellent product and service will see them prosper.

We do not need to see real return on capital back to where it was in 2019 for a restoration of values if there is belief stability of prospective metrics will rise. In life and investing, there is great value in certainty.

As supply chains are enhanced, including moving out of high-risk zones (a process underway), and which may even take years, cost of capital will fall as stability metrics improve.

As firms begin to report and hold their yearly analyst meetings there will be intense scrutiny on the cash burn for the current and upcoming periods, as well as changes to operations, investment and financing decisions.

Our cost analysis includes an “invisible handshake” firms make with employees that, if possible, their jobs are safe, permitting a restoration of revenues and avoid re-training expense when the smoke clears.

Lastly, we add, is our strong desire for legislators to be better prepared for the next health scare or crisis, whenever it may occur. This includes everything from sanitizers to cyber. Of current utmost importance is the capability of the U.S. to produce the active pharmaceutical ingredients for life-saving drugs currently relied on from China and India.[1]

CONCLUSION

Stocks have always risen to newer high ground despite wars, nuclear crisis, assassinations, oil embargos, catastrophic financial crises and deep economic depression.

We conclude the optimal option is to stay with the program, even if we see this short-term pain lasting over a year. In the meantime, there isn’t a medical facility of higher learning or pharmaceutical company in the world not looking for both a treatment and vaccine.

In this report we detailed those many areas of importance central to our analysis. We are confident this will lead to a restoration of values, and then some.

For reasons discussed, will trust you will then view the current value of your account as an anomaly, to be restored as it was following March 2009. Our firms are world-leaders fully capable of generating excellent excess cash over the normal cycle under prudent credit, allowing them to withstand financial stress while providing the fodder to take advantage of value-adding opportunities.

 

Kenneth S. Hackel, CFA

Eli C. Hackel, CFA

 

[1] Sen. Marsha Blackburn of Tennessee has introduced such a measure.

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IMPACT OF CORONAVIRUS TO OPERATIONS AND VALUATION

February 2nd, 2020 Comments off

COMMENT ON THE CORONAVIRUS
While some well-known large fund managers and medical experts have commented the coronavirus will pass, as does the flu, there will undoubtedly be a long-term impact to corporate decision-making, future free cash generation, credit, and cost of capital. This new deadly virus comes not long after SARS, and so the second important health risk out of China must be weighed, especially as expatriate firms typically set up factories in low cost areas where health outbreaks are more likely.

While some sectors are particularly sensitive to China, almost every large firm will feel some effect. To ignore health-related risks is to understate true cost of capital.

As you know, our portfolio accentuates structurally strong firms seeing normalized real growth in free cash flows, coincident with an adjusted return on capital safely above cost. And so, a year’s shortfall in the otherwise expected free cash flows has a lower than benchmark impact to its long-term current fair value.

Indeed, for the average firm in our portfolio, about 80% of its current fair value is comprised of free cash flows 6 years and out, meaning consistency is a central element of our philosophy, with cash flows more evenly spread. A year’s shortfall in the current year should have about a 2.2% (firm dependent) weight to share price. If the free cash flow were to be recouped, so would market valuation. Shareholders, we see time and time again, exaggerate shortfalls, including those firms with growth in key metrics.
Tesla, to cite a contrary example, due to its higher cost of equity alongside more uncertain cash flows further in time, should see a larger drop in its share valuation if it were to underachieve.
We so prefer the “bird in the hand.”

There are six impactful financial areas of note regarding the coronavirus:

1. Current supply chain-Several large Chinese cities are in effect, shut down, with most large firms haven taken actions to curtail or shutter units. Ports are reporting lower volumes.

Should the virus continue to spread, the effect on both cash flow and credit would certainly be impacted should firms not be able to shift resources. Most firms in the portfolio have, to the extent possible, been diversifying out of China. Our technology related firms, due to the trade conflict, have seen a China “hit” and, off the new base, have been forecasting real growth going forward, being leading-edge on the precipice of 5G. This latest issue could cause additional short-term pressure for the sector given constraints on current supply chain.

2. Future supply chain-The coronavirus will undoubtedly force firms to step up their diversification programs, including customers and supply chain, impacting short-term expense yet reducing longer-term risk. Labor, component and assembly, transportation, pension, tax, cost of hedging, and insurance will feel the brunt. Each firm must be individually studied as to cost and sales relations.
3. Valuation multiple-The virus is impacting, for reasons cited, valuation multiples. The contraction influences firm credit, depending on need to raise capital to tax and cash flow implications.

4. Impact to revenue-This is complex depending on whether sales are customer direct, intermediate or postponed. To the extent consumers reign in current purchasing, sales, employment, and capital spending would be impacted.

5. Impact to credit-Should the virus linger, Boards would halt their stock repurchase programs and perhaps draw on existing lines. Cost of capital would thusly be affected.
6. Increase in trade friction with China-It is conceivable China could claim the virus has passed, yet the US may want a prophylactic period or further proof. This could alienate the Chinese who might then threaten to raise tariffs or refuse to buy goods promised under the phase 1 deal. Firms are also getting tired of Chinese threats.

So, given the above what are we doing?

We are monitoring at this stage, yet expect our firms, regardless of their sector, historical results or prospective expectations, to take measures in furtherance of diversity of the various layers out of China.
We have long recognized the China risk and have so written in the past.
We hope the Congress will practice the “shoe on the other foot” approach, and like China, support the nation’s leading-edge industries. As plainly evidenced, China provides wide support to the likes of Huawei, and the US must do likewise.

Kenneth Hackel, CFA
Eli Hackel, CFA

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2019 REVIEW AND OUTLOOK

January 5th, 2020 Comments off

REVIEW AND OUTLOOK

2019 was a solid year (+682 vs Russell 1000 (TR) and +188 vs S&P 500) despite only one holding (the 15th) of the top 15 most heavily weighted firms in the S&P 500.  For Q4, the 32-basis point gain vs. the S&P going into December’s “fool the client games” flipped while still outperforming the harder to manipulate Russell 1000 Value (TR) index.

Moving into the new decade, we remain confident as holdings sell at a median 14.7x normalized and adjusted free cash flow with 14.7% adjusted return on capital and 7.2% cost of equity capital versus a latter of 8.1% for the S&P 500. Our firms are of stronger credits, possess greater stability in key metrics and, in general, are seeing growth in in adjusted free cash flows in excess of benchmarks. Such are the characteristics that bring superior long-term financial management.

 

FOR THE FULL REPORT CONTACT CT CAPITAL LLC-—INSTITUTIONAL INVESTORS

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CT Capital +29.15% Year To Date With Lower Than Benchmark Risk

November 9th, 2019 Comments off

……………

Yet, our accounts are of higher quality than benchmarks.

The firms enjoy more consistent key metrics, have a safer spread between cost of, and return on capital, stronger credit, and higher return on equity and economic profit. Each of these metrics is formulated via important adjustments to the published financial statements. In our last report, for example, we illustrated the difference between our estimate of free cash flow and that used by the leading data service provider, FactSet. In prior reports we showed the adjustments to arrive at cost of equity.

It has indeed been an unusual economic expansion, yet as we continue this stretch of worldwide slowdown, trade disputes and US political cycle, we should continue to find investors gravitate toward firms offering superior value, judiciously analyzed, both qualitatively and quantitatively.

The linchpin going forward will be these firm’s ability to deploy their excess cash and credit in a manner consistent with past practice, accounting for but certainly not limited to a change in tax policy (foreign or domestic), supply chain or factors outside the sphere of normal business practice.

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CT Capital Outperforming S&P 500 (TR) and Russell

August 7th, 2019 Comments off

….from our latest report to clients

 

That the account is outperforming both S&P 500(TR) and Russell 1000 Value (TR) indexes this year is merely in line with historical trend given the alternation in risk landscape and stage in cycle. Employment of an accurate discount rate guides us to firms in the portfolio as their valuations become faulty due to analysts’ overstatement of entirety of risk profiles.

As risk levels to free cash flows ascend our accounts should continue this outperformance, though any given quarter is subject to the many externalities.  As the period elongates, outperformance should broaden vs. benchmarks as a greater cross-section of investors adjust for previously unaccounted-for risks, including that of outright financial failure.

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Just read comments sent to me–sorry haven’t seen before

May 27th, 2019 Comments off

Didn’t realize how many of you enjoyed our previous works on this site. Just read comments, some of which were years old.

 

Unfortunately, more recent works are for the benefit of our research clients, all of whom are very high NW or institutional in nature.

 

We will, from time to time, distill some of our analysis a week or two after client receipt, and post here.

 

Sorry haven’t kept this up-to date; suggest you look at my twitter account (@credittrends), though there I post on a variety of topics, many baseball related as well as finance—as you will see I am a big Yankee fan

 

Lastly, I would urge you read my last book, “Security Valuation and Risk Analysis,” after which I am sure you will rarely listen to analysts or other gang of idiots you see on CNBC. They have NO idea of the scores of items behind each line entry in the published financial statements. And in most cases, neither do their CFO’s

 

KSH

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