Sallie Mae Preferred Looks Interesting

Sallie Mae (SLM), the education loans company, has a preferred floating rate stock that is very interesting.

  • Par Value is $100.
  • Currently trade around $60.
  • Dividend is floating based three-month LIBOR plus 1.70% per annum. Three-month LIBOR is at an all time low. Here is the libor rates history. The last four dividends add up to $2.14 or 3.5% at the current price. 
  • They are callable at anytime at $100. They do not mature.
  • They trade on NASDAQ under the symbol SLMBP. 
  • The are non cumulative meaning if the company misses a dividend payment, they don’t have to pay later.

The positives:

  • For every 1% the libor rate goes up, the stocks yield will go up 1.67% due to discounted stock price.
  • If LIBOR rates go up from historic lows, the stock price will go up significantly. For example, in 2006-2007, the three-month libor was around 5+%. If rates go up to that level, this stock will yield 11+% at the current price of $60. During that time, the stock was trading around par value or $100.
  • 3.5% is a decent yield in this environment. 
  • SLM is a $9 billion company.
  • Taxed at 15% dividend rate.

The negatives:

  • Need to more research on SLM. The security is only good as the viability of the company. 

I will update the site once I do more due diligence on SLM.

Disclosure: I do not own SLM

Federated National – Part 2

A reader Jeff S. sent me a good write up about potential risks about insurance companies in general. In the rush of posting this article yesterday, I should have mentioned them as they are important:

Book Value

Insurance companies hold a lot of assets, mainly bonds. The value of those assets shift dramatically depending on market conditions and thus, book value can go up and down dramatically. For example, Federated holds $150 million in cash and investments and the majority of it is in bonds. If the value of those bonds goes down say 10%, we are talking about a $15 million hit to book value or about $2/share. 

When you are investing in insurance companies, you are investing in bonds. Right now, it is not a great time to be an investor in bonds (especially, long term bonds) because of the low interest rates. About 16% of Federated’s portfolio bond portfolio, is in bonds that mature after 10 years. Another point is that any extra cash flow that the company gets will be invested in more bonds at the current anemic rates. 

Loss and loss adjustment expenses

Insurance companies not only have to expense actual paid losses, but also losses they expect to pay in the future. As a result, an overly optimistic management team could increase earnings by underestimating losses they may have to pay in the future.

It is worth noting that losses this year for Federated were stable even with a 20%+ new business. Also, unpaid losses and LAE has gone down $10 million year over year from $59 to $49 million.

Management attributed it to “primarily to a reassessment of our losses by line and increased underwriting procedures to manage our risks.” Federated has been focusing on writing more profitable policies. This has resulted in lower reinsurance premium rates and obviously lower losses. However, I am not a huge fan of the first reason (reassessment of our losses). 

Takeout

One thing I like about Federated is that they have grown organically and not from takeouts (taking business/premiums from other insurance companies). Takeouts result in instant premium growth and a boost to earnings. Homeowners Choice, Inc. (HCI), an another florida insurer, has growth this way, but the Federated CEO is not a fan of this approach and is adding business policy by policy.

Management

You need a good management team to manage risk. In regards to Federated, I can’t say either way they are good or bad, but I do like that they are saying the right things in the conference call.

Conclusion

With any investment, there is risk, but insurance companies are riskier. Federated is still a buy for me as I wrote in my previous article, but  investors should invest with caution.

Disclosure: I own FNHC

Buy Federated National (FNHC)!

Federated National (FNHC) provides homeowners insurance in Florida. It is a very small company:

  • Market capitalization of less than $60 million.
  • No analyst coverage.
  • Average volume of less than 14,000 shares traded daily.

It just reported good fourth quarter earnings over a week ago and since then the stock has surged almost 20% from $6.17 to $7.30 yesterday. However, further gains could be in store for this company as revenues should get a huge boost in 2013.

Background

The state owned Citizens is the largest insurer in Florida. Due to concerns about whether Citizens would be able to pay out claims if major hurricanes hit the state, it has been state approved raising rates over the last couple years with the hopes of writing profitable policies and pushing customers to the private sector. This has had a positive impact on Federated:

  • Over 20%+ growth in gross premiums written in 2012 to almost $120 million.
  • State approved rates rises and disciplined underwriting have decreased loss ratio and increased net income to .53/share in 2012.

2013

Based on management’s comments in the earnings call, 2013 should be even a better year:

  • Significant growth in new business in 2013. Last quarter the company was doing $1 million in new business and this quarter it is doing $2 million business and the CEO feels they could reach $2.5 to $3 million in business. Based on normal retention rates of 90% of existing customers, gross premiums will increase anywhere from 50% to 100%.
  • A signed deal which would allow 700 Allstate agents to write business for Federated has not gone into effect yet. This should help grow new business. 
  • Earnings should increase at a higher rate. Even though most of expenses such as reinsurance are variable, some of the smaller costs are fixed which should significantly help the bottom line with the revenue growth.
  • It is possible that earnings could be over $1/share and book value could increase from $8.26 to over $9+ share.

I bought some shares at $6.59, $7.10, and $7.15. I will most likely buy more at the right price.

There is a good seeking alpha article on the stock.

Disclosure: I own FNHC. 

All Companies Should Issue Apple’s iPrefs

moneyIn order to increase the sagging Apple (AAPL) stock price, famed hedge fund investor David Einhorn suggested that the company should issue perpetual cumulative preferred shares. Here is the presentation if you have not seen it. 

The basic idea is that Apple should distribute to its shareholders one of more of $50 denominated iPrefs that pay an annual dividend of $2. The shareholders can either sell them on the open market where Einhorn expects them to trade at around $50 or keep them a get 4% yield per year ($2/$50).

The main reason for the iPrefs over other ways to distribute income (dividends, share buybacks, etc..) is that it will significantly increase the value of Apple’s shares. For example, if Apple issued 10 $50 iPrefs for each share, it would have to pay an annual distribution of $20/share ($2*$10) and theoretically, you could sell the shares for $500. $500 is above todays Apple share price of around $430. If you add the earnings that are left over after the distribution ($20+share and the $137 billion in cash), Apple would probably trade around $250-$300 post distribution.

The more iPrefs Apple distributes, the higher their valuation will be. The iPrefs also have other advantages:

  • There is no default or bankruptcy in the event that Apple cannot pay the dividend.
  • Apple can wait to bring over the cash pile they have overseas and not have to worry about the tax implications.

The iPrefs will definitely unlock value. How much value will depend on two factors:

  • The number of iPrefs they issue.
  • The price they trade on the open market. I think Einhorn is being too optimistic. They will most likely trade at a 5% yield or $40/share. 

The reason the iPrefs will unlock value is that there is discrepancy between what stable high quality companies trade for and where long-term bond yields are at. With iPrefs, Apple is just levering up the company in a smart way and distributing the proceeds to shareholders.

If I was an Apple shareholder (which I’m not), I would continue to hold the shares because as the shares go down, there is a greater chance that they will issue iPrefs. I will most likely start buying the shares at around $400, if they ever get there.

Microsoft

If Apple ever does issue iPrefs, the first company I will buy is Microsoft (MSFT). This will most likely be Einhorn’s next target. It has a similar profile as Apple:

  • Tons of cash on the balance sheet.
  • Trades at less than 10 times earnings and generates tons of cash ever year.

Last quarter, Einhorn increased his stake in Microsoft by over 40% to over 10.8+ million. 

Other companies that could follow suit are other tech giants such as:

  • Cisco
  • Oracle
  • Dell (if the takeover falls through)

Eliminate dividends

I would take it one step further and eliminate dividends and issue iPrefs to take advantage of the aforementioned discrepancy. It would be a big boost to the stock market.

Disclosure: I do not own any of the companies mentioned above. 

Short Thoughts

As many of my readers know that I am short some stocks that I have written about on HypeZero:

With the market trending up the last couple of months, both Pandora and SHOS have skyrocketed costing me some money. However, Orchard has really tanked which has helped my short portfolio pretty much break even. Not bad in this market. 

I am keeping all three shorts as nothing fundamentally has changed from a business perspective at any of these three companies.

Because the market has gone up quite a bit, I am looking to add to my short portfolio. Here are some companies that have caught my eye as possible short candidates:

Zillow/Trulia

I have written that Zillow is better than Trulia based on sheer numbers. However, as I read more about this industry and these companies a couple of things concern me:

  • When I search for real estate in my area, I don’t use Zillow/Trulia because their information does not come from MLS so it is sometimes inaccurate or outdated. I use the realtor site run by Move Inc (MOVE).
  • I don’t see much of a difference between Move’s business plan and that of Zillow or Trulia. In fact, Move has better data.
  • Move has been around for a while and they have been struggling growing annual revenue past $200 million. Zillow is half the size at only $116 million in annual revenue, but worth 4+ times as much. As Zillow gets to Move’s size it will have similar growth problems.    
  • Sales and Marketing expenses are going up at a faster rate than revenue. If the market is so big and these companies have such a small percentage of the market size, why is it so hard to grow revenue? In 2012, Zillow revenue grew over 75+%, but sales and marketing grew over 100%. 2013 forecast calls for 45% revenue growth and 70% growth in sales and marketing expenses.
  • Both companies are trying to enter other markets by acquiring companies at premium prices. This is a big hint that the current business model does not justify the current valuation.
  • Zillow is barely profitable and Trulia is not profitable.

One thing that these companies have going for themselves is that the housing industry is bouncing back. This could result in real estate agents increasing their advertising spending on sites like Zillow. 

Moneygram (MGI)

I wrote that Wester Union is a value trap a couple of months back. Moneygram is Western Union’s biggest competitor, but it is smaller and does not enjoy Wester Union’s premium pricing. A couple of things concern me about this industry:

  • They charge the poorest people high prices to transfer small amount of money. Every year fees per transaction keep going down and there is constant pricing pressure. They need to increase the number of transactions per year just to keep revenue and profits from going down. Western Union, a huge cash cow, has been making $1 billion in profits for over 8 years.
  • Wester Union is performing price cuts across certain corridors and this should have an impact on Moneygram in 2013. 
  • New competitors (Xoom) and the wide adoption of smart phones will impact this industry in the future.

Monster/Dice

LinkedIn (LNKD) is hitting on all cylinders and the by-product of this that sites like Monster (MWW) and Dice (DHX) are hurting. Monster is at a 52 week low and I think Dice, a career website for technology professionals may be next. Even though the technology market is hot, Dice is barely growing revenue and profits. 

I will do more research on these companies before I short any of them.

Disclosure: I am short Pandora, Sears Hometown and Orchard Supply