Tuesday, November 29, 2011

Moose Hunting Photo's

We'll I just arrived back from Moose hunting and I am sorry to report that we harvested no moose this season.  We actually saw very little action until our last day, Saturday.  That day my hunting partner was caught right in the middle of a chase between a couple of wolves and a cow moose.  He only saw one of the wolves and it was within 50 ft of him.  We are not able to hunt cow moose during the season we hunt.  I don't think the wolves caught the moose since the amount of snow we have gave the moose an advantage. 

Just to give you an idea of what it's like to moose hunt, I am including a few of photo's of our hunt.

A typical view heading into the forest.  The forest is a mixture of Pine, Spruce, Birch, and Poplar.  Most of the areas we hunt we're major logging camps dating back to the 1940's, and some of the more recent logging happened during the 1980's. 

This is the portable hunting cabin we stay in during our hunt.  It is 12ft x 18ft (216 sq ft) and can sleep three comfortably and four people if required.  It has insulated wall sections and an insulated tarp roof.  It was designed by my father-in-law and all packs nicely into a 6 ft x 8 ft x 2 ft steel box that stays up in the forest.  We take a small generator to run interior and exterior lights and propane tank to run our coleman cook stove and a lantern if required.  A wood stove provides heat.  If you look closely the door you will see the cabin is appropriately called the "Attack Shack". 

This is a picture of a sunrise early in the week. I climbed up about 50-60 ft up a really, really old spruce tree that was over 100 ft tall. The base circumference of the tree was so large if I put my arms around it my fingers couldn't touch. I'm sure some of the really old trees measure 3 ft in diameter.

This picture was from Thurday afternoon (yes afternoon).  The temperature warmed up from -30°C (-22°F) to 0°C (32°F) and hoar frost made everything look white.  Other than the first couple days, the weather was quite nice. 

I went for a walk near sunset Thursday in familiar territory without my GPS.  It was amazing how quickly disorientated I became without the sun as a reference.  I honestly couldn't tell you which direction was north.  All I knew was that if I stayed on the skidoo tracks I would make it back to a main trail.  Needless to say, I don't leave the cabin very often without my Garmin. 

Here is a picture of a whitetail deer (doe) that I took.  I saw about a dozen deer including one fairly large buck I could have shot.  He had a decent 3 x 3 rack, fairly wide.  I am fairly fussy on deer and I am only looking to shoot a 150+ buck.  I have a 5 x 5, 160+ class mounted in my basement and I am only looking to shoot something larger.  If you have done any hunting you will know that deer always look bigger through the scope on your gun.  Once they hit the ground they horns shrink by about a third. 

As for the markets they continued to zig and zag.  No new news of substance other than the US economy is quite strong despite the rampant pessimism.  A number of bargains are currently available in high quality large cap stocks.  Given how low interest rates are stocks are obviously cheap.  This will become more clear in the years ahead.  Hopefully everyone is enjoying the buyers market.  As much as you may not like the low prices, it really is good for a number of the businesses I own that are actively buying back shares.  Every day the companies I own become more valuable even though the market prices don't reflect that reality.  In the long term the market will figure it out. 

Best Regards,

Sunday, November 20, 2011

Gone Moose Hunting

We'll I have been a little slow posting of late.  I had an extremely busy week getting ready for a big moose hunt.  Today I will be leaving for a week into the north to hunt big game.  Here is a sample of what I will be looking for:

Or this guy:

The second photo was taken by my brother in-law's trail camera approximately 15 miles from my house.  We do have some huge deer up here in Canada.

Just to give you an idea of what we do, we drive to the edge of civilization and then get on skidoos (or quads) and travel into the forest.  We pull sleds packed with all kinds of gear (generator, ropes, food, clothes and guns).  We the travel into the northern forest for a couple hours and set up base camp.  This will be my fourth year.  Like I said last year it takes lots and lots of patients hunting moose. 

I will try and post some pictures next weekend when we return  (Click here for Pictures)

Best Regards,

Saturday, November 12, 2011

Investment Idea - Berkshire Hathaway

Yesterday I gave you a number of quotes from the Oracle of Omaha, Warren Buffett.  The last quote was the following:

Your goal as an investor should be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist temptation to stray from your guidelines: If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes.

So I got thinking to myself, are there investments available today that meet Mr. Buffett's criteria.  I was originally going to post on another company that is significantly undervalued and will most likely be taken out at a premium over the next year or two for reasons that would become clear upon investigation.  I had come to the decision that I wasn't going to invest but the stock has recently gotten cheaper and I do some buying.  The stock isn't overly liquid but the company is fairly large.  Anyone want to make a guess? 

Upon further reflection the best example that I could think of today that meets Mr. Buffett's criteria is his own company, Berkshire Hathaway.  Today Berkshire Hathaway represents a very asymmetric investment opportunity.  The downside is very, very low and the upside is very, very significant.  My argument for investment won't rely on any facts or figures but simply a statement recently issued by the company itself. 

It stated, "Our Board of Directors has authorized Berkshire Hathaway to repurchase Class A and Class B shares of Berkshire at prices no higher than a 10 premium over the then-current book value of the shares. In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount, though any such estimate is necessarily imprecise."

So what we have is hat tip from Mr. Buffett who is clearly signaling that he believes his stock is cheap.  Not only does he believe it is cheap, but worth considerably more than a 10% premium to book value.  The 10% premium is likely to reflect the fact that they don't believe a significant portion of their principally deferred income taxes, listed as a liability, is really a liability.  Some other minor balance sheet modifications could also be made. 

Secondly, downside is limited to 110% of book value or currently $71/share (Class 'B' share).  So, for the sake of argument, let's assume Berkshire is worth 1.75 times book value or about $115/share.  So at recent prices you have around 8% downside and 50% upside making this opportunity very asymmetric.  Besides the very attractive risk/reward scenario you are buying a business that owns a number of fantastic businesses from Dairy Queen (a personal favorite) to GEICO.  They also have some fantastic equity investments in growing companies like Coca-Cola and Wells Fargo.  Nearly all of the Berkshire companies earn exceptional returns on equity. 

So lets run down the checklist from Mr. Buffett's quote above: 

1) Rational Price?

Check - Mr. Buffett has told us it's not only undervalued, but significantly undervalued.

2) Easily Understandable Business?

Check - Although Berkshire is a complex conglomerate of many businesses and equity investments, most all of these businesses are quite simple and provide valuable goods and services that people use everyday. 

3) Are the earnings are virtually certain to be materially higher five, ten and twenty years from now?

Check - Wholly owned business have increased per share earnings by 20% annually for the past decade.  Those companies will be providing the same goods and services 20 years from now as they are today (very low technology risk).  Examples would be bricks, carpet, insurance, ice cream, razors, soft drinks & candy.

4) Would Berkshire be a good company to own for the next ten years?

Check - I can't think of another company I would be more happy to own for the next ten years.


What does Mr. Buffett recommend you do when you find a company that meets all of his requirements and is available at a reasonable price?  You should buy a significant amount of stock.  Enough said, the writing is on the wall. 

My recommendation is to buy some Berkshire and forget about it for at least ten years.  When you check it again, it will be worth much more than what you paid.  No need to get a daily stock quote or read every single news update out of Europe.

Lastly, by investing in Berkshire, you will benefit not only from earnings per share growth but also from a market that will value the company in a more optimistic mood in the future.  In the short term if the stock does get cheaper realize that is in your best interest for Berkshire to buy back as many shares as possible.  Just remember to use Mr. Buffett's assessment of fair value and ignore what the market says.

Best Regards,

Kevin Graham

Disclosure - I am long BRK.b

Friday, November 11, 2011

Warren Buffet on Market Fluctuations

Recent market movements will have caused many "investors" to be scared.  Yesterday I talked with a coworker who said she very upset that her mutual funds were down significantly in September.  I have received emails from fellow investors who have said the recent market movements have made their stomach's churn.  I have heard some say that you should sell your stocks and wait for the mess in Europe to sort itself out. 

In times like these it becomes clear who who should and shouldn't be managing money.  I'm sure many of my readers will have read many of the quotes below but quickly forget them and act differently when markets go crazy.  If you read my first post on this blog (Are You a Value Investor?) I made the case that many understand value investing but don't practice it. 

During times like these it is always good to review some Warren Buffett quotes on market fluctuations.  I hope they help you put things in perspective. 

  • We’ve long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short term market forecasts are poison and should be locked up in a safe place, away from children and also from grown-ups who behave in the market like children. 
  • The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It is optimism that is the enemy of the rational buyer. 
  • Success in investing doesn’t correlate with I.Q… Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing
  • The stock market serves as a relocation center at which money is moved from the active to the patient
  • Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greed and greedy when others are fearful
  • You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.
  • Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.
  • Stop trying to predict the direction of the stock market, the economy, interest rates, or elections. (or Greece)
  • Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.
  • Lethargy, bordering on sloth should remain the cornerstone of an investment style.
  • Wild swings in share prices have more to do with the "lemming- like" behaviour of institutional investors than with the aggregate returns of the company they own. 
  • Remember that the stock market is manic-depressive
  • As far as you are concerned, the stock market does not exist. Ignore it.

If you struggle in turbulent markets, like those of the past few months, print this last quote off and read it every day. I would also recommend reading it every time you feel like you are getting hijacked by your emotions. 

Your goal as an investor should be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist temptation to stray from your guidelines: If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes.

So do you practice what Buffett preaches or do you just agree intellectually? It is a natural human tendency to ignore flagrant inconsistencies between what we profess to believe and what our actual behavior implies. Being intellectually honest is difficult. Our egocentric tendencies make ourselves the easiest person to fool. 

Perhaps you have the business valuation side down and struggle with the temperament side of investing. By constantly reminding yourself of the concepts above and using a checklist you can avoid a lot of pitfalls in your investing.

Happy Remembrance Day,

Kevin Graham

Disclosure - Long BRK.b

P.S. If you are Canadian, I would encourage you to reflect on the 110,000 people who laid down their life so we can enjoy the freedom we enjoy today.

Wednesday, November 9, 2011

Five Reasons Oil Prices Will Fall

Someone recently emailed me and asked the follow:

I juxtapose your thinking with the thinking of a blogger with a similarly named blog; when I read each of you, you each seem to be right to me but then this simply can't be so- at least about near term oil prices. Wondering how you see Fairfax purchase of SandRidge, and perhaps how I reconcile 2 variant blogs.

To eliminate any confusion I thought I would post my response here.   My apologies for being so long.

If you look into recent history you will find I am not the same as the other blogger you are referring to.  We have intensely debated in the past.  That said I do regret picking a name similar to his blog as it is confusing.  For the record, I never read his blog before starting mine and haven’t read it since.  I read a few articles on another site and thought they were high on opinion and lacking in facts.  He doesn’t have much to offer other than mainstream thinking.  Original ideas are hard to come by and it is why I believe my blog has been so successful.  I refuse to rehash the daily news.

When we debated PBG/PBN it became clear he doesn’t understand O&G and had never read the reserve report. He doesn’t understand how the reserve report is determined and doesn’t understand how an O&G company makes money. He believes that all an oil company has to do is buy a bunch of land and then start shooting fish in a barrel. I can assure you it is much, much harder than that.

Many of the companies he has recommended are very speculative and many have generated little to no real economic return. I don’t know what he’s saying now because he charges for his content.  If history is any guide most of his ideas are small speculative O&G companies.  Many don’t generate real returns but merely only turnover their cash flow and are at best asset plays. By asset plays, I mean you are essentially betting on the underlying commodity prices. 

If that is “value investing” then he needs a new definition. It’s really speculation, be honest. You and the company have absolutely no control over the price of their products; you are a “price taker”. How do you make reasonable estimates about the future revenue and earnings?  If we go to the other side of the spectrum, Coca-Cola is a company with huge “pricing power”. An increase in price doesn’t affect demand. Moreover, Coca-Cola increases the price of their products every year and sales continue to climb.

As for the price of oil, I am aware we disagree on where it is going. He is a believer in peak oil and I am not. What are the reasons that oil will go up further? I would like to know them. Is it just because it’s gone from $11/bbl to $100/bbl during the past decade?

If you have read my blog for any amount of time you will be aware that I am a firm believer in “reversion to the mean”. As Prem Watsa says, “Trees don’t grow to the sky.” Simple extrapolation of short-term trends will hurt you more in investing than anywhere else.

Five Reasons Oil Prices Will Fall

I have discussed my bearish position on oil for some time now, let me highlight five reasons. 

1.  Oil has had a tremendous run over the past decade and I doubt it will continue indefinitely. Reversion to the mean will happen. The reason for the run is mainly because of very accommodating fiscal policy both in the US and BRIC nations (Brazil, Russia, India & China). The Chinese stimulus has carried the commodity trade for the past two years. 

2.  China cannot defy economic gravity. Despite what the pundits say, real estate bubbles rarely have soft landings (Read Michael Lewis, When Irish Eyes are Crying). It is almost unbelievable that people still believe today that you can command control an economy. I mean look at the US. According to the Federal Reserve Chairman everything was great in 2006/2007. Then the crash comes and they say, “trust us” we are in control and can get us out of this mess. Let’s be honest it’s comical. Let me be blunt… You cannot command control an economy. This is the 21st century and we should have learned this lesson by now. 

Reasons for the US Housing Bubble

To further explore how you cannot command control an economy, let me list my reasons for the US housing bubble (Let me know if you agree or disagree).

A)  US government policy encourages home ownership and because they intervened in the “market”, people responded to the incentives. The creation of the GSEs (Fannie Mae, Freddie Mac), the tax deductibility of interest, and non recourse mortgages are all interventions that alter behavior in the housing market. Thus the housing market was no longer a “free” market.

B)  The Federal Reserve dropped interest rates after the internet bubble and kept them too low for too long.  Here the incentive was cheap money and it further encouraged home ownership and fueled the early speculation. This is another example of how intervention altered people’s decisions in the market. Thus we did not have a “free market” but a market full of incentives. 

C) Finally, people believed in the sound premise that “real estate only goes up”, acted on the incentives, and then the price action took over.  Finally in the late stages of all bubbles the focus is almost entirely on the price action.  Once the price action took over, the bubble exploded and speculation become rampant. Stories about how your neighbor just flipped a house and doubled their money in one or two years become common.

Warren Buffett has said one of the most important things he learned from Ben Graham is that “you can get into more trouble with a sound premise than with an unsound premise.”   If you understand what he's saying it so true. 

Back to our Discussion 

So China will not be able to defy economic gravity. They have some serious mal-investment in real estate.  Because they consume 40-50% of the world’s commodities, once the game us up commodities will get hit hard.  Back in 2008 the Chinese stimulus was something like 23% of their GDP. This resurrected oil and nearly every other commodity that fell hard back then. 

3)  Commodity prices do not reflect reality. Copper, although off its highs, is still selling for much more than the marginal cost of production.  Copper is selling for $3.50/lb and it cost $1/lb to get it out of the ground. Have you looked at the returns the mining and metal companies making? I’m sure you have heard it said that profit margins are at record highs and are bound to fall to more normal levels. Well this is a sector that will have some significant margin contraction. If you look at commodity related equities, they have fallen much more than relative to the fall in commodity price. Why is this?  Clearly the market (investors) are signaling a further fall in commodity prices.  When commodity prices fall, oil will fall likewise. 

4)  I don't believe in "new era's.  I also don’t want to take any unnecessary risks. If you step back and look at the price of oil you have to believe this is a “new era”.  The market has numerous other opportunities so don’t box yourself into one sector.  

5)  On the flip side, what is the bull case? The bull case is we are running out of oil. While that may be true but isn’t it interesting US oil demand has fallen since 2005 (Click Here). High oil prices have also led to an onslaught of new technologies and energy sources. If you have a free market economy and someone has a need (in this case energy), someone will find a way to meet that need. Thousands of engineers are working on it everyday (Click Here for an Example). 


I’ll keep this short. I looked very, very briefly at Sandridge. I'm not interested in owning an oil company and I didn’t see anything appealing so I took a pass. That said I believe Fairfax has invested because of two reasons. One is management and the second is hedging. I have heard Prem Watsa say that the speculation in commodities is out of hand and that he knows of only one company that hedges their prices. I took that statement to refer to Sandridge although I don’t know their hedging policy. If SandRidge has significant hedges that is smart and is likely the reason why he’s invested. Many companies won’t hedge.  You want to know why? Because they are speculating that prices will go even higher. People never learn and never change. They constantly reach for risk & yield with little regard for the downside. 

Prem understands this well and he never reaches for unnecessary risks or yield without adequate compensation. He wants to earn 20% on every investment that Fairfax makes. When he does that he leaves himself a large margin of safety. 

Best Regards,


Disclosure - Long FFH

Tuesday, November 8, 2011

Buffett was Buying in Q3 - Were You?

It's funny, the first thing I noticed as I flipped through BRK's 10Q this past weekend was the cash flow statement.  Significant buying of fixed income, equity and other investments to the tune of $22.5 billion.  The financial news quickly picked up on this and and it made headline news for about one day.  Then they were all quickly back to the issues in Europe.  Who can blame Buffett as stocks sold off during the quarter?

That said, how about some personal reflection and intellectual honesty.  Did you feel fearful and sell during Q3?  Did you buy during Q3?  Were you worried about Greece and sold off some holdings?  Be honest what did you do during the third quarter?

If you are honest and reflect on what you did you can learn a lot about yourself.  Humans are natually egocentric and to reflect on mistakes is a sign of strong intellectual ability (and leadership).  This exercise will also demonstate your self esteem.  Are you secure enough in your mind to be honest with yourself?  So what did you do during the quarter?

I'll be honest with everyone reading this.  I bought a tiny amount of BAC class A warrants in the quarter.  I didn't sell anything.  I must admit though, I felt like day trading when the swings were getting out of hand but I resisted doing anything foolish. 

Now that we know Buffett was buying during the quarter... any guesses on what he bought?  I would be willing to bet that Buffett bought more Wells Fargo.  Furthermore, I would be willing to bet he purchased over a billion dollars worth of Wells.  Anyone want to make me a friendly bet?

Best Regards,

Disclosure - Long BRK.b, WFC and BAC

Postscript - Buffett didn't buy a billion in Wells Fargo.  I wish to retract my offer.  HT:Cord

Postscript2 - I also purchased some GE and JNJ for a family member in a retirement account.  Both were being offered at a 4% dividend yield. 

Sunday, November 6, 2011

Occupy Wall Street

I find it humerous that the occupy wall street crowd doesn't really know what to protest.  I personally believe the real heart of the issue is the envy.  Just listen to the lady in this interview.

You can just hear the buzz words in the background... Corportism, Un-Regulated Greed, & We Need Government to Protect Us.  What these people need to do is go back and read what Thomas Jefferson wrote in the delaration of independence. 

These people are angry because they are drowning in debt.  They lived a lifestyle that was beyond their means and now they are slaves to those who lent them the money (banks).  People need to realize that to wealth doesn't come from consumptions but from underconsumption.  Capitalism works and it works well, it's just that the current generation that doesn't have a clue what capitalism is. 

I don't know about you, but the "we are the 99%" signs make me sick.  If you make the average wage in Canada, $25/hr or $50,000/yr, you are in the top 5% in the world for income.  These people claim they are the 99%?  What these hypocrites really want is more money because they are the greedy and envious of those who have even more. 

Perhaps these people should voluntarily give up three quarters of their annual income for the real 95%?.... hmmm, I'm quite sure the average greedy, self indulgent, selfish wall street occupier wouldn't give up a dime.


Canadian MoneySaver Magazine

Here is some personal confirmation bias.  I have said a number of the points mentioned in the article below.  What is interesting is Mr Hodson comments come from someone who earn their living from working in the financial services sector. 

I stumbled across an interesting article by Peter Hodson (Click Here To Read).  While I never really liked much of what that came out of Sprott, Mr. Hodson has left and has now purchased Canadian MoneySaver Magazine.  With Mr. Hodson's other business he seems committed to helping individual investors.  What I particularly found interesting in the article is a number of things I have said over and over.  Here are a few of my favorite quotes: 

Every time there is a crisis, investors re-discover the fear of the unknown. As investors, of course we do not know when the current crisis – whatever it may be – is going to end. The problem, though, is that investors act as if the crisis will NEVER end.

Even the Greece/Eurozone crisis will come to an end even though everyone is acting like it's the end of the world.  No need to buy gold and ammo. 

In the 2008 credit crisis, for example, S&P reported than more than 1,100 companies actually traded below their net tangible cash balances. Investors were so scared, effectively, that they were willing to give away cash, literally.

As an investor you much be able to separate you emotion from your thinking.  My current employer has placed a strong emphasis on critical thinking and teaches every supervisor critical thinking skills.  Recent we have been discussing how our Amygdala (part of the limbic system in our brain) can be hijacked and our rational faculties disappear.  When subjected to a threat, either physical or psychological, our natural tendency is to fight back or take flight.  If you have spent anytime reading or understanding human behavior you will know what I am talking about. 

One example we discussed was what we do when we hit our hand with a hammer.  What is our natural tendency?  Often people would throw the hammer and express some verbal anger.  That is an example of an Amydala hijack.  Is throwing the hammer rational? 

The same goes for investing.  Some investors immediately hit the exits during a crisis because their thinking has been hijacked and they aren't think clearly.  Emotion and adrenaline take over.  Selling something for less than tangible cash is not rational. 

The good news for value investors is that isn't going to change any time soon, so enjoy and take advantage of the wild market swings. 

A similar investment lesson involves brokers and research analysts. In my cynical viewpoint, changes in brokers’ recommendations and target prices are designed to do only one thing – generate trading activity

I don't think much more need to be said.  Much of what analysts say is useless drivel.  I have a friend who is an analyst in the O&G sector and he has told me it is difficult to continually come up with something to say when nothing has really changed. 

Finally... watch out for conflicts. Everyone, it seems, makes money in the investment business, except the individual investor. Advisors earn fees, investment bankers earn fees, fund managers earn fees, traders earn fees, and analysts get bonuses.

Always ask what is in it for the other guy.  If research was truly independent it might be useful, but due to the inherent conflict I would avoid most of what they say.  

Lastly, it's funny how many people complain about how much money is made in financial services, but here's the thing.  People are continually paying for these services so until people speak with their money and avoid the fees nothing is going to change. 

Enjoy the entire article at the link above. 

Best Regards,

Saturday, November 5, 2011

Problems in China

Fascinating couple of articles on the Globe and Mail today regarding the problems in China. 

You can read them here:

Bank of America Issues Jittery China Forecast

And here:

China's Vanishing Factory Bosses


China consumes 40-50% of the worlds commoditites.  When the music stops, and these articles are definite warning signs, Canada and every other commodity producing country will get hit hard.  Nearly every commodity (except natural gas) has gone up in a parabolic curve over the last few years.  The TSX will likely be worth half what it is today when this is all said and done.  If you look at the margins and returns these commodity producers are earning it's a clear sign that it is not sustainable. 

So what is the individual investor to do?  First, if you look at many of the commodity companies in Canada, many are already priced for a significant fall in commodity prices.  I would recommend selling every commoditity producer, especially speculative ones.  If you have a good way of shorting actual commodities like copper, iron, and cement let me know.  Shorting marginal oil producers will also be a good way to make money. 

Owning some Fairfax Financial is also a great way to protect yourself.  I have a signficiant amount of my net worth in the company.  They are currently 100% hedged and own some derivative contracts that will pay off handsomely if we have any deflation over the next 9 years.  They don't own anything commodity related and in fact the CEO Prem Watsa has been bearish on commodities and China for a while now.  I have commented on this before.  Read the letter to shareholders for the past couple years to read about Mr. Watsa's concerns. 

On the topic of FFH, I have read every single shareholder letter since 1986.  I made some condensed notes about each and every market call Prem Watsa has ever made since starting Fairfax.  One would be very wise to listen when Mr. Watsa says something.  If you are interesting in these notes send me an email. 

I would also suggest telling friends and family how to protect themselves, if they will listen to you.  At least you've done your part.  The TSX is predominately a commodity index and with financials making up the next biggest chunk.  Very dangerous. 

Best Regards,

Disclosure - Long FFH

Tuesday, November 1, 2011

Bellatrix Exploration

I was recently asked by a visitor to my blog on my thoughts on Bellatrix Exploration. I was away last week on business and wasn’t able to respond.  I have decided to write the response here for everyone to enjoy.


Bellatrix is an E&P company that formerly was called True Energy Trust. True was a created in 2005 via the arrangement with TKE Energy Trust (formerly TUSK Energy) for those who remember back that far. 

Now, just for the sake of a history lesson, True Energy Trust was a disaster from a financial point of view. Since 2005 till the end of 2009 when they changed back to a non-dividend paying E&P company they had cumulative losses of $390 million dollars. In fact they only turned a profit in of $14 million in 2005, and losses were $234 million, $24 million, $20 million, and $127 million, in 2006, 2007, 2008, and 2009 respectively.

So obviously they weren’t good explorers, but then again most income trusts weren’t good explorers. Most were legalized ponzi schemes whose distributions consisted entirely of return of capital.

Bellatrix 2010

In 2010 the company transitioned back into an E&P company. Company started getting into some plays such as Cardium oil and Notikewin gas wells. Losses in 2010 totalled $28 million dollars, bringing the cumulative total to $418 million since 2005.

Bellatrix 2011

In 2011 the company continued pursuing oil in the Cardium and liquids rich Notikewin gas. Of interest, shareholders should be aware that upon transition to IFRS accounting the company incurred impairment of $44 million. You know a few million here and a few million there... these losses are starting to add up.

Now the good news is the company is starting to turn a profit. In Q1 2011 the company would have recorded a profit of $2.4 million if we neglect the $10 million loss on hedging (actual loss was $5.5 million). In Q2 2011 the company would have realized a profit of $5.1 million if we neglect the $10 million gain on hedging (actual profit was $12.3 million).

So if we isolate profits actually attributed to operations in the first half of 2011, the total is approximately $7.5 million (assumes hedges are a wash in the long term).  We have to keep in mind that oil prices were over $100/WTI bbl in Q2 and they have declined somewhat.

Now if we make the assumption Bellatrix can maintain the level of profitability they had in Q2 and annualize the results, annual profits would run about $20.4 million. Shareholders equity was $359 million at the end of Q2. This gives an annualized return on equity of 5.7%. This is nothing to write home about.  Because the company employs leverage the return on total capital is even less.


Net Asset Value (NAV) for proved reserves is around $3/shr and NAV for proved and probable reserves is around $4.75/shr.  The price deck for WTI oil used in the reserve report was $100/bbl till 2015, which is quite aggressive in my opinion. I am pessimistic on oil prices going forward.  

Secondly I estimated their netback to be around $25/boe with all in finding and development cost of $15/boe (Please note that you cannot use managements numbers that don’t include future development capital). This gives a recycle ratio of 1.7 times, which is nothing to write home about. At the end of the day you need to be consistently above 1.5 times if you want to add any value.  

Book value for the company is $3.11/shr at end of Q2. Considering they can earn about 5-6% on equity capital with $100 oil, I wouldn’t consider BXE a fantastic business.


One thing I noticed when reading BXE news releases and other information is that it really isn’t shareholder friendly. For example, they like to quote finding and development costs excluding future development cost.  Whenever you see that, don't let management pretend your some sort of fool.

Secondly, I found the graphs of the share price increases of predecessor company run by current management to be quite humorous. First, Meridian Energy was acquired by True Energy in 2005. Given the level of losses occurred since that date the takeover was obviously a failure for True shareholders and a gain for Meridian shareholders. Secondly, oil and gas prices increased significantly during the years 2002-2005 so it wasn’t some sort of magic that caused Meridian’s share price to compound at 104% annually. Any idiot could have purchased assets during that time and watch the value magically increase due to the increase in commodity prices. 


Bellatrix is at best a mediocre company that has been performing a little better as of late. Given the track record of the company (current management has been in charge since 2007), I wouldn’t invest in such a money losing operation if you paid me.  I would want to purchase the assets at a significant discount to book value or NAV to protect myself from potential issues down the road.

I rely heavily on good management with a solid track record and I don’t get that with Bellatrix.  Instead with the name change from True Energy into Bellatrix, all you get is lipstick on a pig.

The current price for a share of Bellatrix doesn’t offer any downside protection if oil prices fall.  I happen to feel oil prices will fall over the next few years so buyer beware.  You know I may well be wrong on oil prices, but if you step back and take a look at the forest instead of the trees you will see how high many commodities are today.  The nice thing about the markets is that you can totally avoid the potential bubbles and crazy asset prices. 

I know many of my critics will say the same thing about the bank stocks I own.  Don't worry, I'm well aware of the issues.  It's just that those stocks just happen to be very cheap right now and in a few years todays the market will be singing another tune.  A good rule of thumb I tend to ask myself is this, has the sector done very well or very poorly over the past five to tend years?  If the sector has done poorly I like to look for cheap stocks to buy and if it has done well I tend to look the other direction. 

Reversion to the mean is a hard lesson some people never seem to learn.  Some people just don't have what it takes to own companies that the masses consider to be trash.  Separating the facts from the emotional fiction is what value investors enjoy doing. 

Best Regards,

Disclosure – none