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JeffryClarke (33.48)

They Aren't All Winners: Salmon Lice and Other Scoundrels



April 06, 2014 – Comments (4)

I read a lot of 10-Ks and earnings call transcripts.  Unfortunately, they can't all be winners like ABGB and GTAT.  There are some boring ones - Abercrombie & Fitch (ANF) is just trying to right the ship so it can sell itself in 2015, Digital River (DRIV) has an outdated business model and too much customer concentration with MSFT, etc.  Sometimes there are interesting companies out there for other reasons.  Here are a few:

Marine Harvest Group (MHG) 

What:  World's largest aquaculture (salmon farming) company, based out of Norway and traded in the US under the ticker 'MHG'

Attention Grabber:  7% dividend yield and forward PE ratio of 9x in a growing and consolidating industry

Why MHG is Interesting:  First of all, there aren't many opportunities to research companies in the Fishing, Hunting and Trapping industry classification on the SEC website.   Second, the salmon farming industry is fascinating. 

MHG is a 'protein producer' which should be boring and puts them in a leauge with Tyson, Pilgrim's Pride and Smithfield Foods.  That grouping is one of the few industries with forward PE ratios below 10x and basically no interest from anyone who isn't being paid to be interested.  But here's the thing with MHG and the salmon industry:  the price volatility for salmon (unlike chicken and pork) is insane due to the relative newness of the industry and because farmed salmon are subject to disease outbreaks which dramatically impact short-term supply.  MHG has at least doubled in price in a short period of time three times in the last eight years.  

Unfortunately, MHG and salmon prices are in an upswing right now but it's worth watching this stock because it could crash in line with short-term salmon prices at any time, due to something as unsavory and unpredictable as a salmon lice outbreak in Chile.  If you'd like to learn more, you're in luck, because on its web site MHG publishes an Industry Handbook, which is 72 pages long and could substitute for a college microeconomics class.

Verdict:  I wouldn’t take a long position right now, as salmon prices are in an uptrend and are capped due to the availability of substitutes (other forms of fish and meat).  I will be watching the news out of Chile and Norway for a salmon disease outbreak though.


United Therapeutics (UTHR)

What:  Pharmaceutical company with focus on treatments for pulmonary arterial hypertension (PAH), a rare and fatal lung condition

Attention Grabber:  10x forward PE ratio with revenues tripling since 2009; 23% off of its 52-week highs

Why UTHR is Interesting:  The company has revenue of over $1B per year and its entire addressable market of PAH patients is approximately 8,000 people, almost all in the US.  Yes, that is over $100K per customer per year.  The patents on its main products are expiring in 2014 and 2016 and UTHR is mobilizing to fend off generic drug manufacturers who, you know, might cut into those margins a little.  Its main products are delivered under the skin using a pump or similar mechanism.  By amazing coincidence, the company has found a way to deliver the same treatments in pill form and expects to roll that product out later this year, around the same time that the subcutaneous generic treatments will likely become available.  To the company’s credit, they are developing a treatment for a rare form of cancer in infants.  When asked about pricing of that treatment on the earnings call, management hinted that they would show restraint, since the US government co-funded the research. 

Seven different UTHR insiders sold shares in March with six of those reducing their holdings by more than 10%.  Think they know something about the competition from generics that we don’t?

Verdict:  I don’t know much about the pharmaceutical industry and with all of the patents and R&D it is a complicated space where I assume you have to be either well-diversified or super knowledgeable about the subject in question.  I also don’t take naked short positions, although it’d feel good to short this one, and I bet it would pay off.


PennyMac Financial Services (PFSI)

What:  Financial services affiliate of PennyMac Real Estate Investment Trust (PMT); originates and services mortgage loans in conjunction with PMT and independently and collects an investment management fee from PMT

Attention Grabber:  7x forward PE ratio with revenues growing to $386M since its founding in 2008; 24% off of its 52-week highs

Why PFSI is Interesting:  PFSI is a smaller re-incarnation of Countrywide Financial, the notorious mortgage lender based out of California that pioneered all sorts of NINJA-like products, created billions of shareholder value in the early part of the last decade and then dumped $50B in losses on BofA.  The CEO of PFSI is Stanford Kurland, the former President of Countrywide.  He is also the CEO of PMT, which creates all sorts of interesting conflicts that seem to mostly benefit PFSI.  Kurland owns 11% of PFSI and by some accounts has made more than 12x on his initial investment.  Kurland has a habit of being around situations that make money and an impeccable sense of timing – he left Countrywide in 2006 at its peak.  He then teamed up with BlackRock and another hedge fund to start PMT, which has returned 10%+ to shareholders annually.

The mortgage market had a rough second half of 2013 and 2014 isn’t expected to be any easier.  At its peak in 2006, mortgage originations were $3T annually.  Originations declined to $1.9T in 2013 and are expected to be $1.2T in 2014.  Rates have risen from 3.4% for a 30-year fixed rate mortgage at the bottom last year, to around 4.5% today.  Refinancings are drying up, and at an accelerating pace.

The originations market is declining, but the numbers on PFSI are real interesting and they might get better.  I say ‘might’ because it’s hard to tell what’s going on with their servicing numbers.  In Q4 they increased the value of their mortgage servicing rights (MSRs) by almost 100% - from $252M at the end of Q3 to $483M.  For such a big deal, the disclosure on how they did this is virtually nil. They have a line in a shareholder presentation about “bulk MSR buys from money center banks” and a couple of 8-K’s filed during the holidays about financing MSR purchases, but that’s it.  Nothing about timing, or where the MSRs came from or what the impact might be in 2014.    

Given that the company is run by ex-Countrywide executives, the market reception to this opacity has been poor.  Fidelity and Leon Cooperman have sold over 7M shares in the last month, which is over 33% of the company’s float. 

PFSI is well positioned to benefit from further changes in the mortgage market.  They have a ‘clean’ book and they’ve built a modern system from the ground up that is very scaleable.  Due to regulatory changes, banks are exiting mortgage lending and servicing and may be happy to cede market share to non-banks like PFSI.

Verdict:  I’m interested, but something doesn’t feel right about this company.  I’ll take another look after Q1 earnings and I’ll be especially interested if they start doing more MSR deals and disclose how it’s all working.



4 Comments – Post Your Own

#1) On April 06, 2014 at 11:26 AM, awallejr (57.24) wrote:

I wouldn't touch any of these.  MHG is too closely connected to the price of salmon.  UTHR will be losing patent protection.  And I wouldn't touch anything run by former Countrywide officers.

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#2) On April 08, 2014 at 2:20 PM, chk999 (99.97) wrote:

Excellent writeups! I especially liked the salmon farming one.

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#3) On April 09, 2014 at 5:21 AM, JeffryClarke (33.48) wrote:

It's a funny market out there.  UTHR is up 5% this week in the face of a biotech meltdown and the only news is their CFO and an EVP unloading another $1.5M in stock.  If there is stock market god, it is tempting me to short that stock...

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#4) On April 10, 2014 at 10:07 PM, Starfirenv (< 20) wrote:

I would hope you watch this video- Norway specific, about salmon farms.  I think not only would you abandon the idea of investing in that,  I would bet you'd never eat another "farmed" salmon.  Part 1 of 4. "Farmed Salmon Exposed".  Worth watching and sharing. 

And if you want to know more, watch how it's done in Canada.  "Salmon Confidential, documentary about Salmon Farms in Canada.


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