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The Crap Of The Crop: Is The Biggest Move Of Garbage Stocks During This Year Justified?
Over the past year there have been some phenomenal moves in stocks, which some call high beta names, but which for all intents and purposes can be called "crap" companies (we use the term generically in the fashion it has been previously used by the mainstream media). So Zero Hedge decided to do a more in-depth analysis of just which names have benefited by the unprecedented equity rally, and whether their fundamentals justify the record moves from the stocks' 52 week lows.
In order to do this we looked at two company universes: EBITDA positive and EBITDA negative, all of which have had at least a 150% bounce from 52 week lows. In the EBITDA positive universe we further narrowed it down by companies that have an EBITDA-CapEx(or Free Cash Flow as defined)/Interest Expense ratio less than 1, in other words, companies which, without digging too deep, are unable to satisfy their interest expense from Free Cash Flow alone and thus are forced to use either cash, revolver or working capital to meet debt obligations, and also are based in the US, and are members of the Russell 2000 index. The other EBITDA negative universe basically focused on companies that have not only negative EBITDA but a large (>$20 million) interest expense outlay and >$20 million capital expenditures (both on an LTM basis). Lastly, we sorted the EBITDA + universe by TEV/EBITDA and the EBITDA - universe, sorted by % change from the 52% low.
The results are presented below.
EBITDA positive:
EBITDA negative:
What is immediately obvious is that in the "EBITDA positive" camp there are 12 companies that have a EV/EBITDA metric of over 10x currently, and yet can not meet their debt obligations merely from operations (FCF/Int Expense <1). These 12 companies have on average had a 673% change from their 52 week low. This is mindboggling. We are talking about companies whose equity value has bounced on average over 6x, yet whose EBITDA can not meet interest expense and CapEx! Some of the outliers in this group: Clarient, Newport Corp, Powerwave Technologies, Power-One and Morgans Hotel are in fact trading at higher than 20x EV/EBITDA. Someone must be seeing a lot of growth in these five names which need to use cash, revolver or sell working capital in order to avoid filing at some point in the future.
Even more shocking is looking at the "EBITDA negative" companies. Of the 19 companies, if LTM trends are any indication, 9 will have no cash in less than one year! This calculation assumes cash burn is satisfied not only by cash and cash equivalents but also by unused revolver borrowings. One can be positive that the banks, once they see their borrower is starting to go "into the red" will promptly make borrowing on a revolver prohibitively difficult. More shockingly, the EBITDA negative group has a cash burn rate that will deplete all available (excluding working capital) cash in 9.8 months! To say that these companies are viable is practically insane. Biotech analysts will immediately realize the business model: major cash burn with frequent and recurring dilutions in order to raise more and more cash to allow the company to survive. Yet of the 19 companies in this list, there are only 4 biotechs (Human Genome, Cell Therapeutics, Molecular Insight Pharma and Incyte). The "cash burn" model has gone pandemic. And yet, this universe of 19 companies has an average 1,109% outperformance from its 52 week low. This is pure speculative dot com mania, with no basis whatsoever in fundamentals. Amusingly, one of the companies is Goldman Sachs darling and most recent equity follow on offering candidate Palm, Inc. Does a pattern emerge here?
Yes, and the pattern is all about the short interest as a % of float, which is at an astronomic 15.16% for the EBITDA negative companies, and 8.26% for the EBITDA positive list. In addition to the stock loan custodians pulling shorts massively across the board, nank after bank has used its repo desks to recall shorts, thus making both of these universes skyrocket. The goal: issue round after round of equity dilution in order to fund the upcoming capital shortfall. With fundamentals no reason whatsoever to buy into the stocks, the only thing that has driven the stock prices so much higher has been the artificially induced short squeeze. And if the banks pocket hundreds of millions in underwriting fees doing this, so much the better.
So what is the growth trajectory here in the absence of EBITDA growth: keep cutting CapEx (i.e. declining future revenues), reducing net working capital (selling assets) and hopefully reducing debt (through equity offerings). By purchasing follow on equity offerings, investors are buying shadows of these companies, which are now caught in a liquidity conservation mode. As always the key question: where will revenue growth come from remains unanswered?
We plead readers to go through this list and to be very cautious of the names listed here, which are merely the tip of the iceberg. The same concept applies to hundreds if not thousands of companies. That these companies have ramped the way they have is begging regulatory intervention, yet the SEC will of course not lift its little finger to do anything here (at best it may lift its middle finger and wave it in the face of retail investors once this bubble collapses and all these stocks come crashing down). While our methodology has been more a back of the envelope rational approach, we are well aware that there may be unique circumstances for one or more companies that in fact allow it to below on this prestigious list of huge S&P outperformerns. Yet we have our doubts that there is anything secular about these companies, which are merely benefiting from a cyclical short squeeze bounce compliments of an unprecedented bear market rally.
As always, caveat emptor.
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Check out the ramp on PALM in the last 2 days, the ramp this morning after the news of an extra 4m shares in the offering. Totally makes sense right? This is such textbook bubble mania, just like the dot com bubble. We will be looking back on this in 5 years and laughing cause it all will seem so obvious then that this was a bubble but no one wants to admit it now.
Nice work T! These capital really are pointless companies resemble chips on the Vegas tables, nothing more, nothing less.
at the blackjack table at least you have a 48%hance at a bet paying off. "investing" in any of these companies is almost a certain loss, kind of like picking individual numbers at roulette.
Depends on what you mean by "invest" - has the supply of greater fools been exhausted? if not, you can ride the trend for a little bit unless your timing is wrong...
I think writing Jan 2010 out of the money calls is likely a winner if you can stand the margin calls along the way
i think "playing a game of chicken", sums up this whole phenomen
what amuses me daily, is analysts and tv commentators trying to come up with fundamental reasons for the moves in these POS.
What about DTG....why no mention on the list?
I applaud ZH and Tyler Durden for their efforts in pointing out the insanity of the markets. Sadly, using sanity to define insanity is in and of itself insane.
Things are insane precisely because they don't make sense. To measure an insane occurrence using sane metrics is silly.
Of course, I'm having some fun with the subject. It's either that or go ballistic.
Laughter, the only medicine remaining for those with any sanity left in an investment world gone mad.
In a similar vein, there was a good article recently at Seeking Alpha on how Trash is King:
http://seekingalpha.com/article/162092-trash-is-king-beware-being-late-to-the-party?source=y
“We looked at the universe of companies traded on the US exchanges that have volume of at least 100,000 shares a day, market cap of 25 million dollars and revenues of 25 million a year. Only 84 of the 2408 stocks that meet these criteria have declined for the period from March 6th through November 10th. Many stocks were trading as if they were going into bankruptcy at this point, particularly in the consumer discretionary and retail space. The opportunities that existed at this time have disappeared with the rally. 953 of these stocks we screened have advanced more than 100% since the March low. Out of these stocks only 399 have positive net income, the rest lose money. 101 stocks have advanced more than 500% since this time. The biggest winners are Dollar Thrifty (DTG), Avis Budget Group (CAR), Smurfit-Stone and Dana Holdings (DAN) up 2980%, 2960%, 2350%, 2230% respectively. The net incomes of these companies for the previous twelve months respectively were -49 million, -1.18 billion, -2.82 billion, and -684 million. ArvinMeritor (ARM) and Tenneco (TEN) made the top 10 list with gains of 1790% and 1770% respectively, while losing a combined 1.87 billion. Smurfit Stone is currently bankrupt, and there is still a significant chance that some or all of the other companies will declare bankruptcy as well during the next year.”
I had seen that article but TD takes it one step further to impart a reason to the madness. Namely, (if i can presuppose) that since these debt loads are on the books of cetain parties, it is in their vested interest to prop them up and improve the metrics as well as the opportunities to raise capital such that if a V shape is in the cards (yeah, right) then these efforts will be rewarded, and if not, then the loss in trading will be nothing compared to the loss in in securities and, if nothing else, it extends forward the timelines of failure providing opportunity to get in front of the coming tsunami.
While getting in front of a tsunami sounds crazy, it's really little different than any other wave and attacking and approaching it at the right angle will get you on the good side of it instead of swept away by it.
EBIT and EBITDA - two metrics that I have always thought were senseless viewed without reference to NET earnings and you've shown it admirably where even the interest payments might not be covered by EBITDA!
A great piece Tyler, well done.
DavidC
Charlie Munger once said at a Berkshire Hathaway meeting that whenever you read or hear the term EBITDA you should substitute "bullshit accounting".
Looked at another way, EBITDA is just a very generous proxy for cash flow that might be available to pay interest on debt. If the company is doing a poor job of managing its working captial, the cash flow situation might actually be worse.
In other words, TD is being "kind" to these companies by using EBITDA as a proxy.
The funneling of money to the crappiest parts of the market may well be the most egregious part of this transfer of wealth that continues to play out. If you're a retail investor, please heed TD's warning about these pieces of crap-- just because they receive equity offerings and get upgraded based on "bolstered balance sheet" resasons-- doesn't mean that these stocks aren't crap. Fundamentally, they are still steaming piles of dung.
Has anybody noticed that everytime TG or BB are in congress the market tanks?.Anybody can construct a graph of all the testimony events and how the market acts in those days?I think they have people in their who points to congressmen when they go for lunch"look what could happen guys if you suffocate our people". And sure enough,testimony after testimony and things are still the same(lol).
Further, as Will Rogers noted, every time Congress is in session the market tanks, and every time they are out of session, it rises...
Who cares about profits?
The government will never let AIG or GM fail anyway. Freddie and Fannie can be the mortgage market, GM the auto market, AIG the insurance market, etc. etc.
Free markets were too disruptive to investor psychology to be allowed to continue.
Free markets are bad. Printing money endlessly is freedom. War is peace.
1984 anyone?
Bright analysis by TD leading to the observation that none of the government bailouts appeared on the lists (hard to
read).
So further proper analysis needs to go to the macro level:
How long can governments keep credit and solvency
printing money, borrowing and bailing out losers with
tax revenues that declined -34% this past April?
How long can businesses without profits survive?
Those that believe in the tooth fairy may want to
believe indefinitely.
The rest of us may want to take serious market
Preparation H for what is coming...
http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3251493
Then good luck came a-knocking at my door
Skies were gray but theyre not gray anymore
Blue skies
Smiling at me
Nothing but blue skies
Do I see
WILLIE!
At least for NEWP your numbers are way off. The company has no net debt ($150mm cash and $150mm debt), and capex has fallen substantially the last 4 qtrs, and EBITDA is skewed by non-cash writedowns.
I dont think we can make any statistically relevant insights by a crude balance sheet screen and taking the top 1% of results.
just 'sayin
I read Ben Graham's Intelligent Investor for the first time years ago. There was a sentence in chapter 1 where Graham says that there will be periods where it makes sense not to own any stocks. That sentence stuck with me.
The junk is overvalued, but so is the good stuff. I can't think of too many companies that build better products and have a brighter future than AAPL, but who would buy it at 6x book and 5x sales? Not me. I guess this is one of those times Graham was talking about.
EBITDA = "Earnings Because I Tricked the Dumb Auditors"
Perhaps the excessively leveraged CDO's simply outweigh all logic at this point. No company can fail as the counter- parties are all broke. Derivatives now rule the day....they are currently unregulated of course so we can assume the "powers that be" have insured against bankruptcy... AIG, Goldman, and JPM. It's so obvious.
The ralley has 10 more months to go then? Shit! Better create an EBITDA Neg portfolio and ride the bull into the sunset!
In the short run, the market is a voting machine.... B. Graham.
There are firms on your list that will make it and offer great returns. Just looking at past metrics is a sure way to lose money. I agree that the voters are over-exited, but I think this post is worthless. You have to look through each of these names to determine long term valuations and investment merit.
Care to stick you neck out a little more??
Sure - Example Ambac
The company has been at cash flow breakeven over the past year. But from a earnings perspective has reported huge losses. Losses were to bolster reserves and indicate total expected cash obligations for insurance written. Loss curves for all RMBS (except some 2007 deals) are actually improving more than expected. Thus reserves could be overstated. Thus after reporting a loss last year they could report a gain if reserves are reversed and tax benefits build. From a liquidity perspective they have cash and short- term securities of $2 billion on a consolidated basis and if they become profitable, are allowed to pay dividends to the holding company. So, if this scenario plays out Ambac is worth at least 10x current value. See Radian for an example of how quickly this reversal can occur.
I'm curious about your "loss curves for all RMBS (except for some 2007 deals) are actually improving more than expected" comment.
The data I see shows that the subprime default rate has leveled off in the low 40's while the default rate on prime and Alt-A mortgages are steadily increasing. Severity rates had been steadily increasing but leveled off in the last quarter or so.
Trying to generalize the RMBS market is pretty tough, but generally refering to the 60 plus bucket that in most of the guaranty industry reserve models (10q) were set to continue increasing into 2010.
I should have said 60+ days delinquent where I said default rates in the prior post.
The 60+ day delinquency rates are steadily increasing for prime and Alt-A and about flat for subprime. Jeff Gundlach of TCW, who I think is about as expert as anybody in mortgage backed securities, thinks the delinquency and default rates for prime and Alt-A will continue to rise and will peak far above current levels.
We are seeing improvement in 2006 and earlier FRM buckets & flattening in ARMs. Too early to tell 2007 trend.
Great analysis. Some may question the specifics of certain measures applied to certain names, but the overall message is correct - we are in a Fed-induced bubble.
Unfortunately this type of bubble damages our economy by mis-allocating capital. Your comment on the goal of dilutive equity offerings is correct - these companies want to raise equity to avoid liquidity (and solvency) issues, and the banks want to earn fees for helping them.
The problem is, this allocates capital to companies with broken business models, who can then compete with companies whose business models worked through a severe recession. The result is a weaker economy in the long run.
The Fed is repeating the mistakes of Japan to a T. Unfortunately we are in a weaker position as a nation than Japan was, so the result will not be nearly as positive (or will be more negative if you will).
Amen! Time to construct the FED liquidity "lunacy" model which measures the point at which irrational buyers forced into buying stocks on their supplied liquidity dries up. Whoever designs this "model" will win the Nobel prize in economics.
In the mean time, the Dow is trying to make another new high. When this bubble breaks, what will be left to stabilize the markets?
You raise a good question - when this bubble breaks, what is left?
There was a great post on Calculated Risk a few days ago about the unemployment rate vs the Fed Funds rate, which highlighted quite well the diminished capacity of a lower Fed Funds rate to spur employment.
The truth of the matter is, the Fed's easy money policies actually hurt, not help, employment in the long term, via the mechanism I outlined above - easy money causes a mis-allocation of capital. While easy money can cushion a blow in the short term, it hurts over the longer term.
So when this latest asset bubble bursts, what can the Fed do? Interest rates will probably still be at zero. They may have exited their asset purchase programs, so I suppose they could restart those (though I suspect they will not be able to exit the MBS purchase program for long). They may just blatantly buy stocks (which they had done from March - June, though under the table).
Beyond that, it is hard to say. Maybe they really will just drop dollars out of helicopters. It might be the only option left.
Then after that, what will they do?
Eventually the fiat currency system collapses, it is a mathematic certainty.
I was thinking that very same thing back in 2007. It's capatalism but it blurs the line of faith based capatalism as trash is put on equal standing with sensibility as far as drawing money with ever expanding valuations by society (hence ever decreasing cash flows and/or more manipulative actions required to maintain cash flows).
You just aren't paying attention, or you wouldn't even ask the question "What is left?" There are many things left. Just because the Fed, since it's creation, has used the same 3 credit control mechanisms over and over doesn't mean that's all it can do. BB clearly stated his intentions and his reasons for paying interest on excess reserves (to control their movement into - or not into - the active monetary stream). He has explained that this gives the Fed controls beyond the interest rate boundary, to increase or lessen the money multiplier effect of the money printing the Fed does. Now, try to picture another few trillion dollars printed and placed by the Fed in excess reserve accounts with interest CHARGED by the Fed on that money. Those funds will be loaned out immediately to anyone who will take them at any rate necessary to move them out of the banks' accounts. "Helicopter", I assume you are aware, is a metaphor - keep your eye on the Fed-controlled excess reserve accounts if you really want to know whether the Fed thinks inflation or depression is the big danger (they aren't capable of imagining both at the same time, but that's another story).
Very well put, ghostface!
Excellent post. And, it is more than back of the envelop.
However, "caveat emptor" is not applicable under Dearest Leader's new consumer reforms proposal.
Frank's HR 3126 revokes that position and offers a 'fiduciary' duty. So be very careful.....they are going to be watching you.
GS Institutional client: Wow, there is a new definition of growth cap in town - inability of a firm to cover CapEx, this is crazy.
GS Analyst / Advisor: Who needs the CapEx.. this is SPARTA!!! (unspoken: oops PONZI)
@TD: nice analysis, but I would also like to see the analysis repeated based *purely* on short interest and days to cover (historical profile analysis leading to and during the ramp). Short interest should be representative of company crapness (as you've defined it), so I would expect a decent correlation between the two datasets, but what I'm interested in seeing is whether rampage is more tightly coupled to short interest than to crapness itself. I'm firmly of the belief that HAL9000 deliberately targets stocks with high short interest and low volume with a perma-bid. Easy money generating buyers (bears getting creamed) when there really aren't any bulls in sight. Company viability is irrelevant to this model.
one of the best articles you've written, tyler.