The Hard-Hat Trade
The price of admission to a secular bull market ain't cheap, and it will try to throw you several times.
When it was announced yesterday that US Steel (X) was buying Lone Star Technologies I had to smile even though I don't own a share.
A few years ago I was wearing a pink hard-hat sweating through my suit and tie at a subsidiary of Lone Star Technology, way out on a country road down here in Texas. I realized later they give that hat to the visitor they want to get a good chuckle at. Okay, several good chuckles. That hat, and being a foot away from melting steel is a day I'll not soon forget.
I was laughed at back at the office as well. Why would I waste an entire day driving a long way to see a company that could have been one bad quarter away from going out of business and was not even publicly traded (later purchased by Lone Star). An entire little town around its largest employer was in serious trouble. My only protective put was that I knew at least I would be on the right side of a very good BBQ-for-lunch-trade.
I stumbled around with some guys and gals who made steel tubes for the oilfield services industry all day long. Inches away from losing a limb tends to focus your attention. Dabbing sweat and cleaning my goggles with an Italian tie, I couldn't have been more out of place – usually a good opening position in the stock market I've learned. I nervously ducked my untimely demise more than a few times that day. In that way, it actually did feel like my trading room just a bit, if you add 50 degrees and subtract breathable air you've got the picture.
After the guys with the real hard-hats stopped laughing, their "tell" was striking. I will never forget what the bottom in that business looks like. It truly felt like their blank stares flashed tiny "save yourself" signs, trying to warn me against using any capital in a dead-end investment that was about to swallow their entire families, company, and town. I did not end up taking a position in anything but a brisket that day, back in the summer of 1999. But I was very close to building several positions. I was doing homework following my hunch that cycles tend to cycle. I've noticed that over the years. Eat your heart out Ivy Leaguers.
This little business made tubes and pipes for energy companies. Back then the entire Energy Sector made up only 6% of the S&P 1500. Everywhere I looked confirmed the same story, that because of how bad business had been for so long it had slowly become under-invested, both in the plants and in the stock market. Capital chases margins going up, not those going down, or in, the tubes. Until…enough capacity is taken down or closed forever, that even the slightest up-tick in demand is bidding on a dwindling supply. It wasn't as easy as it sounds, even in Houston back then $15 oil was feared to be greeted by single digits. 'Back then' was not that long ago.
So where are we in the cycle now? Another "tell" can be found in the closing price of US Steel yesterday. Despite paying a tremendous premium for Lone Star Technology (the BBQ is on them next time), notice what the market is telling you about supply by looking at the closing price of US Steel instead. The acquiring company's shares were also bid up strongly, almost 4% even in a terrible tape and almost 40% in the first quarter alone in a flat market.
To be clear, I am not invested in steel. But I continue to hold core positions with the guys who are buying it and who keep getting more orders and more work. I have shared an opinion that the oil commodity trade can get overdone quicker than the energy infrastructure can get over-invested.
Despite all the attention lately, and many who suggest by looking at certain sector funds that energy is now over-owned, I will humbly suggest the opposite. Energy is less than 10% of the S&P 1500, which by a factor of hundreds of billions of dollars, I believe is more representative than sector funds that are traded more than invested in. I believed originally while walking around that tube plant and stalking its customers that Energy's weighting – then at only 6% - could go to 14%. Where did I get that number? I tried to be conservative as that would be climbing back to merely half of where we've been before. That's right, a full 28% was invested in Energy in the 1980's.
"Sometimes good things take time." Lou Mannheim
I think the secular trade is still intact, namely that energy and particularly energy infrastructure and its engineering are under-invested (the guys buying and working on those tubes). Don't get me wrong, it's not as easy a call now. As long as I am, I will still trade around positions. After all, I was the crazy Texan who actually opined at the very beginning of the year we could flirt with a four handle in front of the price of crude before we go much (perhaps much) higher. We almost got there. Recall we were a few pennies from the $40's in January. Seems like a long time ago. The price of admission to a secular bull market ain't cheap, and it will try to throw you several times.
I am still long and over-weight Energy across the board while I wait for full investment. But where are the pink hard-hats now? Are there any unusual places that few are driving to and sweating through? I'll share two possibilities from recent trips my partner and I made.
Number One didn't feel lonely enough. I'll admit it actually felt a little crowded at this engineering firm. The building we were used to visiting had become two, almost overnight. But the "tell" was the new guy in the lunch room. His placement firm had to be hired, and an entire operation moved into the building just to recruit engineers in such short supply. How short? He was calling the Philippines all day trying to get as many on a plane to Houston as he could. Names to look at include, among others: Foster Wheeler (FWLT), Washington Group, Flour, and Jacobs (JEC). You might find order backlogs higher than market caps if you're into that sort of thing.
Number Two felt just about lonely enough to trigger my Jumbo Shrimp Indicator and for my partner to book a flight…to Canada, later this year. I sat in a presentation that was the emptiest at this conference, by far. On Halloween last year this industry got news that created the same blank stares I saw at the tube plant. The Finance Minister of Canada announced that Royalty Trusts would be taxed at 31.5% on certain cash flows starting in 2011. The industry was overwhelmed with selling, immediately. (Sorry to interrupt predictions with reality but…you mean higher taxes slow business? Can we get a couple of these price charts to our own lawmakers? It's quite simple. Heck, our very own royalty, Mr. Sedecca would gladly walk them through a Bloomberg session.) He could punch up the ticker ERF, Enerplus and see what happens.
I have plenty of work to do in the space, currently have no edge whatsoever, own no shares at all, but I'm intrigued. Enerplus was the very first Royalty Trust formed in Canada. I looked past its structure long enough to realize it is one of the few oil and gas plays (about 50/50) to have oil sands assets as well and its debt is among the lowest in the industry. There is always a chance the government comes to its senses and realizes how many businesses and its own citizens, not to mention retirement plans, rely on the shares that have been taken apart after this disastrous announcement…but I do not bet on long-shots. However, my favorite bet is taking a capitalist against a bureaucrat any day and especially if he has time to train. My hunch is that something changes before 2011, and my money is on the capitalist. Re-organizing, merging, breaking up? I don't know enough yet to hazard a guess. I do know the company just opened an office in Denver, has tremendous property in Montana, and U.S. assets are exempt from the tax ruling. Hmm…
Almost all my ties, including the one used on the tube trip, have been retired, turned into a pillow that my wife is making for my one year anniversary of opening my own firm where ties are outlawed. She was the best trade I've ever made. She may have gotten top-ticked on me but I got one heckuva deal. Sorry for the personal interruption but thanks to her I get to go on trips like these and do the work that I love at odd hours in odd places as you can see. A big thanks to Toddo as well, he was no small part of our excitement one year ago today. He may not know how big an inspirational role he played. I am genuinely honored and thrilled to wear the MV hat every day.
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