Thursday, March 31, 2011

The Nuclear Saga Continues

After 3 weeks of intense battling with the nuclear reactors, our heros at Fukushima aren't really winning. In fact the situation is going from bad to worse. Radioactive substance is found in almost 100 different types of food, seawater is contaminated, tap water in Tokyo cannot be drunk, the area around Fukushima would probably be unlivable for the next 20 to 30 years.

The final outcome might be similar to Chernobyl, ie pouring a few hundred thousand tonnes of concrete to entomb the reactors. Even that is just a temporary fix. Ukraine now needs financing for a permanent structure to seal Chernobyl and has difficulty getting it.

The key company in question, Tokyo Electric Power or Tepco, meanwhile fell 80% over the last 3 weeks and it looks like it's going to zero. The reasons: cleanup, decommission, compensation costs is likely to wipe out its entire equity. Even bondholders might need to bear the brunt.

Tepco is also a sad case of becoming a political sacrificial lamb. Its public track record has been dismal. The co was run by ex-bureaucrats "descending from heaven", who are there to enjoy retirement rather than to run a company. Experts warned the company about inadequate measures, both Fukushima and also another nuclear plant that was affected in the past, but were brushed aside. And of course, the most unforgivable mistake: mis-reporting the radiation levels! Man, wake up your idea!

So while the earthquake, theoretically speaking, was a natural disaster and hence Tepco should not be asked to pay for compensation to the farmers and the fishermen, the Japanese govt would likely let it shoulder the bulk of the cost. Not to mention, the govt itself is really tight on budget. It cut the child allowance to raise money for the handling this disaster. Sorry kids, no milk for you until you are 18, and we have to send you to study in University of Heidelberg, where education is free.

But even without the compensation costs, the other big ticket stuff like decommission of the plants, replacement fuel cost and other nitty gritty are likely to put a huge dent into the equity. Assuming the market is correct, these should add up to like USD 20 plus billion, roughly equivalent to the fall in value of its market cap.

For the retail shareholders who held this stock for its dividend, tough luck. Suddenly, almost the entire capital is gone! I guess this truly highlights the risk of equity investing, or rather, any kind of investing. Things can go really, REALLY wrong! Hence it's always prudent to just put money you can afford to lose.

The bigger lesson: diversify. Make some kind of rule, like never put more than x% of your net worth into one investment or something. While it will be difficult to hit the jackpot, at least, if something like Tepco happens, the kids still can have their milk or go to a school of their choice.

With the nuclear story going down the chute, the smart money is pouring into LNG, oil and coal. This is the sad outcome: the world will become a hotter place. Well if we get to tap on more of LNG, it's not so bad bcos it's still the less carbon intensive among the three.

But LNG requires huge infrastructure: the gas pipes, the LNG tankers, the terminals to store them, liquification and gasification equipment etc. It would take some time for Asia and some of the emerging countries to build this up. Meanwhile the LNG stocks have gone to the moon in recent days. Check out Woodside Petroleum of Australia.

I guess in time to come, the world would realize that it still needs nuclear energy. Nothing is as cheap, reliable and scalable in a big way. Hopefully we won't have to wait 25 years after Fukushima. Or we would be wearing a lot more dry-tech T-shirts and using a lot more Ice-Type face wipes!

Saturday, March 19, 2011

A Long Nuclear Winter for Nuclear Stocks

The nuclear industry was one of the sexiest story for 2010. With the BRIC's rising fast, the world's hunger for energy looks insatiable. Renewable energy, bio-fuel, oil sands, nuclear were the buzz words. Nuclear was special though. It's clean, cheap and scalable in a big way. It can contribute 25% to the global grid if the world's govt put in the effort. Some developed countries are at that ratio. France, the No.1 nuclear supporter, is at 70%. Sadly for the world, today it's still a miserable 14%.

Undoubtedly it will go down below 10% in the next 10 to 20 yrs, thanks to what had transpired at Fukushima. Almost every country with major nuclear plans started talking about holding back, including the US, France, UK and India. Germany, a country that had never believed in nuclear after Chernobyl went a step further to expedite the decommission of existing plants that are deemed too old. Finally, a couple of days ago, China the last man standing, decided to review its nuclear power plans.

As for nuclear stocks, which were darlings just a couple of months ago, became dogs. On average, they were down 30%. Some of those most badly affected by Fukushima were down 40-50%. Some are now trading at 10x PE multiple, as compared to at least 15-20x when the story was hot.

I guess the lesson learnt here is one on valuation vs story: never pay for a sexy story. Just like Buffett, he is known never to pay for growth. Value investors should follow Jerry Maguire. Show me the money first. Buffett pays a good multiple for a good franchise, with strong track record but not for concept, nor sexy growth. Well he did buy BYD, but he paid HK$8 for HK$0.60-0.80 earnings ie 10-13x at that time. That's not so bad. You have to give it to him lah.

If you have a hunch for a good story e.g. nuclear or smart grid or cure for cancer, look for beneficiaries but also look at the multiple. If it's 10x, well that's a no brainer, buy. If it's 15x, then you need to ask, okay, is the growth going to be more than 15% and how sustainable is that, 2 yrs or 5 yrs or 10 yrs? If it's 20x, then forget it, even if it makes the growth, you have paid $1 for $1 worth of goods, there is no additional upside.

The nuclear stocks were just that. trading at high teens, the growth was factored in and when Fukushima came about, they cracked, like a Singaporean having a hard time in Mumbai, after drinking its water.

So now is it time to buy nuclear stocks? Sadly, I don't know. Some of them are now 10x, yes that is cheap, but earnings might decline going forward. After Chernobyl, we know the industry is not going come back for a long time. Last count, it's about 25 years. It's a long nuclear winter ahead. Maybe this time we are in a different era, we are really short of energy. Maybe the governments will finally get rational as they know that without nuclear, we are going to make the Arabs very rich and Qaddafi very powerful and that is not good. So they push ahead with their plans for more nuclear power. Well, that is wishful thinking perhaps.

As a last note, it is worth highlighting that for all the unfortunate souls who suffered or died from the effects of nuclear radiation since nuclear came about, the worst impact was not the pain nor the fear of dying. It was actually discrimination, by "normal" people. Imagine telling someone you just met that you are from Chernobyl in 1986 or Hiroshima in 1945. Next thing you know, they are ten feet away and running. Shunned by society, these victims suffered the most at the heart, not the body.

I hate reducing people to numbers, but it tells the story really well. So this is the punchline: The number of victims due to nuclear accidents since the birth of nuclear energy is less than 10,000 in all. In comparison, 20,000 coal miners dying every year. Not to mention the many millions more who get affected by polluted air and water. So should we be shutting down coal mines or nuclear plants?

For a solution that can solve a huge part of Earth's energy problem, Chernobyl and now Fukushima does really have a disproportionately huge negative impact far beyond what the media monkeys can imagine.

Anyhows, for now, let's just hope that our 50 heros at Fukushima can save the world this weekend!

Monday, March 07, 2011

Blue Ocean Strategy

This is the name of a popular book published about 5 years ago that helped improve how the top management of many companies think and how they should come out with strategies to help their company grow.

I started reading this year (yeah, I know...) and found some intriguing ideas that I thought I should share it here. Here are some of those that would really help investors when they do some analysis on companies.

1. Blue Ocean Strategy simply refers to innovations that companies come out with that separate them from the competition. The strategies centre on creating uncontested market space, new demands which was non-existent in the current world (red ocean). This can be done by reconstructing market boundaries by focusing on value-add to end users, combining virtues of different but competing industries or simply creating a new product. The strategy also involve reducing current cost structure while creating new demand thereby helping grow both the topline and the bottom line at the same time.

Some well-known examples of Blue Ocean Strategies would be:

Apple's iPhone (redefining value-add to users)
Apple's iPad (new product, new market)
Nintendo's Wii (expansion of gaming to non-core gamers)
Cirque du Soleil (combining virtue of circus and art)
NetJets (value add of both private jet and commercial airline)
Berries (focusing on fun-to-learn Chinese for English-speaking kids)

2. According to the book, blue ocean strategies are usually not created by new players in the market, nor by technology, nor by big companies. Most companies never continuously come up with blue ocean strategies. The unit of analysis, then, is not a company, nor industry, nor change in technology. The most appropriate unit of analysis is therefore the strategies.

3. Blue Ocean ultimately becomes Red Ocean as competitors catch up. Fat profit margins eventually go down and the whole industry succumb to volume and price competition. ie pursuing profit increase by growing the revenue (usually targeting only single digit improvement) and/or reducing price (by reducing cost and passing on this benefit to clients).

For investors, we should always try to look for companies that are going into wonderful Blue Oceans which they are creating. Companies with strategies venturing in the Blue Ocean ultimately enjoy huge profit growth that are not factored in by the markets. However it may not be easy identifying such companies, hence it is still important to look at the valuation of the stock while betting on Blue Ocean.

This means that as value investors, we cannot buy a Blue Ocean company when the PE is 20x. It goes against the grain of value investing. What if the Blue Ocean turns out to be only a 1 yr phenomenon, then we are pretty screwed bcos when we bought at 20x, and the market is usually discounting a few good years ahead. A good investment strategy would probably be buying into a cheap stock with potential to unlock a Blue Ocean.

However we must also be cognizant that Blue Oceans will ultimately become Red Oceans. Blue Ocean stocks probably see their intrinsic value explodes in the first few years but later plateau out or even decline. This is in contrast with the fantastic Dividend Aristocrats whereby the intrinsic value simply rises over time usually for decades.