DIY Profits

In This Issue: DIY Profits YieldCos: Let the Buyer Beware Trans-Atlantic Differences No More Guessing Two years ago, we started testing a new investing system. It made 58% more money than its benchmark. So now we're taking it public. The beautiful thing about this system is that it takes every scrap of guesswork and every iota of emotion out of my investment decisions. You can use our formula on any day and on any stock and you'll know if it is time for you buy it, sell it or do nothing. That's a priceless feeling of confidence. If you can use a simple tool like this to make better decisions about when to get in and out of a stock, why not use it? DIY Profits 12/05/2014 By Benjamin Shepherd The European economy is hardly booming, with the European Central Bank recently halving its growth forecast for 2014. The bank also drastically reduced its outlook for next year, now saying the region's economy is likely to grow by just 1% rather than the previously forecast 1.6%, and believes the new reduced rate might even be overly optimistic. With that weak economic backdrop, this wouldn't seem like an ideal time to start looking at European home improvement retailers. When the US fell into its own recession, shares of Home Depot fell by more than 50% thanks to a plunging real estate market and rising unemployment. The nature of the European crisis is a little different though. While their woes may have begun because of a contagion effect of our own crisis, at this point the region has largely worked through the housing aspect of the troubles. In fact, rather than focusing on keeping people in their homes, some countries are actually incentivizing sales. In the United Kingdom, for instance, after home prices are once again on the rise after dipping slightly in September and are expect to be up by as much as 7% in some areas of the country. Earlier this month the British introduced a drastic reform to their Stamp Duty Land Tax system, wiping out a rigid system of pricing bands in favor of a more progressive system which results in those buying lower-priced homes paying significantly less in taxes. The move is expected to create many first-time buyers and a wave of upgraders -- people moving up to the next price rung as they buy larger properties -- and give the U.K. property market a boost. That was bound to be encouraging news for executives at Kingfisher (London: KGF, OTC: KGFHY), Europe's largest home improvement retailer and the third largest globally, trailing America's Lowe's Companies (NYSE: LOW) and Home Depot (NYSE: HD). It operates nearly 1,200 stores in 11 European and Asian countries. The company's profits in the U.K. and Ireland were up 11.1% in the third quarter, even before the recent tax changes were introduced. With a wave of buying in lower-end properties likely imminent thanks to lower taxes, a resilient housing market and generally stronger British economy, the company's performance in the region is likely to only strengthen from here. Granted, the picture isn't quite as rosy in France, the home improvement chain's other major market. Third quarter earnings there fell by 14% in the quarter due to the generally weak economy and recent legislation there that, among other things, capped rents and slowed investment. The French government appears to have seen the error of its ways though, announcing in November that the rent caps would only be applied on an experimental basis in some of Paris's most expensive neighborhoods. It also said that landowners who sold property before the end of next year would get a massive 30% break on capital gains taxes in an effort to spur property development. Most watchers expect those changes to result in marked improvement in the French property market next year. That makes it likely that Kingfisher will catch a tailwind next year, good news for what is already the region's strongest DIY chain. The company has focused on selling common products across all of its major chains (B&Q and Screwfix in the U.K., Brico Depot and Castorama in France), and aims for 50% of sales to be its own common brands. As a result, most of the company's products meet the safety standards of each market it operates in while helping to keep costs in check. As a result, it generally shows better returns on both assets and equity than most of its European peers with solid operating margins. The company is also extremely attractive on a valuation basis, trading at just 13.8 times trailing earnings. By way of comparison, the company's own 5-year average PE is 25.4 while the industry as a whole is trading at 22.6 times, a figure largely skewed by its American counterparts. So while the third quarter was challenging to say the least, with revenue down 3.6% to $4.4 billion and profits down 11.8% to $350.5 million, it should get a boost in the quarters to come thanks to helpful government policies. Granted, this is a higher risk play since it is possible the European economy could continue to worsen, but with shares trading near a 52-week low and yielding nearly 3%, there is substantial upside potential even if the region just holds its own. Kingfisher is a great European turnaround play up to $14. Have Your Cake and Eat It, Too… My pick, chosen several years ago, has been paying a dividend averaging 7%. At the moment, it's taking a rest at 5.3% – because the company behind it has just put over $1 billion into a new technology that will drive a triple-digit growth upside. We've landed 70% in gains since we first recommended this pick in 2012. But this latest development will achieve new heights that are sure to please investors. Become one of them – it's not too late. YieldCos: Let the Buyer Beware 12/04/2014 By Richard Stavros The latest YieldCo spinoffs continue to underwhelm, much like their recent predecessors. And the small size of these companies could eventually make them more akin to "RiskCos," since they'll ultimately need to compete against much larger firms. While YieldCos do initially offer enticing yields, as their name suggests, investor enthusiasm has pushed prices for these securities higher, resulting in a situation where many YieldCo stocks currently yield less than those of larger, more stable utilities. Utilities created YieldCos as investment vehicles for operating assets that generate steady, low-risk cash flows, particularly from renewables, since current law precludes them from being dropped down into a master limited partnership (MLP). But YieldCos don't offer the same tax-deferral benefits as MLPs since their payouts are generally taxed as dividends. Furthermore, while MLPs enjoy minimal taxation at the corporate level, YieldCos will only be shielded from taxation at the company level for the initial five- to 10-year period during which their net operating loss carryforwards can be used to offset taxable income. That's a key distinction because favorable tax treatment at the corporate level helps support a sizable payout. So with one or two exceptions, I've concluded that most income investors should probably steer clear of YieldCos. But their allure has grabbed headlines once again, with First Solar Inc's (NSDQ: FSLR) decision in early November to abandon its plan to develop a YieldCo, a reversal that sparked a sharp selloff in the company's stock. At the time, First Solar CEO James A. Hughes said he believed the firm was not "missing either gross margin opportunities or market share capture opportunities because we don't have a YieldCo today." We're inclined to support Mr. Hughes' decision because long-term contracted assets typically provide a level of diversification and safety for companies while they pursue new business opportunities that can incur greater risk. In other words, it's prudent for most companies to keep steady, income-producing assets in house, rather than carve them out for short-term gains from financial engineering. Nevertheless, First Solar has paid a hard price for its stance, and the company's shares are now down 17.5% from their close prior to the announcement. Though conspiracy theories always abound at finance conferences, the buzz at the Edison Electric Institute Financial Conference, an event I attended last month where the investment community meets with energy companies, was that First Solar was being made an example. Certainly, when I met with Mr. Hughes at the conference, he seemed as perplexed as I was about the stock's selloff. After all, as Mr. Hughes pointed out, the firm has a more extensive pipeline of projects than in years past. And from surveying some of my contacts among utility executives, First Solar is one of the most well-regarded solar developers in the utilities space. I do hope that what First Solar has suffered does not dissuade other CEOs from saying no to developing what, at this point, seems like a faddish investment. Because the problem with YieldCos could be fixed if Wall Street and some corporate chieftains would just pay closer attention to what investors actually want. YieldCo Price Performance Source: YCharts Building a Better YieldCo Although some in the power industry clearly hope to unlock greater value from dependable, income-producing assets, just as has been done with MLPs, no company wants to do this at the price of putting the parent company at risk, or by creating a risky subsidiary that could fail. Therefore, YieldCos must be developed with sufficient size and scale to rival electric utilities or super MLPs. Size is important here because while YieldCos can rely to some extent on asset drop-downs from their parent companies, they will eventually have to compete for new income-producing assets against larger, better-capitalized energy firms. And YieldCos--like MLPS--must be given similar tax benefits along with the corresponding obligation to pay most or all of their distributable cash flow to shareholders. While some argue that not having this obligation affords firms greater financial flexibility, I believe such a rule would enforce discipline on management teams to remain focused on income-producing assets. As they're structured presently, YieldCos also have significant governance risk. For example, according to a report by Moody's Investors Service, many YieldCo senior officers hold similar positions at their parent companies. As I've written in the past, non-arms-length transactions can be a recipe for disaster, given examples from the recent past where parent companies negotiated advantageous agreements at the expense of subsidiaries. In some cases, the parent company even dumped non-performing assets into a subsidiary or off-balance sheet partnership to improve the optics of the legacy company's financials. The question here is how to know whether the YieldCo is getting a good deal on an asset, when the parent company's management team essentially controls the terms on both sides. To ensure such deals are better aligned with shareholder interests, investors should demand that YieldCos have their own independent management teams. Of course, I'm probably wasting my time in proposing such improvements, even if they help illuminate YieldCos' shortcomings. After all, some of the more cynical analysts believe that YieldCos are nothing more than vehicles to enrich corporate management teams and earn fees for investment banks at the expense of investors. That's at least somewhat evidenced by the skeptical tone in a recent report from Moody's entitled "FAQ: Global Credit Implications of YieldCos." Though the bond-rating agency acknowledges there is a rational argument for YieldCos attracting premium valuations, they doubt such premiums will persist over the long term because the current YieldCo structure can only support several years of dividend growth. Moody's says that of the three ways that YieldCos could theoretically sustain dividend growth, the only one that's feasible over the long term is acquiring new assets through the judicious use of debt. And when growth inevitably slows and valuations fall, YieldCos will no longer offer companies a cheap way to raise capital, and their appeal will largely wane among investors and utilities alike. But give the power industry another five to 10 years, and it will eventually come up with another faddish spinoff strategy to raise easy money from existing assets, just as it's done previously. Subscribers toUtility Forecasterreceive the full update, which lists those companies best positioned to benefit from the YieldCo trend. This article originally appeared in the Utility & Income column. Never miss an issue. Sign up to receive Utility & Income by email. The Tiny $5 Company That Could Turn $10,000 Into $214,290 I've found a tiny $5 tech stock that has its sights set on a $10 billion pocket of the massive Internet market currently up for grabs. It holds 500 patents and has another 400 pending. When you see how it's maneuvered itself to ensure victory, I'm sure you'll be impressed. And when you find out how much money you can make from it, I know you'll want to pick up shares right away. Don't delay. This situation is moving with lightning speed. I'll give you all the profitable details here. Trans-Atlantic Differences 12/05/2014 By Jim Pearce I was struck by the seeming incongruity between two news announcements this week. On Thursday the president of the European Central Bank, Mario Draghi, announced that the ECB was not yet ready to implement aggressive stimulus intended to nudge interest rates higher in Europe to avoid deflation. Meanwhile, here in the U.S., our Congress is working hard this week to hustle a $42 billion package of tax breaks through the House before heading home for the holiday recess. In the overall scheme of things the American tax breaks may add up to peanuts compared to the potential consequences of European monetary policy, but it does illustrate the extent to which the fortunes of the two continents have diverged since both were mired in "The Great Recession" not that long ago. However, it would be nave to think that the two economies have become disconnected. The U.S. needs Europe to get healthy, as it is a major trading partner and is the manifestation of western influence on the other side of the ocean. The Europeans have gone so far as to introduce a negative interest rate on money held by commercial banks overnight at the central bank in hopes of inducing them to lend that money out to businesses that will in turn invest it in new infrastructure and hire more employees. If there are any doubts about the efficacy of supply side economics, those questions will soon be answered. And if there was any question about our elected officials being able to resist the temptation to extend tax breaks to a wide variety of constituents and special interest groups, well, I guess that never really was a question to begin with. It is estimated that approximately one in every six U.S. taxpayers will in some way benefit from these tax breaks, so hopefully you will be one of the lucky 17%. If not, then you will be one of the unlucky 83% that is indirectly subsidizing a miasma of federal assistance for the movie industry, racetrack owners (both cars and horses), and liquor producers, among other things. To be sure, there are some worthwhile beneficiaries included in this effort. I'm okay with tax credits that encourage research and development since that should eventually result in a higher GDP for our country. But I'm having trouble ginning up much enthusiasm for an exemption that allows banks and brokerage firms to avoid paying taxes on foreign profits, even though just about everyone else has to. I also don't object to giving a tax break to teachers who use their personal savings to buy classroom supplies for their students, since that can also be viewed as an investment in America's future financial security. But I'm less sanguine about tax breaks for wind farms and other highly inefficient sources of renewable energy. Recently the price of oil has dropped below $70/barrel after topping out above $100 less than six months ago, so what's the hurry? When governing bodies step in to introduce tax breaks or inject artificially cheap money, it has the effect of skewing the workings of the free market in ways we cannot predict. For all we know the solution to the "energy crisis" -- to the extent there really is one -- is something other than wind, biofuels, or solar. In fact, it may not be a direct source of fuel at all; it could be better technologies that decrease the need for energy altogether, or something else entirely that is presently unforeseeable. What I do know is that if you distort the true supply and demand relationship of something by throwing enough of other people's money at it, you can temporarily create the illusion of financial justification. In the long run that is the greater folly than not subsidizing it at all, as wasting time and money going down a blind alley while a competitor is pursuing the correct economic solution is the surest way to gradually slide down the global pecking order. At first glance all of this may appear to be nothing more than a case of one governing body exercising discipline in the face of mounting adversity, while another governing body lacks the discipline to discontinue tax breaks that, for the most part, are no longer necessary to stimulate an already reinvigorated economy. And if that's all this really is, then at least I have the comfort of knowing that some of my hard earned money is going to support rum manufacturers in the Caribbean. C'est la vie. This article originally appeared in the Mind Over Markets column. Never miss an issue. Sign up to receive Mind Over Markets by email. We Trade Just Once a Week… And we win 8 out of 10 option trades. We rake in gains of $2,300… $1,150… and $4,550… week in and week out. The average trade lasts just 134 days. Our put spreads do even better – winning 9 out of 10 times! What's our secret? Simple. We NEVER BUY a single option. Find out our winning trade secret here. You are receiving this email at benjamart.ss.stock@blogger.com as part of your subscription to Investing Daily's Stocks To Watch, published by Investing Daily. To ensure delivery directly to your inbox, please add postoffice@investingdaily.com to your address book today. 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