Unconventional ideas can yield better returns
Investors should regularly look for an edge that will give them an edge in a relatively efficient market, and this is especially true for those who want to beat the market in these very unusual economic times.
Interest rates are lower than ever before, with current benchmark fed funds rates just 0.25%. Separately, it appears that inflation is no longer just a risk, but now a grim reality. The Bureau of Labor Statistics reports that prices rose 6.2% in October, the largest annual increase since 1990, due to supply chain and labor shortages as well as rising prices. energy prices. Gasoline prices are up nearly 50% from a year ago, with a national average of around $ 3.50 / gallon. And it’s not just gasoline. Most commodities have also recovered over the past year.
Looking at all of these signs, it seems obvious that there really is no other place to go than higher interest rates. At the start of the month, US GDP growth was around 6.7%, with an unemployment rate hovering around 4.8%. High yield debt default rates have fallen to record highs, due to massive government support in response to COVID.
Fortunately, the economy has recovered, but not completely. The government has certainly done the right thing in providing fiscal and monetary support, but much of this stimulus appears to be continuing well beyond the planned timeline. And with that, we are seeing significantly higher inflation, as the most recent figures show.
And while default rates have fallen dramatically due to massive fiscal and monetary stimuli, we are seeing some great investment ideas among previously struggling companies. This “post-distress” equity investment opportunity includes both public and private companies.
There are many companies that we can use to illustrate what happens to those who have successfully come out to the other side of distress. Two of these are the post-distress stock of Alpha Metallurgical Resources (NYSE: AMR) and the post-distress stock of Chesapeake Energy Corp (NASDAQ: CHK), both of which have benefited significantly from the price rally. raw material.
AMR is a metallurgical (“met”) coal miner that emerged from a reorganization in 2016 after eliminating approximately $ 7.8 billion in debt. In 2018, its predecessors merged to form the largest American coal producer encountered. In addition to enjoying a healthy balance sheet, it also has significant tax assets (around $ 1.7 billion), which will offset future cash taxes for many years to come. Going forward, most industry analysts expect coal prices to continue to recover. On the cost side, AMR management reduced costs (by about $ 20 / tonne) through workforce reductions, increased productivity and by replacing some high-cost mines with lower-cost alternatives. During the third quarter, they were successful in reducing long-term debt and legacy liabilities by over $ 75 million. Despite these achievements, as well as the company’s advantageous positioning in the face of growing demand for steel, AMR is trading at just 1.55x TEV / EBITDA 2022.
CHK, on the other hand, is a low-cost natural gas exploration and production company. One of the largest E&P companies in the United States, it has interests in world-class natural gas resources in Pennsylvania, Louisiana, Texas and Wyoming. He emerged from bankruptcy in February 2021, simultaneously wiping out around $ 8 billion in debt. The restructured company has a strong balance sheet designed to generate sustainable free cash flow, a disciplined capital reinvestment strategy and a commitment to ESG excellence. CHK management anticipates approximately $ 3 billion in free cash flow over the next five years and plans to maintain the strength of the company’s balance sheet (under 1.0x leverage).
During the third quarter, CHK management announced a transformative acquisition to acquire Vine Energy (NYSE: VEI). The deal, which was zero-premium, immediately generated free cash flow and added ~ 370 premium locations in the Haynesville Basin with an MMR> 50% at $ 2.50 / MBTU of gas. Notably, Haynesville is a critical source of natural gas supply for the large and growing export market for liquefied natural gas. Finally, management expects the combined company to achieve annual savings of around $ 50 million, given that the two companies were already operating side by side.
In addition, CHK management also announced an important new capital allocation framework to accelerate cash distributions to shareholders. The company already had an annualized dividend of $ 1.375 / share, as noted above. After the closing of the Vine acquisition, it rose 27% to $ 1.75 / share. In addition, they also launched a new variable dividend, which will distribute 50% of all quarterly free cash flow to shareholders. This exciting new dividend catalyst was the main event for CHK stocks to recover during and after the third quarter. However, at 3.13x the pro forma TEV / 2022 EBITDA, the stock is indeed cheap.
In the examples cited above of companies that have recently emerged from distress, both are commodity companies well positioned to do well given current macroeconomic inflationary trends. By 2022, there will be many more event-driven and troubled investment opportunities due to (a) massive issuance of low-quality debt securities and (b) rising interest rates . We are already seeing signs of potential opportunities among Chinese real estate companies. In contrast to restructuring, once companies are out of distress, they are sometimes publicly traded and sometimes private. Thus, a flexible approach between these two types of investments can double the set of opportunities.
The current market is highly unusual with interest rates so low, inflation rising and markets near record high post-COVID highs. As a struggling investor for almost 30 years, I know that different periods of the business cycle often present unique opportunities in different industries. These can be very rewarding if you are patient and work with the right specialist to find and capitalize on these investments. However, it is important to keep in mind that troubled investing is a highly specialized strategy and not recommended for inexperienced investors.