Friday, December 11, 2009

Energy That’s Cheaper Than Poultry Litter, Plus Updates

Agora Financial
Agora Financial's Capital & Crisis

Capital & Crisis Hotline -- Energy That's Cheaper Than Poultry Litter, Plus Updates
December 11, 2009


Dear Capital & Crisis Reader,

Last week, I was in New York City for a few days to attend the Gabelli Water Investment Summit and Best Ideas Conference. I got a lot out of both conferences, with much to chew on as a result. I'll share more with you in an upcoming letter. I did get a good update on current holding, Flowserve (FLS:nyse), which I'll get to below. Also found an interesting nuclear story to keep an eye on.

At the Best Ideas Conference, I saw Mark Blinn, Flowserve's new CEO, give a presentation on the latest developments at the company. The Gabelli team thinks Flowserve is worth $147 per share, hence its inclusion in their Best Ideas Conference. That's a more aggressive valuation than I have, but not at all unreasonable.

Flowserve makes pumps, valves and seals. It has hands in all kinds of infrastructure projects that relate to water, chemicals, power generation and oil and gas. These are highly engineered parts for which Flowserve makes good money.

Because the company has its oars dipped in so many waters, it's a good one to follow even if you don't own it. What's happening here can give you a good boots-on-the-ground look at several infrastructure markets.

Looking at power generation, Blinn said this was the promising part of the business right now. There is a lot of activity, mostly in emerging regions as the company builds electric power plants and grids and connects it all to end-users. Blinn mentioned two hot areas that create more work for Flowserve: China and India's expansion of nuclear power and the drive toward renewable energy sources. (More on the supposed "nuclear renaissance" below…)

In oil and gas, investment has slowed overall. In some patches of the oil and gas sector, investment continues to grow -- Blinn mentioned tar sands, deep water and heavy oil. He also mentioned the expansion of liquefied natural gas as another opportunity.

The chemical sector remains weak, but there are some new projects, again, in developing regions. In particular, there is strong demand for agricultural chemicals.

In water, Flowserve has many opportunities. Blinn cited the familiar statistic that one out of six people don't have access to clean, safe water. Water-stressed regions, such as those in the Middle East, are prime areas for investment. Desalination projects -- which turn seawater into fresh water -- are another area where Flowserve is seeing a lot of work.

Overall, there still seems to be a lot of activity in infrastructure, though it is still down from a year ago. We'll hang onto Flowserve yet. The stock is no longer the great bargain it was when we bought, but there is enough potential upside here to hang on.

*** The Nuclear Renaissance

As to the nuclear renaissance, one of the companies at the conference was Scana Corp. This is an electric and natural gas utility operating in the Carolinas and Georgia. But what makes Scana interesting is that it's building a nuclear power plant. It may be the first to complete construction and operate a nuclear plant in nearly three decades in the U.S.

Why build a nuclear plant? As CEO Bill Timmerman put it, "because it's the cheapest to run." He showed us this chart below:

"Busbar" is an industry term. It measures the cost of producing electricity per kilowatt hour. As you can see, nuclear is cheap. It's cheaper than poultry litter, which is interesting, as I hadn't much thought of poultry litter as a fuel source before. More importantly, it's a lot cheaper than coal or wind or solar.

The AP1000 system is the one Scana hopes to finish. It hopes to have two, in fact. Timmerman added, "That's the extent of the nuclear renaissance in America." In China, they are building 100 of the AP1000s. That's a pretty big disparity.

Timmerman also aimed to demystify the nuclear plant. "This is not rocket science," he said. "It's concrete and steel and welding… These plants are real. These plants are going to get built."

Scana itself pays a 5.2% dividend and trades for 12 times earnings. It trades under the ticker SCG. The Gabelli team puts the private market value at $44 per share. It's an interesting story and one I plan to follow.

*** Tsakos Energy Navigation to HOLD

Although Dubai got a lot of ink in recent weeks for its unfolding debt crisis, Greece has debt problems, too. It is the Greek crisis, though, that is more important for investors. That's because
Greek shipowners operate about 20% of the global shipping fleet.

So as ratings agencies downgrade Greece, as they have done, the creditworthiness of Greek shippers also takes a hit. A company cannot have a higher credit rating than its sovereign. If Greece is a junk credit, a Greek shipping company cannot be investment grade.

The credit rating hit is important because it raises the cost of capital for Greek companies. When a Greek shipper goes to borrow money in the public markets, it'll pay more for it because Greece can't get its act together. Since the global shipping fleet depends on credit to build and buy new ships -- and has quite a bit of debt -- this could be a problem.

Also, the Greek crisis is important because Greece is a member of the EU. So the question becomes, does the EU bail out Greece? It is the first real test of unity for the EU and its monetary experiment, the euro. My bet is that the EU comes to Greece's aid, but we'll see.

Back to shipping…

We own Tsakos Energy Navigation (TNP:nyse), an oil tanker company. Though it operates all over the world, it makes its home in Athens, Greece. We're down big on Tsakos, as the price of oil collapsed and shipping rates went with it. (The stock market crash in 2008 didn't help either). Yet TNP's stock has not rebounded much from its lows -- up only 30% from its March low. Mostly, this is due to worries that there are simply too many ships and too many new ships on order.

The tanker market, though, seems to have bottomed. Last week, CEO Nikolas Tsakos, was on Bloomberg TV. He pointed out how the market has improved:
"After the seasonally very low second and third quarter, we have seen the market rebound to healthy rates. We are far away from the hundreds of thousands of dollars a day that we were making just 24 months ago. But at least they are in the tens of thousands of dollars, so [tankers] are easily covering their operating expenses and [this also allows] profitability to be maintained. So I think it looks that we have weathered the storm, the worst of the storm so far."
Tsakos has its share of debt. When asked about TNP's balance sheet, Tsakos said: "Our balance sheet is a very healthy balance sheet. We have close to $350 million in cash…" He also said that this put the company in good position to make an acquisition. TNP had $1.5 billion in long-term debt as of its last quarter. This debt is really made up of many smaller notes, tied to ships, like a mortgage is tied to real estate.

It recently announced it would sell 3 million shares of stock and raise up to $300 million in debt to expand its fleet. I'm not sure I like that. It's true that the Tsakos clan has done this sort of thing before. They expanded during the Asian Crisis in 1997 and again after Sept. 11. Times of crisis are when ships are cheapest. It's been a successful formula for Tsakos for many years. Still, it feels risky to me.

For all the reasons above, I'm putting Tsakos at HOLD for now.

*** More on Dubai

Peter Cooper is a journalist who has lived in Dubai for 15 years. When I traveled in Dubai, Peter was my chief guide, and a very good one. He seems to know everybody and has a local's deep knowledge of how the city works. I wanted to share some notes from Peter, which mostly echo my sentiments on the region:

"The Gulf region is still a buy… [It has] cheap feedstock for local industries like petrochemicals, which are receiving massive investment right now in the region. Then there is the low or no taxation status to lure multinationals… Historic returns on equity in the region have been around 25%, far above anything obtainable in the so-called advanced economies, and higher than the 10-15% average for emerging markets.

"Dubai is the commercial, trading, transportation and financial hub of the Gulf region, so it is bound to be a leveraged play on the success of the region. It exaggerates the ups and, as we have seen over the past year or so, also the downs…Other regional cities might have pretensions to copy Dubai, but they lag a decade or more behind in infrastructure, and perhaps a hundred years in business thinking. So for those with a strong stomach for real capitalism, Dubai will be the place to invest for the future."

You can find more of Peter's commentary on his blog at .

*** Other Notes

Hopefully, you've had a chance to review the last issue. I thought it tackled a few important ideas. The first being the ongoing work of the Great Convergence, which is a convenient handle to describe the process of how the emerging markets have caught up with Western countries. This process will continue to dominate the investment landscape for years to come.

We also added a new holding, Griffon Corp. (GFF:nyse), a cash-rich conglomerate with a few good businesses under its wing. Griffon meets all of our CODE requirements. Last week, Griffon received a $17 million contract from Lockheed Martin for radar systems on the MH-60R strike helicopters.

I look forward to some good results out of Griffon, even in a rocky economy.

Gold stocks have taken a beating of late, after a very hot run for the most of the year. This doesn't change the story, and I expect gold miners will make another run for in 2010. Hang onto your shares of IAMGOLD (IAG:nyse).

Shares of Gulfport Energy (GPOR:nasdaq) had a very good week. It picked up another analyst upgrade this week. I think we'll see more of the same in 2010 as people latch on the story again and as Gulfport gets closer to producing out of its Grizzly Oil Sands investment.

Also, shares of Ensco (ESV:nyse) have pulled back quite a bit after hitting $50 per share. This is one I'm actually considering upping to buy again. There is still a lot of potential here, especially as it puts its deep-water assets to work. Ensco has a super clean balance sheet and the stock is still cheap even after nearly doubling.

Have a good weekend!


Chris Mayer

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