Oh boy... Here we go again... Longtime readers may recall my satiric "letters from the chairman" of General Motors. I was predicting the obvious: The company would surely go bankrupt. It was truly obvious, too. The company couldn't even afford its interest payments, much less the health care expenses and union wages it had agreed to pay. As soon as the company's debt was downgraded, its borrowing costs would rise, its access to capital would be constrained, and it would go bankrupt. There was no way out. However, the cold water of reality took a few years to sink in. When I first recommended shorting the stock, it was still trading for nearly $40 per share.
I told you on July 17 we might soon be publishing "letters from the chairman" of another, iconic American company – General Electric. Judging by today's quarterly report, I think the verdict is in...
GE says it "brings good things to life," but in fact, over the decade, it has mostly been about bringing good debt to life. For many, many years, GE relied on its triple-A credit rating to borrow money cheaply in the 30-day commercial paper market and then lend it out at a much higher rate, via things like credit-card receivables. These kinds of financial strategies worked well during the debt-financed boom of 1995-2008. They don't work anymore. In fact, without a government guarantee backing its debts, GE would have already gone bankrupt.
Here are the core facts: GE owes its creditors $518 billion. That is not a misprint. It owns tangible net assets of only $17 billion. Thus, on a tangible basis, it is currently leveraged by more than 30-to-1. That's unheard of for a major industrial company. A 3.3% decline in the value of its asset base would wipe out all of its tangible equity. But here's the real problem. Last quarter, the company produced $2 million in operating income. Again, that's not a misprint. On $17 billion in assets, the company earned only $2 million. So... what will happen to GE if (or when) the free market sets its borrowing costs?
GE spent $4.3 billion on interest in the last quarter – thanks to the government's guarantee. So on an annualized basis, GE is now spending roughly $17 billion to service its $500 billion in debt. That's an annualized interest rate of 3.3%. This is not sustainable. Sooner or later, GE is going to have to pay a market interest rate.
Currently, the yield on high-yield corporate debt is around 10%. GE is now rated two slots above "junk" by Egan Jones, the only reliable ratings agency. So let's assume GE could still qualify as an investment-grade credit – which is a generous assumption. GE would pay something like 8% on its debt in a free market. That would cost more than $41 billion a year. Last year, GE earned $45 billion before interest and taxes – in total. It spent $33 billion of these profits on capital expenditures and necessary investments – expenses required to keep the business going. That left it with about $12 billion in what we call "owner earnings." That's not nearly enough money to pay the interest on its debts – whether they're backed by the government or not.
Imagine if the interest on your mortgage consumed 91% of your pre-tax earnings. Could you possibly avoid bankruptcy? No way, right? But... there's a big difference between owing the bank a few hundred grand and owing folks more than $500 billion. Last year, even though GE couldn't actually afford its debts and required a government bailout, it spent $12.4 billion on dividends for common stock holders. That's 20% more than it spent on dividends in 2006! (GE finally cut its dividend by 70% in February. It will be eliminated soon, I promise. Its creditors will finally wake up and demand it.)
Today the stock market values GE at $171 billion. In fact, the common stock – every single share – is not worth one penny. Plan accordingly.
A very old friend of mine likes to say: Too soon old; too late wise. It is very difficult to acquire investment wisdom, and by the time you've lived long enough to acquire some of it, it's usually too late.
Chris Weber is one of the wisest people I've ever met. In his last issue, he wrote something I found particularly profound. If you've been around the block a few times, I think you'll recognize how true this really is:
The lesson of travel and studying history is to never expect things to go on as they have been in the past. Never get complacent. Always expect change. And more important, prepare for it. There is an investment lesson in this too. The only thing you can count on is that things will change. The asset classes that people valued in one generation will be laughed at the next. And the opposite is equally true.
Our new analyst – Braden Copeland – is hitting the ball out of the park this year in our Inside Strategist newsletter. Most people don't know Inside Strategist was one of the few advisories anywhere that actually produced a profit in 2008 – a year most people saw their portfolios cut in half. And this year, readers of the letter have enjoyed big gain after big gain: More than half of Braden's recommendations have already gone up more than 15% and four are up more than 35%. His biggest is up 120% since the end of April.
And I think his latest pick will be his best: The CEO of a cash-gushing, yet little-known medical company has made five different purchases of his company's stock between August 18 and October 7, increasing his stake by nearly 20%. And his most recent purchase, also his largest, came less than three weeks before the company's third-quarter earnings announcement.
You can bet we'll see a huge pop in shares of this medical company, making millions for the CEO and anyone else who buys shares before the earnings announcement. Braden told his readers all about this stock in his latest Inside Strategist. With any luck, we'll see a triple-digit winner before yearend. To sign up for Inside Strategist – which only costs $4 per week – and access Braden's latest trade, click here...
In Monday's Digest, natural resource expert Matt Badiali told readers about ExxonMobil's latest deal – a $4 billion investment in the Jubilee field offshore of Ghana – and how Exxon paid 10 times more than normal to gain access to this field. "Clearly, Exxon either thinks Jubilee is much larger or it believes oil prices will average higher over the next few years," Matt wrote.
It turns out, ExxonMobil may maintain its title as the shrewdest operator in the oil business...
A recent exploration well two miles east of Jubilee hit more of the same oil and gas reservoir. Oil experts think it is part of Jubilee, and the field will hold well above the upper-end estimate of 2 billion barrels of recoverable oil. Assuming Exxon is shooting to pay its historical average of $1 per barrel, Jubilee could be a 20 billion-barrel field – a "monumental" discovery in Badiali's words.
That would make it bigger than the Tupi field, the massive deepwater discovery off the coast of Brazil. This discovery could mean huge gains for all three companies involved: ExxonMobil, Anadarko, and Tullow Oil.
When asked if the dollar will lose its status as the world's reserve currency at The Economist Buttonwood conference in New York this week, hedge-fund manager George Soros paraphrased Winston Churchill, saying, "The dollar is the worst currency except for all the alternatives."
He also noted, "There is a general flight from currencies." The world is finally waking up to the fact that the dollar is doomed... And a "flight from currencies" means money should be – and is – flowing into the world's best currency, one that is nobody's liability... gold.
Biotech stocks are some of the most volatile in the world, which is why they can make people rich... We've already witnessed a number of 10-baggers this year, and finding only one of these could easily pay for your retirement.
If you're interested in biotech, S&A FDA Report Editor George Huang has uncovered what could be one of the highest-returning stocks of the year. He's recommended a company that could release all-important Phase III data for its lung-cancer drug any day now. If results are positive, shares will double.
But he has an even better trade than buying the stock outright... a way to make bigger returns with less risk. George expects this trade to return more than 200%. But you have to act quickly before the data are released... To learn more about the S&A FDA Report and George's latest trade, click here...
New highs: iShares S&P Index ETF (IVV), iShares Hong Kong ETF (EWH), Morgan Stanley Emerging Markets (EDD), Patterson-UTI (PTEN), Visa (V), Amerigas Partners (APU), Enterprise Partners (EPD), Kinder Morgan Energy Partners (KMP), Coca Cola (KO), Microsoft (MSFT), Longleaf Partners (LLPFX), POSCO (PKX), Automatic Data Processing (ADP), Portfolio Recovery Associates (PRAA), Sprott Resources (SCP.TO), WD-40 (WDFC), 3Sbio (SSRX), Rex Energy (REXX), Encore Acquisition (EAC), International Tower Hill Mines (THM).
In the mailbag... nada. Not much mail recently. Send us something. Here's a topic: What's the most valuable business lesson you ever learned? How did you figure it out? You can tell us: feedback@stansberryresearch.com.
"I am not one of the rich guys but i do see extreme value in what you say. I am very concerned about where our country is headed. Especially with the devaluation of the dollar. You mentioned a while back that we are better off in some foreign countries like Argentina and Panama. If I moved their within the next few years will I be better off against the huge inflation that the U.S. will undergo?" – Paid-up subscriber Andres Acuna
Porter comment: If you can find a way to generate income in a sound currency, while living in a country with a weak currency (like the USA or any of the other banana republics in South America) you can live very, very well. I remember back in 2002/2003 right after Argentina's big crisis. The U.S. dollar was still strong, but the Argentine peso had fallen from parity to 4-to-1 to the dollar. Friends of mine were buying $5 million apartments in Buenos Aires for $125,000. These were truly trophy properties, too. Traveling down there was incredible: We had a steak lunch, served outside at the best restaurant in this little town in Salta province. Including good wine, the entire bill came to $2.45 per person.
So yes, you can use currency devaluations to your advantage, if you're able to generate income in a strong currency, while keeping your debts and expenses denominated in a weak currency.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
October 16, 2009