It has been a profitable August with some important developments, both domestically and abroad. Second quarter GDP data came in fairly strong, a little over a month ago, however, we do have some concerns. A significant portion of the GDP rise was clearly driven by a significant increase in food sales and, in particular, soybeans. Looking at soybean futures over the last six months there is discernible trend in the downward price movement. This is due in part to an increase in supply that flooded into the market. In the preceding months, soybean farmers increased their output in an attempt to hedge their imminent losses by “beating the clock” on tariffs (which are now in effect) that China announced it would impose. A 25 percent tax on these goods is significant for soybean farmers, as they generally have small profit margins to begin with. Fortunately, the Trump Administration seems to be aware of this collateral damage in this industry and announced a $12 billion program to help stabilize the farmers in the short term.
One of the more noticeable impacts of last December’s tax cuts is the amount of increased corporate buy backs. This helps provide buying pressure on a company’s stock. This process of large, increasing buyback programs announced by companies, is consistent with an economy that is in the later stages of growth. I believe when we look back at this period, we will point to the tax cuts that allowed the markets and economy to extend its growth period another year or two. There has been an unprecedented run in the stock market over the last nine years; we are now in the second longest bull market in our history—surpassed only by ten years during the 1990s economic expansion.
Turning to more local developments, we would like to update you on some of the things happening at our firm. First, as we mentioned previously, we have recently expanded our relationship with Fidelity, one of the leading custodians and investment firms in the world. This will allow for more efficiency and improvement with your interactions with us. We now have direct access to their advanced trading desks, allowing for real-time buy and sell investment decisions. We were also able to reinvest some of the savings from our older contract back into the business. Approximately 20 days ago, we signed our contract to begin using the famous Bloomberg terminal. Having access to this industry-leading analytical and information tool will allow us to process information and perform analysis much faster. The Bloomberg Terminal will also allow us to take full advantage of proprietary market information. As an example, for our bond investors, we are now able to buy and sell bonds with nearly anyone around the world. We have more access to a greater inventory of bonds while also being able to have more competitive prices, since we are no longer reliant on buying bonds through third party traders. It is a very exciting time here and we are very grateful to have you along with us for the future.
Lastly, upon feedback from our clients over the last year we have decided to make a small change to how we allocate funds when a client initially comes on board. There were questions on how much, and for how long, we would carry a cash or money market position with the allocation strategy based on a 1.5 percent allocation for an investment. As fiduciaries we have a duty to maintain diversified portfolios for our clients, reducing unsystematic risk. It would therefore take some time to get an account fully invested. Some clients had concerns they were not generating returns beyond the 0.6% annual yield that the money market account was producing. Fortunately, thanks in part to our stronger relationship with Fidelity, we now have access to a host of commission free exchange traded funds (ETFs). This will allow us to make immediate, profit-generating investments when bringing onboard a client and, as we find initial positions, we will sell their positions in the ETFs and replace them with “permanent” investment instruments. The initial allocations will be tailored to each client’s investment goals and risk tolerance. We are excited by this development and want to thank you for all of the feedback you have provided.
Please review the following updates from some of the existing positions that we manage:
Called/Redeemed early bonds (TCCA, TCCB, GAINN and WHFBL) – As we mentioned briefly in the July letter, we had several bonds get called and redeemed earlier than expected. This is performance neutral but we would have preferred to keep some of these bonds longer. As long-term interest rates continue to go lower (ten-year Treasury bills are currently at 2.82 percent), while short term interests go higher (due to the Federal Reserve raising rates, which will likely happen again in a few weeks), it becomes more difficult to find quality companies to invest in at respectable target yields.
B Riley Financial Bond maturing October 2021 (RILYL) – We are very pleased with how this company has performed since we initiated our position. This past quarter they set records for net income and adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) while also maintaining a good balance sheet. According to management in the most recent shareholders call, “as of June 30, some highlights of our balance sheet include $191 million in unrestricted cash and cash equivalents, $35 million due from clearing brokers, $143 million in net securities and other investments held at fair value, $200 million in advances against customer contracts and $491 million in total debt. When taken together, the balance sheet reflects over $75 million in net cash and investments after deducting the debt.” When companies have net cash balance sheets, it is a great indication of their future health.
Unit Corporation Bond maturing in May 2021 – Another strong quarter with excellent EBITDA of about $82 million following the sale of half of its subsidiary, Superior Pipeline. A projected $328 million of run-rate EBITDA and net debt of $539 million (which is comprised solely of our bonds) results in 1.64x leverage. When net debt to EBITDA is below 2x, the company is in strong standing and will weather economic pullbacks when they come.