A Way To Go Into Small Caps?

Today's blog is very late because I had a business breakfast with a portfolio company after which it turned out that my credit cards had gone missing from my wallet which was hanging behind my seat in my handbag. The hotel where the staffers had the opportunity to snatch was once the finest in my city. It will remain nameless with its head hanging in shame.

I will report to the paid contingent on my views on the portfolio company because my notebook was not disturbed as hotel staffers produced coffee and croissants and scrambled eggs and fruit and all the fittings and groped behind me for cards not cash. This is the price of operating in a big city.

Wisdom Tree today launched its Global Small-Cap Dividend ETF, (GSD). That shows an interest in this stock market strategy by the managers and the potential clients. But is a fund the way to go into small caps? I think not, but I would say that.

Today's truncated news columns are about Britain, Brazil, Canada, Australia, and Mexico for the most part. I have to call my credit card companies.

*Any attempt to hide behind the supposed protection of corporate interests via their 60-year-old jv called Sanmarco was abandoned today by the chiefs of BHP-Billiton and Vale (VALE).

Brazil's environment minister said that the companies would have to pay for the massive cleanup at Mariana where a mudslide covered areas in two states covering about 100 km (62 miles) of the floodplain which was hit by the broken tailings dam at their iron ore mine. An initial fine of $66 mn was imposed. PM Dilma Rousseff compared the mess to the BP (BP) spill in the Gulf of Mexico. Apart from the cleanup the companies also face fines. The two CEOs apologized and promised 100% support to their jv to meet its obligations. Vale was off over 3% today in Brazilian trading at the equivalent of $3.95, below what I had just paid but now has recovered.

*Speaking of BP and Brazil, it has shelved much of its sub-salt offshore exploration capital spending and while not going as far as Shell in the Arctic (throwing in the towel), its level of spending will be $2.5 bn over this year and next, from $4.5 bn. Not all the cuts are by BP itself; the day rate for rigs has collapsed with the oil price.

*Cosan Ltd (CZZ) which mostly makes sugar and ethylene produced sour Q3 results showing a reais 13..3 mn loss (now $3.8 mn) more than double the a prior year Q3 profit of R15.2 mn (then $6.7 mn). Revenues were up 7.5% in reais to 2.259 bn because of much higher levels of sugar sold as well as a modest increase in ethanol sales using sugarcane waste, or begasse both in Brazil and outside it. CZZ hedges its export sugar targets. Non-ethanol energy sales were mixed but fuel distribution fell with the Brazilian economy. It expects the present harvest to make up for the poor one last year, with a full year production of 57-60 mn metric tonnes of sugarcane crushed and output of 4.2-4.4 mn tonnes of sugar and 1.9-2.1 bn liters of ethanol, a recovery from the last harvest.

Adjusted cash flow (earnings before interest, taxes, depreciation, amortization,and asset sales) was reais 572 mn, up 70% from the prior year Q3 mainly from higher prices and volumes in ethanol. Normal EBITDA showed a 4% drop. Normalized EBITDA was 6% higher because expenses were controlled.

Capital expenditure was Rs 230 mn, down 41% y/y because there was no replanting required this year and last year suffered drought. Cash generation rose 76% to Rs 1.2 bn mainly from the Energia sub.

Gross margins fell 80 basis points to 28.3%. The main culprit in the loss was the Cosan Logistica arm of the company which includes Rumo and now also ALL. Its takeover produced an 8.8% increase in costs of sales and took out nearly 72% of sales revenue vs 71% the year before. Again there was a single line showing where the revenue was hit: S,G & A which rose 3.6% to reach 16.6% of net operating revenue.

The cost of finance rose 8.7% to Rs 270.2 mn and the amount borrowed rose 9.5% y/y by Rs9 bn in the quarter. Moreover cash and equivalents fell by another 7.7% to Rs 1.87 bn. This was because of working capital increased for Raizen Energia. The other problem is that while hedged, 94% of debt is in US$s. Leverage is nearly 3x EBITDA (normal EBITDA) but the target is to cut this to 2.5-2.6x by the end of this year.

CZZ also slashed its fully year outlook to profits of Rs4.1-4.2 bn from the earlier forecast of 4.2-4.3 bn on revenues of Rs42-45 bn. Normal EBITDA is expected at Rs4-4.3 bn.

Amazingly, CZZ stock is up on a relief rally, up 4.6% in a poor market for Latin stocks today after falling 3% at yesterday's close. One reason is that CEO Nelson Gomes repeated that the group plans to spin off its Comgas sub.

*CAE Inc (CAE) continues to be rated buy-strong buy by the Canada analysts but I fear a repeat of the Bombardier (BDRAF) diehard support from Bay St. The stock is down along with almost everything else in US trading, but more so, off 3.25%.

*GlaxoSmithKline (GSK) won kudos from the Bioethics Institute for its level of disclosure of trial results in a study by the non-profit organization berating rival drug firm for hiding a third of data on trial results (not the successful ones of course.) Being from across the pond made it even better for GSK because Sanofi of France was named as one of the worst offenders. None of which was enough to stop Medècins sans frontières-Doctors without Borders from hassling GSK for charging $10 per jab of its anti-pneumonia and making money on it. The charity wants GSK to halve its charge and put children's lives before profits. I donate to the charity despite its lack of realism about the inoculation business.

*Trying to figure out what at the annual shareholders meeting Down Under at Benitec Biopharma (BNTC) led to the share price cut is a job for Sherlock Holmes. My guess is that first chairman Dr Peter Francis did not give enough specifics on the progress of its key phase I trials of its hepatitis C gene therapy TT034 which is being given in a single escalating dose to patients with hep C. He may have wanted to hold back until the trial is reported on next week in San Francisco at the American Assn for Study of Liver Diseases but shareholders want to know what cohort the the trial has reached with its dna-directed RNA interference gene-editing. Because he wasn't telling the assumption is that the sign-ups continue to creep along very slowly compared to targets.

Another possible pitfall was his telling the Ozzies that BNTC has put a hold on its non-small cell lung cancer program because of a lack of interest among pharmaceutical companies. In fact there are new gene editing options which are closer to market. Finally the fact that the execs managed to get their options may have caused a boomerang by Australian stockholders.

The share is down % today by 1-1.25% in US trading after being sold off by 1.6% down under overnight.

*I am enthusiastic about the prospects of Mexican REIT Fibra Uno (FBASF) after a breakfast at which I learned much about its strategy and plans. In the current quarter, retail rentals fell to 49% of totals, vs 53% last year and office rentals moved from 18% to 23%. The rest is industrial. So the glitter for now is reduced on tenants.

The FBASF's unencumbered assets are 3.5% of its unencumbered debt, which is conservative. Most debt (85%) is long-term. Only 21% is floating rate with the rest fixed. And while dollar debt is 51% vs peso debt 49%, the group has $2.4 of dollar income for every dollar of debt. So again the glitter is less on the debt side.

Meanwhile the projects in downtown Mexico City are advancing so that in the rest of this year, the Torre Latino office block will go on the market along with Diana, a tower block on the Reforma corrridor already 80% pre-leased to AT&T which is challenging the existing telco oligarchy. Along with other projects, there will be the equivalent of another 1 bn pesos in new annual rentals by the end of 2016, when the first new retail spaces come on the market. In the interim the new spaces will be offices and factories.

The key takeaway for me is that the managing company for our REIT, the El-Manns, a venerable Mexican real estate developer, are becoming more closely aligned with other shareholders. Rather than borrowing money to develop sites, they are putting up their own existing sites, which will be paid for by new shares of FBASF from treasury. Other non-El-Mann sites are also being paid for with these shares: Prudential Insurance in return for providing cash is an example Another is co-investing Spanish banks who want to tap into El-Mann expertise. Fibra Uno is gearing up to use capital provided by someone else, to minimalize dilution, and to align the family interests with those of mere shareholders like us.

The most exciting project still well down the pike is combining with another real estate family, Panacho Diego over the largest mixed-use site development planned in Mexico City. Fibra Uno will do this on its own for about half the total if they do not come in. With the partners the deal with be worth 13.2 mn sq ft; solo it will be only 7.9 mn. This is one of the Prudential investments, but not the only one. 

​The site​ will include 2 world class hotels, a residential tower over one of them, a hospital with doctors' offices, all linked by overpasses, and hit a new height limit for the center of the capital.

When the El-Manns toss in their expertise in, we get more income than rent and rising valuations.

The new sources of gain are the ability of management to build the projects, for which co-investing financial partners pay. Then they manage the property and the rentals, for which partners pay. And our FBASF reserves the right to buy out the financing partners when the contract ends.

With the customary grain of salt, here are what FBASF brass expect they will get besides rental income in their cash-flow. First non-recourse financing, which is beyond price. Then 1.25% construction management fees; 3% developer fees; 4% leasing fees; and 3% property management fees. That comes to 11.25% for shareholders over and above the customary rents and capital gains from a REIT.

Leaving out the​ big city​ site, the co-financing deals already in place would boost net revenues (in pesos) from 8.5 mn estimated at the end of this year to NMP13 mn by the end of 2018 and if you want to go out longer to NMP 18 mn by 2022. That's more than double where we start our​ "Helios"​ 7 year plan.

The assumptions include that it will go up 1% more than the rate of inflation in Mexico (50 to 150 basis points.) That the group keeps NMP 3 bn in cash.

That rents rise with improvements; that that intermediaries (and not Fibra Uno) release 90% of the money for development. A quite small increased spend by the REIT will add $2 bn in net operating income by 2022.

The square meters being managed will rise from 7001mn at the end of this year to 7970 mn at end 2016; 8194 mn at end 2017; 8300 mn at end 2018 and 9314 mn at the end of 2022. Our shares with a current NAV of $1.82 will by then be worth $3.43 and without again tapping the equity market.

At that time paribus caeteris, FBASF will be one of the largest REITs in the world.

Now I did not get carried away. I carefully excluded stuff that is still only a hope, not just ​the Mexico City metasite​ but 3 others in negotiation. These El-Manns from the “in” group are not cowboys but a clan of serious elder statesmen of the Mexican property industry, aiming to add value to the maximum for their own family's inheritance. They now control our REIT with 25 or 30% of the shares out. When all these new projects have been thrown into the hopper, their contribution will up their stake to as much as 80% of the shares out, or 400 mn shares during the 7-yr plan called Helios​.

Of course I was gazing at the speakers and ignored my handbag as the criados brought the chow.

*Bill Ackman of Pershing Square Holdings (PSHZF) and Mike Pearson of Valeant now face a US insider trading investigation for their unsuccessful 2013 takeover bid for Allergan—very successful for PSH own performance. Investors who sold the maker of Botox before the bid was announced have the right to sue for damages over any collusion. PSH fell to $19.8.