Thursday, January 12, 2017

Latest Credit Bubble Stocks Book Reviews

Haven't updated this in a while! Note our Theory of Books.

5/5 - "Hall of Fame" - timeless

5/5 - These are just "Must Read"

Wednesday, January 11, 2017

Revised Scoring Method For 2017 Contest

The scoring method for the 2016 prediction contest didn't properly reward well calibrated predictions, which we are going to fix this year using logarithms! From a correspondent:

Log scoring is a “proper scoring rule" which means your score is maximized (expected) by reporting the true probability distribution.

As a note, you can shift the scores around (linear transformations) to have certain properties pretty easily. Some examples:

Scoring LN(P(correct)/0.5) or LN(P(correct)) - LN(0.5) gives you scores that would be 0 if someone assigned a 50% probability to everything.

Doing that and then dividing each score by LN(2) gives you a final score that will just be equal to the total number of items scored if someone chooses everything correctly at 100% confidence.

In every case, being confident and wrong sends you toward a score of negative infinity.

I took a decision analysis class in grad school where the tests were probabilistic multiple choice. The professor made very clear that assigning a probability of zero to something meant you were willing to risk failing the class if you were wrong (and apocryphally had failed a former student). It ended up being pretty typical to assign 0.94/0.02/0.02/0.02 most of the time and move the high score downward when you were less sure. You didn't want to expend too much mental energy on calibration.

Another fun activity was having everyone in the class write down what probability range they had in mind when they used phrases like: probably, most likely, as likely as not, maybe, certainly, etc. The lesson was that even if you personally had a well defined notion of what you meant by those terms, it didn't matter when communicating because other people have wildly varying notions.
Do keep in mind that for this year's contest you need to be careful with very low or very high probabilities.

I re-scored the 2016 contest with log scoring, first converting all 0% to .001 and all 100% to .999.

Interestingly, the winner of the contest remains the same. However, the losers changed and are two guys who made a lot of wrong and extreme 0/100 bets.

Monday, January 9, 2017

2017 Prediction Contest

Credit Bubble Stocks has compiled the most interesting potential events submitted by readers into a master list.

* Either Buffett or Munger dies
* A Supreme Court justice is confirmed to replace Scalia
* Another Supreme Court seat opens
* The 10 year Treasury yield falls below the July 6, 2016 low of 1.336%
* Either VRX or SHLD enter bankruptcy
* The home mortgage interest deduction is eliminated from federal income tax
* The state and local taxes deduction is eliminated from federal income tax
* Global negative yielding debt goes from ~$10 trillion  to under $1 trillion
* Bitcoin (@$901) outperforms gold (@$1182)
* Any country leaves the Euro currency
* Buying equal dollar basket of SHLD, JWN, M, WMT outperforms Amazon
* Another Decacorn (peak valuation >$10 billion) is uncovered as a fraud
* Twitter is taken private
* The RMB/USD exchange rate goes over 8 at any point
* The S&P 500 exceeds 2,500
* Donald Trump is President of the United States at the end of the year
* Someone besides Elizabeth Holmes is running Theranos at the end of year (resigns, court appointed receiver, trustee, etc)

Carryover of the Didn't Happen in 2016
* The 10 year Treasury yield rises above 3.5%
* A 2 year treasury yields more than 10 year treasury
* A Euro hits $1 US. (EURUSD parity)
* Gold trades below $1000
* Gold trades above $2000
* Crude trades above $62.58
* One or more of Kim/Merkel/Saudis loses power (dies, resigns, or is deposed)
* A nuclear weapon is used in anger
* One or more of Gross/Ackman/Miller/Hussman/Einhorn leaves the business (dies, fired, resigns, manages personal money only)
* Hussman is up for the year including dividends (fund currently $7.13)
* CMG trades below 300
* Buying equal dollar basket of FB/AAPL/NFLX/GOOGL returns below 0% including dividends
* The BBB yield closes above 5% at any point
* A Cat 3 hurricane makes landfall

Now, everyone can take the master list and give a probability estimate for each event. You can either submit your probabilities via email or leave them in the comments below (in which case you need to give a unique username).

At the end of the year, the contest is scored. We add up your probability estimates for each event that happens. We subtract your probability estimates for each event that doesn't happen. The net is your score.


A correspondent writes,

"Someone on that thread made a comment that Sears should only keep open their profitable stores then it would be an investment win.

You can't do that. They have operating costs for a large company and they want a small footprint. Doesn't anyone ever think of operating leverage? These guys are going down quick because as they close stores costs at other stores are going up. Eventually all of their profitable stores will be unprofitable."
I would agree that this is overlooked, and that the chain store operating model premise is going in reverse for a store that is shrinking.

I noticed in my local mall that Macy's was looking really shabby, although I did not do anything about it the results were indeed poor.

Also in the news is that Macy's just sold its downtown Minneapolis store, which was once a gem of a Marshall Field's property.

One thing you frequently see with these dying businesses is that they sell the good assets and become more and more concentrated sludge, like a tank full of radioactive waste where the water is evaporating.

They have this historic building on a nice corner of downtown Minneapolis and they're going to sell it for $40 a foot and let someone else make all the money redeveloping it.

I view tangible book as an important metric for a distressed company. Tangible book of Macy's is negative $600 million. They have a few billion of goodwill, but of course that comes from buying stores that they have subsequently ruined.

I wonder whether the PP&E, which is substantial, is overstated or understated? You'd think the real estate would be understated, but selling a formerly premier property for $40/sf does not inspire much confidence in that. Also, I'd think the store fixtures, computers, etc for an obsolete retailer would be pretty worthless.

So, a big question with Macy's is: what is the real estate worth relative to the carrying values on the books (book vs market)? Note that it has been selling properties at significant gains relative to the carrying values.

Still with tangible book of -$600 million, and a dying business, you could argue that for the equity to be worth $9.3 billion the real estate needs to be understated by almost $10 billion.

Net property and equipment is $7.6 billion, that's net of $5.3 billion of accumulated depreciation and amortization. The historical cost of land and buildings (gross of depreciation) is $8 billion.

It's not clear to me what Macy's real estate is worth, or whether it could be understated by $10 billion. Given the possibility that the company will steadily destroy value, if I had to guess, I would say that the net present value of dividends to Macy's shareholders will be less than $10 billion, even at a very low discount rate.

Also, some dimensional analysis of the real estate. The company has 142 million square feet of store space. They own either the land and building or just the building for 2/3 of their stores, so call that 90 million square feet. For the equity to be a good deal in my mind, the real estate would have to be undervalued vs the carrying values by $110 per square foot.

They sold a San Francisco (Union Square) store for $1,000 per square foot, but that's got to be an outlier. If the real estate portfolio turns out to be more like the Minneapolis store which sold for $40 a square foot, then it's obviously going to be hard for the real estate to be undervalued by $110/sf.

It is also remarkable that the Sears bullish thesis does not seem to be working. For example, the Craftsman brand just sold for a fraction of what the bulls estimated it was worth a few years ago.

And speaking of values being a fraction of bulls' estimates, how is the commercial real estate market going to absorb all of this supply? Why didn't Sears and Macy's get out when the getting was good the past few years?

By the way, it noteworthy that in all of these conversations about department store retailers, it is implicit that the department store model is pretty much dead. Department stores like Macy's, Dillards have an enormous amount of really ugly clothing inventory. Is the Costco model of stocking only the tried & true items and colors/patterns just much more efficient?

Finally just note some Macy's bond prices. The July 2017 (6 month) paper yields 1%. That's only 20 bps better than treasuries. The 2024 note (7 years) yields 3.82%. You get a whole 160 bps better than treasuries.

Some Thoughts About Costco

  • Some of the hoped-for customer savings are illusory. For two reasons - first, buying excessive quantities ends up being wasteful. If you buy three pounds of ground coffee or 1.5L of olive oil, even if it was good to begin with it's no longer fresh by the time you use it. (Unless you're feeding an army.)
  • Second reason, they are brilliant at finding products that their upper middle class customer will impulse buy. You go there to save $10 and end up buying a $300 cart full of stuff you didn't need.
  • It's for people with no taste. There's no selection. Oh, "toothpaste is toothpaste", "coffee is coffee", X is X. Again, only if you have no taste.
  • The meat is excellent quality. If you go there solely to buy a brisket or a prime rib, you have my blessing, as long as you don't buy two gallons of olive oil.
  • Some good threads on COST on the Motley Fool boards [1,2]. I'll post more in the comments.
  • Previously: Costco and the Three Tier Liquor Distribution System

Saturday, January 7, 2017

Macy's Real Estate Situation: Book Value vs Market Value

In October 2016, the Company announced the sale of five locations to General Growth Properties: one store location was closed in early 2016, three locations will close in early 2017 and one location will continue to operate under a lease agreement. The Company recognized a gain of $32 million during the third quarter of 2016 from this transaction. In addition, as a result of lease terminations or expirations, the Company will be closing Macy’s stores in Douglaston Mall, Douglaston, NY and Lancaster Mall, Salem, OR in early 2017. The Company has also signed an agreement to sell its downtown Portland, OR store for $54 million. The transaction is expected to close in the fourth quarter of 2016, at which time a gain of approximately $36 million will be recognized. The downtown Portland store will continue operations through the holiday season and will be closed in spring 2017.

In November 2016, the Company announced the formation of a strategic alliance with Brookfield Asset Management, a leading global alternative asset manager, to create increased value in its real estate portfolio. Under the alliance, Brookfield will have an exclusive right for up to 24 months to create a “pre-development plan” for each of approximately 50 Macy’s real estate assets, with an option for Macy’s to continue to identify and add assets into the alliance. The breadth of opportunity within the portfolio ranges from the additional development on a portion of an asset (such as a Company-controlled land parcel adjacent to a store) to the complete redevelopment of an existing store. Once a "pre-development plan" is created, the Company has the option to contribute the asset into a joint venture for the development plan to commence or sell the asset to Brookfield. If the Company chooses to contribute the asset into a joint venture, the Company may elect to participate as a funding or non-funding partner. After development, the joint venture may sell the asset and distribute proceeds accordingly.

In November 2016, the Company announced that it had signed an agreement to sell its 248,000 square-foot Union Square Men’s building in San Francisco for $250 million, and will use part of the proceeds to consolidate the Men’s store into its main Union Square store. The Company will lease the Men’s store property for two to three years as it completes the reconfiguration of the main store. The Company expects this transaction to close in January 2017 and expects to recognize a gain of approximately $235 million in January 2018. The Company continues to explore options for its New York City (Herald Square), Chicago (State Street) and Minneapolis (Nicollet Mall) flagship stores.

In addition, the Company continues to pursue other selected real estate dispositions to monetize assets in instances where the store is being closed or where the value of real estate significantly outweighs the value of the retail business.

In January 2016, the Company completed a $270 million real estate transaction that will enable a re-creation of Macy's Brooklyn store. The Company will continue to own and operate the first four floors and lower level of its existing nine-story retail store, which will be reconfigured and remodeled. The remaining portion of the store and its nearby parking facility were sold to Tishman Speyer in a single sales transaction. As the sales agreement requires the Company to conduct certain redevelopment activities at Macy's Brooklyn store, the Company will recognize a gain of approximately $250 million under the percentage of completion method of accounting. Accordingly, $107 million has been recognized to-date and the remaining gain is anticipated to be recognized over the next two years, with approximately $4 million expected to be recognized during the remainder of fiscal 2016.

Wednesday, January 4, 2017

Scoring the Credit Bubble Stocks 2016 Reader Predictions (Part II)

See previous post.

My score was 118%. The other scores were:

  • 150%    
  • 18%    
  • -80% [Hall of Shame]   
  • 235%    
  • 9%    
  • 41%    
  • 272%    
  • 31%   
  • 200%    
  • 194%    
  • 135%    
  • 66%    
  • 5%    
  • 95%    
  • 450% [Winner!]
  • -17%
The average was 113%.

Here's a table that compares and contrasts the winner and the "hall of shame" participant.

Summary Happened Winner Hall of Shame
USTs below 1.5% 1 65% 10%
S&P trades below 1,820.66 1 75% 40%
S&P trades above 2134.72 1 75% 35%
Crude trades below 30 1 100% 55%
Trump elected 1 60% 25%
Republicans retain House and Senate 1 100% 25%
McClendon/Ward/Clinton/Pearson indicted 1 50% 10%
CHK, NAV, RIG, or SSE bankrupt 1 10% 15%
Autonomous vehicle 1 100% 95%
Unicorn liquidates below $250MM 1 75% 65%
USTs above 3.5% -1 0% 5%
2yT yields more than 10yT -1 0% 5%
EURUSD parity -1 75% 70%
Gold trades below 1000 -1 75% 50%
Gold trades above 2000 -1 0% 15%
Crude trades above 62.58 -1 0% 55%
Kim/Merkel/Saudis deposed -1 0% 10%
Nuclear -1 0% 5%
Gross/Ackman/Miller/Hussman/Einhorn retire -1 10% 40%
Hussman up for the year -1 0% 40%
CMG trades below 300 -1 0% 15%
FB/AAPL/NFLX/GOOGL below 0% -1 50% 70%
BBB yield above 5% -1 50% 50%
Cat 3 hurricane landfall -1 0% 25%

The winner put very high probabilities for stuff that happened and 0% for 9 things that didn't happen. People should try that approach for 2017.