Thursday Night Links

• I know many people view Netflix as invincible. Its market capitalization is around $250 billion—and revenues have grown a hundredfold since I signed on as a customer. But financial analysts underestimate the risks Netflix took on when it decided to be self-sufficient, creating its own library of movies and TV shows. This huge and ongoing cash drain is a weakness, not a strength. The key number here is cash flow. Even as Netflix has grown its revenues at an amazing pace, the company has proven incapable of generating much cash. To build its proprietary position, the company has taken on more than $15 billion in debt, meanwhile accelerating the pace of spending even as it grew more indebted. That’s why Netflix is raising subscription rates. The folks running that huge business understand how much they need cash, and how fast they are burning through your subscription payments. But the metrics are still ugly. Netflix’s market share has been declining steadily, and has now fallen below 50%. One estimate claims that the company’s share of consumers fell more than 30% in a single year. Netflix’s recent quarterly report was a disaster, spurring a share sell-off. You could easily conclude that “Netflix’s long awaited funeral is finally here”—as Bloomberg hinted in its blunt assessment of the results. And then there’s a whole different question of whether the amortization practices that create reported earnings are reasonable—but I will spare you the nitty gritty forensic accounting. I’ll leave that to the Wall Street analysts. [tedgioia] 
• Concerns about the degree of concentration in cap -weighted indices like the S&P 500® seem to arise whenever performance is dominated by mega- cap names—as it has recently been. A simple way to measure market concentration is to add up the weight of the largest constituents in an index. Interestingly, after peaks in concentration—such as the aftermath of the technology bubble—the S&P 500 Equal Weight Index has typically outperformed its cap-weighted counterpart. In this paper, we propose an alternative way to measure concentration. By adjusting the Herfindahl-Hirschman Index (HHI) to account for the number of names in a sector, we’re able to make meaningful cross-sector comparisons. We show that concentration tends to mean-revert in most sectors, which has important implications for the relative performance of equal weighting. Exhibit 1 shows recent and average adjusted HHI levels across S&P 500 sectors. [S&P Global]
  
• I’m still confused how people who are convinced that 50 percent of humanity will die due to climate change can simultaneously be concerned that COVID-19 will kill up to 1 percent of humanity. (Also, the folks convinced that climate change is an existential threat tend to also be passionate supporters of unlimited migration from low-carbon-output societies to high-carbon-output societies. It is tough to think of a better way to accelerate climate doom than bringing millions of people from low-income countries to the carbon-profligate U.S.) If you’re anxious about climate change and need a decent place to relax for the next few years, consider William Jennings Bryan’s old house in Miami. It will soon be inundated by the rising sea and can be yours for $150 million. [Phil G]
• “General practitioner developed bad connotations because it was basically a physician who did not complete a residency. You were considered a general practitioner (GP) in your third year of medical school. My dad delivered babies by himself as a fourth-year medical student. Family Medicine fought back against this confusion by becoming the first society to require a board examination.” The orientation was followed by a lecture on geriatric polypharmacy (drug interactions and the consequences of our pharma-happy medical system). [PhilG]
• We often have a discussion about the new shingles vaccine, Shingrix. Our office does not carry the vaccine, which costs $100 at a local pharmacy and Medicare Part A or Part B do not cover this. Patients on whom taxpayers are spending $10,000 or more annually balk at the idea of paying $100 dollars to cut their risk of getting shingles from 33 percent to about 1 percent. [PhilG]
• Covid-fighting hero Gavin Newsom promised California voters a single-payer universal health care system in 2018. A majority of Californians agree that health care is a human right. California has a larger population than most European countries that we consider our models of proper government. California has tons of income and wealth. There are no Republicans capable of preventing California state government from following Science and acting morally. So, as with housing the unhoused, there shouldn’t be any obstacle to California living its principles. A year ago, AB-1400 Guaranteed Health Care for All, was published. Apparently, when a fundamental human right is being denied there is no reason for California politicians to act quickly. [PhilG]
• What constitutes “actually invaded” for purposes of Article I, Section 10 (“State Self-Defense Clause”) and “invasion” for purposes of Article IV, Section 4 (“Invasion Clause”) of the U.S. Constitution? Do States retain constitutional power to defend themselves when “actually invaded” by hostile non-state actors such as armed cartels and gangs, or only by foreign powers? Can the current situation at Arizona’s border with Mexico—where the federal government has lost or severely degraded its operational control of the border and in which cartels and gangs are smuggling unauthorized aliens and large quantities of drugs outside of authorized ports of entry and also engaging in acts of violence in pursuit of their objectives—satisfy the definitions of “actually invaded” and “invasion”? [Mark Brnovich]
• That chart is from @PricetoWealth on Twitter. In the past when we have sold dying businesses short - something we have done quite a lot of - they have had certain elements in common. Falling revenue, low gross margins, high fixed costs, low operating margins, operating income declining faster than revenue (operating losses), high (and increasing) debt, no dividends (raising money from capital markets, not returning it), high debt yields. Altria does not match any of those criteria of dying businesses. There is a big question with tobacco investments, and that is whether cigarette sales will ever stop declining, and whether cigarette price increases can compensate for volume declines in perpetuity. This is a question about the elasticity of demand for cigarettes. We have some reason to believe that there is a core cigarette customer that is very price insensitive. Also, Altria's price increases - mid single digit percentage increases - used to be greater than inflation, but now they are arguably less than inflation. So that should be building in a little bit of cushion to take the price of a pack higher if needed. [CBS]
• MMP ended up earning $982 million in 2021, including $244 million in the fourth quarter. The current earnings yield is 9.4% with the stock basically unchanged since early November. During fourth quarter 2021, the partnership repurchased nearly 1.1 million of its common units for $50 million, resulting in a total of 10.9 million units repurchased during 2021 for $523 million. EPD ended up earning $4.6 billion and had distributable cash flow of $6.6 billion. The current earnings yield is 8.7% with the stock up about 5% since early November. [CBS]
• Philip Morris' Marlboro (ex-U.S. obviously) cigarette volumes were up 2.4% year-over-year in Q4; that's better than Altria did. The PM dividend yield is now 4.8% and it trades at 18x the prior year's earnings and 17x management's forecast for 2022. Nice to see that management made well-timed share repurchases when the stock inexplicably dipped in Q4. You pay a premium to Altria and British American for great capital allocation, strength in the Marlboro cigarette business, geographic (and regulatory) diversification, and a growth business in smoke-free alternatives. Thought experiment: if you had to pick two securities to leave to your heirs, might they be Philip Morris and Dorchester Minerals? [CBS] 
• Our first post ever about old Peabody (pre-bankruptcy) in 2015 when it had subordinated debt trading at a yield to maturity of 40%. How things have changed. Now Peabody is free cash flow positive, deleveraging, and has debt trading close to par. Peabody's current market cap is $1.9 billion, and I count $2.2 billion of net debt, for a total enterprise value of $4.2 billion. The FCF/EV yield is 41%. I think we could call that a cheap cyclical! With Peabody's $420 million of cash from operations in 2021, they spent $165 million in capital expenditures, a reinvestment ratio of 39%. In Q4, they reinvested only 10% (net) of their operating cash flow in capex. This is the same pattern we saw at the integrated oil majors, which are investing less than half of their operating cash flows in maintaining production. It is amazing watching these natural resource management teams - Canadian oil majors are a great example - so scarred by the recent bear market that they want to run basically deleveraged companies. They're using free cash flow to pay off debt with negative real yields! [CBS]
• Net debt fell from $19.8 (CAD) billion to $16.1 billion during the year. As @HFI_Research tweeted, "Incredible to think $SU given how much FCF it will generate is actually prioritizing debt pay down over dividend or share buyback increase. I understand the debt reduction thing because we are doing it at Gear. But they are one of the few 'haves' that can actually borrow." SU can borrow for 30 years at 3.7%; their latest maturity right now is March 2051. I guess at some point if this keeps going they will run out of debt to repay. [CBS]
  
• The changing of the guard is coming. Not just to Facebook and not just to the rest of the FAANG stocks. The era of the baby boomer is coming to an end. We are on the cusp of an unprecedented generational wealth transfer. Media power is shifting from legacy gatekeepers to podcasters and social media stars. Our political leaders will soon be retiring: Joe Biden is 79 years old. Donald Trump is 75. Nancy Pelosi is 81. Mitch McConnell is 79. Janet Yellen is 75. Jerome Powell is a young 69. I could go on forever. In politics and in markets, you better get ready for the changing of the guard. Market cap weighted index investing works best when things stay the same. When the largest companies get larger and when the smallest companies fail to break through. It is a strategy that profits off the status quo. Reverse market cap weighting works best during a changing of the guard. Reverse cap systematically under-weights the companies that can only be displaced while over-weighting the ones ready to take their place. Facebook came into the S&P500 in late 2013 at a 50 basis point allocation. Today, after it’s recent sell-off, it is at 230 basis points. Facebook came into the Reverse-Cap S&P500 index in 2013 as an over-weight. It is the second smallest company out of 500 in the index today. Less than one basis point of exposure. Reverse market cap weighting works best in periods of mean reversion, and in periods of change. Market cap weighting has done very well for investors, for a very long time. But brace yourselves and get prepared, because here comes the changing of the guard. [phil bak]
  
• Large-scale oceanic currents are slower than wind by about a factor of ten, giving a kilogram of current 1000 times less power than a kilogram of wind. Water density makes up the difference to make ocean current comparable to wind in terms of power per rotor area. Not all the ocean has currents as high as 1 m/s, so I put the total abundance in the same category as wind. Maybe accessing a thicker column of water than we can for wind should bump ocean currents up a bit, but the currents are relatively confined to surfaces. But why dunk a windmill underwater where it’s far from demand and difficult to access and maintain, when a comparable power can be had in dry air? So I classify this as difficult. On the plus side, the current should be rock solid, eliminating intermittency worries, unlike wind. Still, not one bit of our electricity mix comes from ocean currents at present, so it cannot be said to have been meaningfully demonstrated. [Do the Math]
• There are many verbally gifted writers and speakers that, when pressed to visualize some math problem in their mind's eye, must helplessly watch their normally high-octane intelligence sputter and fail. They often write or talk at a blistering clip, and can navigate complex mazes of abstractions — and yet, when it comes time to make contact with the real world or accomplish practical tasks, they may be helpless. They'll do great in English class, and terrible in Physics. They can be very fun to listen to due to their terrifying leaps in logic and the exceptional among them will be natural leaders. The wordcel moniker describes more than just one’s level of verbal skill: it’s also a socioeconomic classifier that refers to people whose verbal ability borders on self-sabotage (thus the “-cel”). [roonscape]