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Builders Firstsource (BLDR) Is A Great Short
The analysis and recommendation below is from the March 31st issue of my short sellers newsletter. I present economic, market and individual company analysis from a truth-seeking perfective – no gaslighting allowed. Follow this link to learn more: Short Seller’s Journal information
Builders Firstsource, round two – One stock in particular that continues to baffle me is Builders Firstsource (BLDR – $184.55), which has run from $110 to $208 and back down to $184 since the end of October 2023. BLDR is essentially a big hardware store and lumber yard chain that also provides pre-fabricated construction components and services to homebuilders and commercial real estate developers. The Company’s revenues and profits benefited from rampant lumber price inflation between early 2020 and early 2022. But that ship has sailed.
Over the past several years management has used aggressive, debt-financed roll-up acquistions along with highly aggressive merger GAAP accounting to project a high-growth business model. It has also used aggressive share buybacks, also funded with debt, to keep the stock propped up. But over the last four quarters its revenues and profitability have deteriorated rapidly. At the same time it has accumulated a massive amount of debt relative to the size of its balance sheet. Shorting BLDR is a great way to express a bearish view on the housing market and commercial construction activity.
I’ve profited from BLDR in the past and its financials continue to deteriorate. The Company released its Q4/full-year numbers on February 22nd. YoY for Q4 sales declined 4.7%. For the full-year sales plunged 25.1% to $17 billion from $22.7 billion in 2022 and $19.8 billion in 2021.
Incredibly, the Company did not provide a full income statement for Q4. But “adjusted” net income declined 6.6% for the quarter. This “as-adjusted” net income was down 38.4% for the full-year. The Company has repurchased a massive amount of shares in 2023, polishing up the EPS vs 2022, which is likely why the stock price is levitating.
But here’s why the terse table with “adjusted” net income is not to be trusted: in the full-year income statement the stated GAAP net income is $1.54 billion vs the $1.88 billion “adjusted” net income in the table with the select quarterly numbers – a $340 million difference. From this it’s not unreasonable to infer the quarterly GAAP net income was materially lower than what was disclosed in the “as adjusted” table. This is a really sleazy move by management.
There’s an even bigger red flag. The Company spent $1.85 billion for share buybacks in 2023, leaving it with just $66 million in cash at the end of 2023. At the end of February it issued $1 billion in unsecured 10-year bonds. The proceeds will be used to pay down indebtedness under an asset-based loan facility (similar to a revolver) and the rest will be used for SG&A. As of the end of 2023 the outstanding amount of debt was $3.2 billion, up from $2.9 billion at the end of 2022. At the end of 2023 the ABL facility had $464mm drawn. This means that, after paying that down with the bond proceeds, BLDR’s debt load will increase by approximately $500 million.
The book value of the Company is $4.7 billion. However, net of goodwill and intangible assets, the book value is zero. $3.7 billion of debt sitting on balance with a $0 tangible book value for a company in a highly cyclical business heading into a brutal economic downturn is an insane amount of debt. To be sure, for now there’s plenty of operating income to cover interest expense. But I anticipate that both residential housing starts and commercial real estate new construction likelywill hit a wall in 2024. For sure office building and multi-family projects, from which BLDR derives a substantial amount of revenue. This will translate into the rapid evaporation of BLDR revenues and cash flow.
Investors/speculators/perma-bulls have a short memory when it comes to chasing highly cyclical momentum stocks higher. With construction-related companies, the revenue and cash flow fountain suddenly turns off. These companies are left sitting on inventory that suddenly plunges in value. I truly believe the construction sector is on that precipice, as the rapid easing of financial conditions by the Fed since March 2023 has temporarily deferred reality for the real estate sector and construction sector.
BLDR has been a tough short, especially if you didn’t set a stop-loss or used puts. But it’s apparent to me that the fundamentals are deteriorating rapidly for its business model. The fact that management issued another $1 billion in debt in order to continue buying back shares (“general corporate purposes” my ass) is a big red flag.
I’m tempted to throw on a long-dated, deep OTM set-and-forget put position. Timing the top in this thing will be tough, if not impossible, but I feel confident that the stock will be below $110, from where it launched at the end of October 2023, within the next nine to twelve months. Right now I’m eyeballing January 2025 $150’s and January 2026 $100’s.
Is China Weaponizing Gold and Silver?
Over the last few weeks, the resiliency of the gold and silver prices to repeated attempts by the price management squad to pull the rug out and send them plunging has been remarkable – if not unprecedented in the 23 years I’ve been studying, researching and trading the precious metals sector.
While the financial media attributes the big move in the metals to a marginal decline in the dollar, in fact it’s the rapid deterioration of underlying economic, financial and fiscal policy fundamentals that are causing the devaluation of the dollar and capital flight globally into gold and silver. This is despite the fact that the sharp move higher has left the metals technically vulnerable to a price ambush on the Comex.
GATA’s Treasurer, Chris Powell, has penned a fiery, must-read commentary which suggests that it is possible that the West may finally be facing the consequences of decades in which the Governments have run big spending deficits, printed trillions of currency units and have devolved into abject corruption – and have operated using paper derivatives to mask these deadly sins by suppressing the price of gold. The fact that the canary has been dead for many years may now be apparent.
Arbor Realty Trust (ABR) Is Going To Zero
The following short-sell analsys is from a recent issue of my short seller’s newsletter. To learn more about this follow this link: Short Seller’s Journal information
ABR loans money to speculators and operators who acquire CRE buildings – primarily multi-family and office buildings – either as “value” plays or rehab plays. It also underwrites GSE single-family and FHA multi-family mortgages but this is a tiny percentage of its operations. The loans that ABR both holds directly and that it stuffs into the CRE CLOs it sponsors are becoming distressed at an alarmingly rapid rate.
Given the increasing distress in CRE CLO’s and other risky debt instruments held by ABR and for which the number of non-performing loans (NPLs) are starting to pile up, I believe that ABR will collapse possibly within the next 18-24 months, depending on how quickly ABR’s borrowers can no longer make debt service payments and the degree to which multi-family and office buildings continue to lose value. It is highly likely that the stated book value of most of the real estate that collateralized the mortgages underwritten by ABR over the last several years, particularly when interest rates were near zero, is worth well less than the outstanding loan amounts. ABR has stuffed about 60% of this paper into CRE CLOs and it holds around 40%.
The bulk of ABR’s loan portfolio consists of risky bridge loan financing and CRE CLO loan obligations. Most if not all of the loans could labeled as “the dregs of the industry.” Per a report by Banco Santander, the percentage of loans in Arbor CLO’s that went delinquent in Q4 doubled from Q3 to 16.5%. According to industry data, this is about 2.5 times the delinquency rate for the CRE CLO market at large. Santander’s analyst expects the delinquency rate on ABR’s loans to continue rising this year. Of ABR’s $12.8 billion loan portfolio, about $7.3 billion is represented by loans used in CLO financing structures.
But it gets worse. According to specialized research firm, Viceroy Research (@viceroy-research/viceroyresearch.com), based on data on ABR’s CLO book provided by CreditIQ, through the end of February 20% of the loans structured into ABR’s CLOs are now delinquent. The delinquency rate thus has risen just two months into 2024 from 16.5% to 20%. Also per Viceroy’s analysis of the data, the number of loans with a greater than 30-day delinquency rate has risen from 7 loans in September 2023 to 50 this month (March 2024).
In addition, the principal loan amount of ABR’s NPLs soared from 2022 to 2023. A loan is designated as non-performing when it is 90+ days past due. Per the table below from ABR’s 2023 10-K, the unpaid balance (UPB) of NPL’s jumped from $7.7 million in 2022 to $274.1 million in 2023:
With respect to the latter, ABR has been swapping some of the bad loans from the CLO trusts with the performing loans that the Company holds. But this is merely a short term fix. In going through the 2023 10-K, I spotted several areas of accounting treatment that raise red flags. The number of accounting red flags I noticed in reading through the footnotes of the 10-K gives me cause to believe that the $274.1 million is fraudulently understated.
Furthermore, in the face of the rapidly rising NPLs, management has been using extend and pretend gimmicks, like loan extensions and shell-game refinancings to defer the eventual default and foreclosure of many of these loans. As Viceroy Research notes, per data available from the trustee of ABR’s six CLOs (U.S. Bancorp), the average net operating income to debt service (debt service coverage ratio) is below 1. This means that the combined cash flow of each borrower with loans held by these CLOs is negative (table produced by viceroyresearch.com):
As mentioned above, for now ABR has been able to plug the cash flow holes in its CLOs by drawing down on the reserve in each trust, extending loan maturities and swapping performing loans held by ABR for NPLs in the CLO trusts.
For now, ABR is generating positive GAAP income. The weighted average interest rate on the mortgages it underwrites is 8.42%. But keep in mind that the average yield on the 10yr Treasury between 2021 and present is roughly 3%. The spread between the 10yr and the weighted average interest rate on ABR mortgages is 5.42%. This would imply a triple-C bond rating, which means this paper has a high probability of defaulting. Viceroy Research believes that every mortgage on ABR’s books, including the CLO mortgages, will go bust.
ABR produced $400.5mm in net income in 2023. But in my opinion this is because it is under-reserving for credit losses by a substantial amount. Part of this understatement is attributable to ABR overstating the amount of recovery (the amount of proceeds from selling after foreclosing on defaulted mortgages net of the the loan amount). In my opinion ABR is committing fraud in this regard.
ABR’s stated book value is $3.2 billion. If just 26% of ABR’s loans are wiped out, its book value goes negative. Keep in mind that 20% of ABR’s outstanding loan balance is delinquent and that rate of delinquency is rising rapidly. Furthermore, based on the recent building sale data, the commercial real estate values have started to head south quickly. The influx of multi-family units (detailed a few issues ago) will further exacerbate the rising distress rate of multi-family real estate.
The all-time high in ABR’s stock is $20. It hit $4 during the worst period of the covid ordeal. The state of distress in CRE is similar if not worse to what it was in 2020:
The caveat on shorting the shares outright is that, for now, ABR pays a 13% dividend. But if the loan performance data continues to deteriorate, that dividend won’t last much longer. Also, the short interest is 40%. I think the best way to express the view that ABR will hit the wall within the next 18 months is with October $10 puts. I also think August 2025 $5 puts are interesting. Recall that NYCB plunged from $10 to $3 after it reported bad numbers and cut its dividend. If ABR is forced to cut the dividend, the stock will trade below $5 quickly.
The Collapse Of CRE Debt Is Accelerating
The commentary below is the opening commentary in the latest issue of my short seller’s newsletter. You can learn more about here – also profile Arbor Realty (ABR), which underwrites loans for the worst type of CRE garbage: Short Seller’s Journal information
The graphic above was sourced from @BankerWeimar. Powell once again earlier this month said that “bad commercial real estate loans will likely cause some bank failures but don’t pose a risk to the overall system.” Either he’s blind to reality or lying. Probably the latter. All we need now is for Powell to assure us that CRE loan defaults are “contained” a couple more times to confirm that a collapse is around the corner.
The CEO of a big investment fund (Fortress Investment Group) that has been buying CRE loans at prices ranging from 50 cents to 69 cents on the dollar said that about half of the maturing loans in CMBS securities (commercial mortgage back bond trust) are troubled. But it is going to get much worse. The CEO of Cantor Fitzgerald warned recently that there could be as much ast $1 trillion in commercial real estate defaults coming over the next two years. Moody’s estimates that 80% of CMBS office loans are at risk of default or restructuring this year.
Part of the problem is the work from home trend triggered by the covid cluster-you-know-what. But there has been an oversupply of commercial real estate in most metropolitan areas for quite some time (20 years). I’ve seen data thats suggests some of the biggest cities now have an office building vacancy rate of 50% or higher. A local business rag here in Denver said that 38% of the office space in Denver is empty. Two buildings in San Francisco were recently written-down to zero by their owner (which will soon be the bank that is sitting on the mortgages).
Most of the existing CRE debt was underwritten while interest rates were below 2% and asset values were rising. As long as banks were willing to lend the trillions printed by the Fed, there were developers who would put up buildings. With rates much higher now and the value of CRE plummeting, it will be nearly impossible to refinance most of what needs to be refinanced over the next two years. The majority of buildings requiring refinancing are worth far less than the amount of debt outstanding. As an example, earlier this month an office tower in Chicago’s River North area went under contract at a price that was just 33% of the seller’s outstanding loan. An office tower in Baltimore that is 51% vacant is being auctioned at a starting bid of $4 million. And an office tower in Manhattan sold this month for $150mm. It was purchased in 2014 for $500mm.
Another big problem is there has yet to be consistent price discovery for the value of office buildings other than the fact that the value of office buildings continues to decline when there is a distressed sale. The Wall Street Journal published an article last week titled “America’s Office Fire Sale Has Barely Begun:”
Only 3.5% of offices sold last year came from a distressed seller, thanks to optimism and forgiving lenders…forced sales are still surprisingly rare. In 2023, only 3.5% of all office deals in the U.S. involved a distressed seller, based on analysis by MSCI Real Assets. Pressure is building slowly as leases expire: Many companies are reducing their space by 30% to 40% when their contracts end. Lenders are also eager to kick the can down the road. They don’t want to force borrowers to sell buildings into a weak commercial real-estate market, which would lead to punishing losses.
Per the report, as I suspected banks are giving distressed borrower loan extensions to avoid foreclosure and a distressed sale. The benefit of this is that the bank does not have to take a big impairment charge and a large write-off of the loan. But, unless there’s a miraculous U-turn in CRE akin to Moses parting the Red Sea, kicking the can down the road will make the problem even worse, particularly with the economy heading south.
Then there’s the issue of OTC derivatives. Despite the fact that CRE loans represent a small percentage of the loan portfolios at the biggest Wall Street banks, analysts and financial media reporters are overlooking the massive exposure of these banks to CRE via OTC derivatives. Massive. Much of that exposure is accounted for off-balance sheet (opaque data tables buried in the footnotes to the financial statements). This is thanks to accounting “reforms” in 2010 that enabled the big banks to move most of their risk exposure to OTC derivatives off-balance sheet. And the counterparty risk is enormous.
The distressed mortgages were a big problem during the great financial crisis but it was the bank banks’ exposure to the bad loans via OTC derivatives that pushed the banking system to the brink of collapse and triggered trillions in money printing. Goldman Sachs, which was exposed to AIG’s subprime mortgage holdings via credit default swaps, would have collapsed in 2008 if Henry Paulson had not convinced Obama and Congress to bail out the big banks. As well, Citigroup and Morgan Stanley likely would have disappeared.
Bloomberg published a report on March 19th which discussed rapidly rising impairment of CRE CLOs (collateralized loan obligations), which are used to finance risky commercial real estate projects – projects a bank won’t touch. The ongoing and accelerating melt-down in these CRE CLO’s is the basis for shorting Arbor Realty Trust (ABR), which I mentioned in the last issue and which is profiled below.
A CLO is a bond trust backed by a pool of loans. The trust is “sliced” into bond tranches which are ranked by ratings/risk level. The bonds that make up the tranches are sold to investors. The top tranche is considered least risky and receives the highest credit rating. The bottom tranche is a mezzanine trust, often too risky to rate and usually retained by the CLO sponsor. The securities attract “yield hog” investors who typically underestimate the risks but are attracted by yields that are higher than standard mortgage bonds.
The debt service payments (interest plus principal) are used to service each tranche based on seniority level. So the highest rated tranche is the first in line to receive payments. As the loans backing the CLO become distressed and the cash flow from the loans is not adequate to make payments to all of the tranches, there’s a cash reserve structured into the CLO that is used to make up the shortfall. When the reserve dries up, the CLO sponsor must make-up the shortfall up to a certain capped percentage. Once the cap is reached, the tranches go bust, starting with the lowest tranches and moving up as the cash flow shrinks.
The idea behind the CLO (or CMO) is that pooling the risky loans diversifies away enough risk of each individual loan and thereby reduces the risk of investing in the CLO tranches, particularly the higher-rated tranches. In addition, the initial value of the real estate backing the loans is greater than the loan amount (over-collateralization) and a reserve is funded to provide a buffer against some of the loans becoming delinquent. But that model failed in 2008 and it will fail again with CRE CLOs.
During the great financial crisis, even some of the highest rated tranches in these mortgage-backed trusts (primarily CMOs – collateralized mortgage obligations) ended up highly impaired.
For now the Fed is reflating the stock bubble in an effort to reflate the value of office buildings and multi-family apartments. But the supply of both exceeds demand for the foreseeable future (the highest influx of multi-family since Nixon was the President units hits the market) and Powell’s attempt to “push on a string” to stimulate demand will fail.
Powell himself admitted last week that liquidity conditions are loose. The Monetary Base (bank reserves + coin/currency in circluation) has risen nearly 10% since the end of February 2023. WIth this Powell is papering over the holes blowing open in bank balance sheets – both regional and the TBTF – from a rapid escalation in non-performing loans (CRE, credit card, auto). The Fed’s effort will fail, banks will collapse and inflation will be out of control.
Gold Remains The Best Long Term Hedge Against Inflation
This chart is from John Williams’ Shadow Government Statistics newsletter. It shows the price of gold, CPI and predecessor measures and Shadow Stats alternative CPI (John removes the statistical gimmicks used by the BLS to mute inflation) from 1665 to present:
Gold Breaks Out – Is Silver Next?
Gold recently hit all-time highs in all of the major currencies (euro, yen, British pound, yuan). Last Friday (March 1, 2024), priced in dollars gold achieved its highest weekly close and then proceeded to hit new all-time highs. Wednesday (March 6th) gold hit a new all-time high in yuan. I think the move in gold primarily reflects the fact that inflation is picking back up because the Fed has substantially loosened liquidity which in turn has pushed the money supply higher since February. The Monetary Base, M1 and M2 continue to hover around all-time highs. The rising price of gold also reflects the fact that the U.S. banks have big problems with bad debt and the U.S. economic and financial system is becoming increasingly unstable. When the stock bubble pops it will inflict major damage on the economic and financial system.
Chris Marcus invited on to the Arcadia Economics podcast to discuss the recent breakout in the gold price and what needs to happen before the mining stocks participate in the precious metals rally:
I’ve identified some junior project development micro-cap stocks that I believe have 10-20x upside potential. These stocks trade under 20 cents and are worth multiples of that. To learn more, follow this link: Mining Stock Journal
Questions About Gold The CFTC And Fed Won’t Answer
“The unsustainable will not be sustained, except through ever-increasing force and fraud”
The gold “held” in custody by the Federal Reserve on behalf of the U.S. Treasury Taxpayer has not been formally and independently audited since President Eisenhower was in the White House. Anyone who has studied this issue, particularly GATA, does not take the official published numbers seriously. Many of us question if the gold is still there, having likely been leased to bullion banks in the official effort to keep the price suppressed.
The following is yet another Dispatch by GATA, which has tirelessly and relentlessly uncovered the facts backed by both circumstantial and hard evidence showing that the Federal Reserve operates in conjunction with the BIS, ECB and BoE to suppress the gold price in an effort to prevent gold signalling the onset of economic and financial trouble:
If mainstream financial news organizations ever work up the courage to report honestly about monetary gold, the commanding heights of the issue will have been mapped out for them by U.S. Rep. Alex X. Mooney, R-West Virginia.
After all, where can investigative journalism start better than with questions that already have been shown to be too politically sensitive for the highest government officials to answer, even when a member of Congress is asking?
Thanks to Mooney, in 2020 the U.S. Commodity Futures Trading Commission was shown refusing to answer whether it has jurisdiction over manipulative trading in the commodity futures markets when such trading is undertaken by or at the behest of the U.S. government:
And now, also thanks to Mooney, Federal Reserve Chairman Jerome Powell has been shown refusing to answer questions about the repatriation of gold
vaulted by other nations at the Federal Reserve Bank of New York, repatriation being something that would signify foreign loss of faith in the Fed, the U.S. government, and the dollar.
In December Mooney wrote to Powell to ask:
“Has the Federal Reserve or the Federal Reserve Bank of New York repatriated any gold to foreign nations this year? If so, to which countries and how much?
And:
“How much gold is the Federal Reserve vaulting for foreign nations now and how does this compare to the amount vaulted at the end of 2022?”
Mooney’s letter to Powell is posted here:
Powell replied to Mooney last week without even acknowledging the congressman’s questions:
“Thank you for your letter of December 14, 2023, regarding the gold market. The Federal Reserve Bank of New York provides gold custody on behalf of certain official-sector account holders, which include the U.S. government, foreign governments, other central banks, and official international organizations. The Federal Reserve Bank of New York does not own any of the gold it holds as custodian, and no other part of the Federal Reserve System owns gold.”
The Fed chairman’s reply to Mooney is here:
In not even acknowledging Mooney’s questions, Powell was arrogant and insolent, especially insofar as the Federal Reserve in previous years has disclosed the tonnage of custodial gold vaulted at the New York Fed and the number of countries vaulting gold there. Indeed, even now the New York Fed’s internet site claims that it is vaulting 6,331 tonnes of gold for foreign nations:
Is that data no longer accurate? The Fed chairman’s refusal to acknowledge the congressman’s questions suggests as much.
But Powell’s refusal to acknowledge Mooney’s questions also demonstrated absolute confidence that his arrogance and insolence would never be noted and challenged by mainstream financial news organizations, which seem to understand the Fed’s position that gold price suppression is crucial to maintenance of the dollar as the world reserve currency, that it is the foremost weapon of U.S. imperialism and economic exploitation of the rest of the world, and thus is “the elephant in the room” — something that must never be discussed.
In turn the cowardice or collaboration of mainstream financial news organizations, their refusal to press critical questions to central banks, is central banking’s greatest advantage — an advantage greater even than central banking’s power to create and allocate infinite money.
Mooney’s latest exposure of the Federal Reserve’s unaccountability has been added to GATA’s extensive file of documentation of gold price suppression policy —
GATA articles about gold suppression
— whose history is summarized (if at length) here:
Gold market manipulation: why, how and how long
If you know any financial journalists with integrity and courage, please forward this dispatch to them as an invitation to start trying to do their job of speaking truth to power instead of being afraid of power.
CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.
CPowell@GATA.orgd
The Stock Market Is Broken, Unstable And Dangerous
The following commentary is the opening salvo to my latest bear newsletter. In the last issue I updated my work on $NVDA and $TSLA plus two homebuilder stocks and I reviewed $CVNA’s earnings. You learn more about it here: Short Seller’s Journal
The irrational exuberance that has engulfed the stock market is officially more idiotic than the tech bubble asset that popped in March 2000. The forward P/E ratio for US technology stocks (S&P 500 Information Technology Sector index) is just below 30, its highest level since 2002. But that comparison needs to be “unpacked.” Back then, the P/E ratio for tech was higher than it is now because most of the tech stocks in the S&P 500 tech index were still in the early years of operation and growth. Relative to now, they generated very little in earnings.
On Thursday, the Nasdaq 100 (100 largest market cap stock on the Nasdaq) jumped 3% to a new all-time high. The last time the NDX hit an ATH after spiking up 3% was…drum roll… March 2, 2020 (@SamanthaLaDuc). Ten days later, on March 12th, the Nasdaq hit its then ATH. The following day it plunged 4.5% and the tech bubble officially popped. I responded to Samantha LaDuc’s tweet with this:
“I was trading dot.coms and tech stocks from the short side in the late 90’s through the crash. The current market doesn’t even rhyme – the current market bubble is a much bigger and unstable than the tech bubble market. The current stock market is more like Frankenstein off the chain.”
The breadth of the current stock market rally is a big red flag. Again, on Thursday with the Nasdaq up over 3%, just 55% of the stocks in the Nasdaq Composite were higher than the previous day. According to SentimenTrader.com, the last time this occurred, and it occurred five times, was between 1999 and 2001. In addition, per @unusualwhales, the market cap concentration of the top 10% of stocks hit its highest level since 1929, which is even higher than it was in 2000. This market is headed for a huge accident in my opinion. The only unknown is timing.
In yet another sign of a top in the stock market, the formerly most esteemed U.S. university which hired a now former president who is anti-semitic and a plagiarist (Harvard University), has 98% of the public stock investment portion of its endowment portfolio in tech stocks (Harvard tech allocation). Of this, 70% is in Google and Meta.
The price discovery function of the stock market has been completely disconnected. That canary is dead and, for now, hidden from view. In its place is computer algorithmic momentum-chasing and gamma-squeezes caused by the massive amount of hedge fund and retail money that piles into weekly call options, thereby forcing market makers who short the calls to hedge by going long some percentage of the underlying shares. The “investing” decision has absolutely nothing to do with fundamentals-based investing. As a result, the stock market is very unstable and dangerous.
Calpers Is A Ticking Time Bomb – Leverage Plus Loading Up On Nvidia
Calpers – the California Public Employee Retirement System pension fund has borrowed 8% of its assets in order to load up on risky stocks. From the Financial Times: “Calpers, the largest pension plan in the US with $452bn in assets, had total fund leverage of 8 per cent as of June 2023, which included what the fund described as “active” and “strategic” leverage.” “Strategic leverage?” Leverage is leverage and pension funds, with large, monthly fixed obligations, should not be using leverage to load up on risky equities. It may be borrowing even more money so to avoid have to sell part of its massive private equity holdings, some of which have no bid right now.
Sure, leverage works great as long as the stock bubble continues to inflate. But it’s a double-edged sword that has tendancy to decapitate entities that abuse the leverage. I’ll confidently assert that Calpers’ use of leverage to load up on stocks like $NVDA is abusive, particularly since Calpers has monthly pension beneficiary cash outflows. Its private equity holdings, with a recklessly large allocation as a percentage of assets, is already worth far less than the amount Calpers invested. Calpers added 1.5 million shares of Nvidia in Q4, giving it 7.5 million shares ($5.4 billion). This is an insane 1.2% of Calpers’ assets. By the way, most public pension fund managers I’ve met are idiots.
Below is the latest update on NVDA excerpted from my latest bear newsletter. I also updated $SMCI after to doing a deep-dive the previous week. You learn more about this newsletter here: Short Sellers Journal information.
Nvidia update (NVDA – $726) – CSCO reported its FY 2024 Q2 numbers last week. Revenues declined 6% YoY and EPS were down 3%. The Company also cut full-year and announced that it was cutting 5% of its workforce. I bring this up because, outside of corporate capex that has been spent on upgrading to AI hardware, there’s a general slow down in the tech sector in both corporate capex spending and consumer electronics sales.
It’s also starting to look like AI chips will not be immune to a pullback in corporate spending. UBS published a report in which is said that lead times for NVDA’s H100 GPU for the 2H of 2024 are coming down: “customer discussions confirm Nvidia’s lead times have come in sub-stantially over the past few months, meaning shipment slots are still available in the 2H of 2024. This is interesting because, up until now, there’s been a supposed shortage of NVDA’s H100, which gave the Company some pricing power and fat profit margins. Companies like META and MSFT – plus the Chinese – likely bought what they needed for upgrade programs and are now busy deploying the hardware. Based on the UBS report, it would appear as if the initial rush to load up these chips has subsided.
40% of H100 GPU’s shipped are not yet in service as there is a lag to install the hardware and power up. Based on the number of AI chips already shipped, there is a lot of AI capacity. MSFT, META and AMZN account for 34.2% of NVDA’s revenues. All three are developing their own AI chips. In addition, AMD’s competing chip-set, the Mi300X, is going to start shipping in the 1H 2024. Finally, I would suggest that a material percentage of NVDA’s GPUs are going to the small, private companies that NVDA funds to enable them to buy chips from NVDA. It’s likely that many of these GPUs will never be deployed and show at big discounts on the resale market.
It thus would appear that supply and demand are coming back into balance. This will limit NVDA’s ability to dictate pricing and when competitive chips hit the market and the price wars will begin. A contact of mine who follows this stuff more closely than me explained that there is “an insane amount of [AI] capacity” for many applications that have yet to demonstrate profitability. As an example, I started toying with ChatGPT and Microsoft’s Copilot (which was forced on Windows users). While they make internet-based research faster and easier, I would not spend a dime to use them.
In the context of the chart-path taken by bubble stocks (or tulips), a path that is consistent throughout history, I thought this analog chart comparing CSCO during the tech bubble and NVDA currently is interesting:
I don’t know that we can expect NVDA necessarily to crash the way CSCO did when the tech bubble popped, but I wouldn’t rule it out. For those who were not active in the market during the tech bubble, CSCO was billed as the back-bone of internet build-out similar to the way now that NVDA is promoted as the king of AI chips. The dreamers and snake-oil salesmen conveniently overlook the fact that competition and obsolescence prevents a monopolistic tech product from achieving much more than a brief period of dominance. Between its all-time high March 2000 and October 2002, CSCO lost 82% of its value. The stock price is still 41% below it’s all-time high. I would suggest that there’s a strong probability that NVDA will experience the same fate.
In that regard, the Financial Times published an article last week titled “Nvidia is nuts, when’s the crash?”. The article has a discounted cash flow analysis by an analyst from Chameleon Capital, a UK-based money management and investment banking firm. He noted that “to get to a $740 share price requires that the company maintain monopolist-like operating profit margin of 55% over the next decade, while growing sales ten-fold, from $60 billion/yr to more than $600 billion.” The entire semiconductor industry sold $527 billion worth of chips last year.
A big factor in the stock’s resilience is the $25 billion share buyback program it announced in August 2023. It has been aggressively buying shares in an effort to support the stock price. Instead of investing in future growth, and fending off competition, by deploying free cash flow into R&D, NVDA chooses to buy back shares and fertilize its ponzi-like scheme of “investing” in many unprofitable companies – many are supposedly data-center providers but have no customers – who turnaround and use the NVDA capital to buy H100 GPU’s from NVDA.
It feels like NVDA is finally starting to lose upside momentum. Last week I sat on my hands to prevent me from chasing NVDA higher with puts. But I think I’m going to start testing the waters again, likely with longer-date, deep OTM puts. As an example, I may start to accumulate July $550’s or September $500’s.
The Putin Interview, Stock Bubbles, Massive Debt And Black Swans
Tom Bodrovics invited me on his Palisades Gold Radio podcast to discuss a wide range of tops, most notably the Tucker Carlson interview of Putin, the reflated stock bubble, the existential build-up of debt in the U.S. and mining stocks.
