ArbMaker: Pairs trading with cointegration made easy

Nine months without a post and no baby to show for it.

Well, there is a baby of sorts. I've been taking a nice stat arb trading app through its paces - and it is not bad. Actually, it's far better than that.

ArbMaker - they were struggling for a title, clearly - but it does produce the goods. Screenshot:


That's WGL Holdings, Inc (WGL) versus Western Gas Partners, LP (WES), both natural gas utilities state-side. The basic message of those oscillating graphs is that the pair are locked in a long term relationship and that, today, WGL looks expensive relative to WES. And, as a result, I'm off to check out the validity of the message with my own methods.

Now, this software runs on cointegration and its goal is to produce linear combinations of companies' prices series that (it is hoped) revolve neatly about the x-axis and, from time to time, signal trading entries based on standard deviations.

There is an awful lot of stat going on to validate matters and the versatility is impressive. It is a tool to complement other analyses (in my view) and, as far as I know, it is the first retail product of the cointegrating trading type on a par (and in not a few cases superior) to custom built systems costing well-north of $25k.

The responsibles have a beta program due to get going next month - anyone can sign up - and a backtester is due before year-end. The web site is here. It's to be a subscription model and while no prices have been announced yet I'd be guessing something between $125 - $150 per month.

All I know is someone owes me a glass of red...or at least a complimentary sub.

NB: DBS hereby discloses a financial investment in the firm behind this application!

All aboard! Union Pacific vs Canadian Pacific

A firm that runs a dedicated "Wine Train" for tourists; counts a major Napa Valley winemaker amongst its customers; has improving end markets; and is recording historically impressive internal financial ratios makes it hard for the wine-drinking arbitrageur to set it as the short half of a position without a heavy heart. But that is what's happening here with Union Pacific.

UNP is perhaps even amogst those railroads who help ship grapes to Canada for use with the incomprehensible (in both 'why?' and 'what exactly is it?' terms) "Cellared in Canada" policy. I have not bothered to attempt modelling the (negligible except in terms of national pride) impact of this on Canadian Pacific who are far smaller than UNP and more reliant on commodity volumes (particularly grain, lumber and its derivatives). Those volumes have looked iffy; and the company was cautious on its outlook at the last results. Moreover its internal ratios largely pale next to UNP's; and it has lost some business due to customer service issues.

However, such transports are ultimately a call on the rising (or falling tide) of macro growth. The valuation gap between the two should close.

Short UNP @$92.63, Long CP @$CAD64.78.

The barely visible arb: Associated British Food / Essilor SA

To prove there is no blind food and wine fetish going on in this space yesterday's short sale, cunningly posted today when already showing profit (inertia not conspiracy), was Associated British Foods plc (profile). Oenophiles will note that ABF own Ohly, a firm that sells wine yeast. To them I say, ferment on, ferment on - and don't take this short sale personally.

Still, as financially robust as the ABF numbers are, its equity is pricey next to some other non-cyclicals. Especially one that has nothing to do with food or wine other than helping consumers read the labels (if so inclined).

Essilor, a surprise match on the model (prompted a review of the internals) do lenses. To see with.

No, the link is not obvious. But it may at least explain why they recently appointed two Chief Operating Officers. Better oversight. Certainly one needs spectacles to deal with the font on their website.

Back on the serious front: Essilor's numbers are good enough to make the underperformance versus ABF striking (no pun, but it is a French firm).

Short ABF@£11.24 / Long EI@€41.03


Other business:
If you want it done right, do it yourself. Failing that use google docs and know it still won't be what you want. That said, a new tracker link in the right column is now up. Sticking it in as a live graph - as well as adding anything remotely visually sexy (in stat terms I'm afraid) - will have to wait.

It is at least a new start (and handles fx).

Non-cyclical arb: Swedish Match / Kerry Group

Swedish Match, best known perhaps for the history of its creator - the "Match King" and financial crook extraordinaire Ivan Kreuger (at left and Freddie is no relation) - is laughing off the greatest financial crisis and scandal-ridden era since the suicide of its founder back in 1932. It is all things tobacco and pretty much the cash machine addiction to its products demands.

Kerry Group, on the other hand, deals in the other things (more) people cannot do without: food and - true to its Irish domicile stereotype - drink. Even the non-alcoholic versions.

Further, I am happy to report that these activities do not remotely touch on the adulteration of wine. It is therefore our champion for today.

Its accounts are also pleasantly and strappingly robust. But its biggest advantage is its very domicile, a source of panic for investors despite the group's mitigating global profile.

Relative valuations for the two are at extreme levels. Sell SWMA @SEK195.7 / Buy KRZ @€24.61

Wine beats oil and gold. But not intrinsically.

Yet another wine-as-investment piece, this one from today's Telegraph:

"According to the Bordeaux Index, a monthly report on the state of the fine wine market, bottles of white and red outperformed gold and oil.

Wine prices jumped 5 per cent, year-on-year, bettering rises in the price of oil, which was up three per cent, and gold – up to two per cent.

The rise has been attributed to an increased interest in China for fine wines over the past 12 months.(link)"

At some point the ancient whiff of tulip mania becomes a modern stench. But wine merely lasts longer (allegedly) and has the mystique that makes marketing men very, very excited - "Monsieur is showing his sophistication with this purchase".

In the knowledge that many auction prices cannot be based on the estimates of buyers' palates one must conclude that vanity, the greater fool theory or simply blind choice drive prices. How else might the £147,020 bottle of 1869 Chateau Lafite-Rothschild cited by the newspaper be explained?

Surely not by relative value - for the quality of a wine has long been determined by factors other than its price.

Rotork plc vs Andritz AG: capital equipment got back

Vacqueyras. Rasteau. Cornas. And, of which the pic is a recent shot, Gigondas. Lots of 'as' amongst the côtes-du-rhône appellations. Both in name and liquid these are red meat tamers.

Which brings me to assorted capital equipment manufacturers. Heavy economic metal equivalents of a muscular 14% Gigondas.

UK engineer/manufacturer Rotork plc is exposed to diversifed markets by geography and type. Encouraging half year results, a strong balance sheet, decent cash management and a tempered outlook comment by management are all positives. Yet its equity is comparatively (see below) unloved.

Austrian firm Andritz AG has similar financial traits, is thrice the size and has an equity performance Rotork can only look at in either askance or jealousy. I did wonder about managers who describe the US housing market as "still very moderate" in commenting on general economic conditions. But this reveals itself later in the reporting text as diplomatic code for "still FUBAR".

One or the other equity ought to give. Short ANDR.VI @ €61.93 / Log ROR.L @ £15.85.

Separately, the online tracker service at right is kaput. Replacement thoughts ongoing.

If you will insist on not drinking wine, at least buy the Rhône

Trust academia to trespass even on bacchanalian pleasures.


Abstract

This paper uses auction hammer prices over the period 1996-2009, with a special emphasis on periods of economic downturns, to examine risk, return and diversification benefits of fine wine. Our research shows evidence that the wine market is heterogeneous...



...dadidadida. Cutting to the chase:

And the sun shines...

Running a firm followed by 36 analysts half of whom rate you a sell and only 4 (did they not get the memo?) a buy is plenty motivation for a new chief to serve up some crow.

Your balance sheet is shite; revenue still suffering a hangover from a shift a public policy; and johnny foreigner is undercutting you by 20% thanks to questionable (and dirt cheap) state loans. In short, you live and breath the turnaround strategy.

Fortunately, forward demand is strong. Your prospects are not terminal. You issue shares in a well-flagged recapitalisation move. Cue 6% share price decline. Or make that "Q-Cells a 6% price decline".

One does not have to believe the market is wrong about Q-Cells. One must only agree it ought to have similar misgivings of Renewable Energy Corporation currently storming ahead in Oslo.

If you can deal with the fx (my portfolio tracker cannot) sell REC @20.15 krone and buy QCE@4.78 euros.

Beer is from Mars, Wine is from Venus

When it comes to the beer and wine debate sensible people bat for both sides. Ambidextrous. Swing both ways. AM/FM etc etc. Or, in the words of Woody Allen, bisexuality immediately doubles your chances for a date on Saturday night.

So having spent most of the summer, sadly even whilst on holiday, refining the arbitrage system, getting a programmer on board and having a partner slog through the augmented Dickey-Fuller method (surprisingly not an adult toy guide) for his personal, erm, pleasure I still hesitate when a company like Heineken comes up on the short side.

Think Mondavi could ever sell wine like this?

I will pass on a little something for tee totalling long only people though. The Dutch agency behind this gem are owned by Omnicom Group Incorporated (NYSE).

Technology has gone mad in my absence

File under the You-have-got-to-be-kidding: wine by iPad.

One might say "fashionable gimmick" but check out the bottom (but statistically dubious) line - turnover up 11% two weeks after intro.

Good news for restaurateurs - but wouldn't it be nice if patrons trusted the experience of their own palates a bit more.

Full House Resorts: not organic wine but tasty...

LONG FLL @$2.83

So I’m at this party drinking an excellent “organic” vin de pays from the Ardèche and the male half of the couple chatting to me – whom I met that same night - keeps describing the streets of the less manicured European cities he has holidayed in as ‘like Africa’. As in “it was filthy – like Africa”.

His wife may have seen my face cloud at this liberal derogatory use of ‘Africa’ and she eventually says, “What do you know – you’ve never been to Africa”. Hubby breaks off from the African traits of Rome and after a pause says, “Well, I’ve been to Tunisia”. An expert if ever there was one.

Ignorance is a glorious thing – so long as one knows one is ignorant and can appreciate the new. And I refer to the organic wine since there is little hope, I fear, for the man.

The sommelier came along later and held forth on organic wines which, at least in the case of France, can contain very non-organic sulphites to stop fermentation and stabilise the product. The “bio” label applies much more to the treatment of the vines and pesticide use. Or at least that’s what I gathered since it appears there are no legal regulations enforcing the term “bio”. The end result is that organic means, for now in any case, non-industrial scale.

Thus there are some small, less than appellation d'origine contrôlée denominated wines looking to add value via the organic path. Based on that evening's tastings they are on to a good thing - particularly the chenin blanc vin de pays the name of which escapes me now but for which inquiries are being made.*

But I suppose I must also talk of today's long selection – for it too has niche and organic attractions.

Never mix gambling with alcohol – unless you own the casino. Full House Resorts is a gaming outfit which will double its net income this year. Without going through all the mind-numbing financials here some key ones are a +20% free cash yield, a x1.3 book value and an operating margin that for this year look odds on to come in north of 45%. In a market where banks and other creditors find themselves owing bankrupt competitors it is the likes of Full House (no debt!) that will pick up bargains. Probably.

Against that the firm is tiny and fairly illiquid - a short-term risk. The real long term problems with gaming in the US revolve around regulatory issues, both at the state and federal level. But right now, the odds on a 2 year outlook favour a very large capital gain.

*email for details if required, the sommelier claimed to be seeking customers.

Back in the saddle

This month has seen no wine pass my lips. Lent inspired penitence, prayer and self-denial? If so, difficult to explain the Guinness and rum (let's be clear - not jointly) consumption. Absence and geographic considerations made it so; and I have noticed that no wine equals little blog work. For the purposes of the little tracker that spells trouble. Burnt shorts etc.

About the only thing I can be thankful for, in a made-no-money-from-it kind of way, is being correct that Palm was, on the balance of probability, not going to be making the new sliced bread with its Pre. But only closed a long instead of taking a modest short.

Don't want to talk about AMD the loss from which has actually managed to surpass the Intel hedge. The world we live in. Office Depot continues to look spectacularly poor judgement. And on it goes.

While not married to any of these embarrassments - and although US markets are attempting a leg up - it is not worthwhile to panic. Yet. Call it overbought on the up; or just stretched optimism on the basis of both recorded results and operating forecasts (at least in the US).

On that basis I close out a couple of staple longs, Kellogs @$54.47 (a kindly +%20 or so) and Campbell Soup @$35.38 (a less impressive circa -7% loss).

Fare thee well, Health Fitness

It has been a lucky month. One holding, Health Fitness, acquired by a third party; another, Overhill Farms, proving today (or so it appears) that sound cash management counts for something after all; no major portfolio blowups; and a handy performance in the last 10 days of January to beat the SPX.

Best of all, a bullet was dodged by avoiding Art Technology Group (mentioned here before as a potential holding). Hitherto a promising outfit for admirers of cash generation, management have decided - to my profound disappointment - to dilute shareholders by circa 20% with a massive cash call.

Clearly they are bent on buying something. But it is hard not to wonder about the cost of $240m odd of equity capital. The new bill for it all will settle around $10m-$12m annually (or between 30% and 40% of free cash flow). Course, you have to accept that equity actually has a cost in order to assign any weight to those numbers.

But there are other fish in the sea. Final decisions on the proceeds of the Health Fitness win to come post-Rasteau (the 'Excellent Value' tip of the moment and permit me to suggest Chapoutier's product).

End-2009 commentary: 'This aggression will not stand, man!'

Some holiday break, final 2009 thoughts and tit-bits:

• If on a Amsterdam-Detroit flight with a dodgy curry in the gut look forward to being described as “verbally aggressive” when the crew cut short your bog time and forcibly check your underpants for explosives.
• A single, inattentive blunder is all a competitive son requires to put an end to patronising chess “coaching”. When he’s nine this may send you back to strategy books.
• Three helpings is more than enough to show one's appreciation of the cook.
  
• If you need to get out of petro industry contractual obligations whilst working a mid-east war zone have colleagues tell the clingy hosts you already left. Then skip town on the next bus to Jordan.
• Considering a career in cosmetics television advertising? The phrase “collagen biospheres” will get you more airtime than your viewers will appreciate.
• The Slacker King not only gave the title of this post, he's still cool. Embrace it, man. But in light of point 1 maybe don't actually go in person to Amsterdam for the Good Stuff.
  

In other news, this was the year (pending December numbers) to ride the ‘Convertible & equity arbitrage’, ‘Latin American equity’ and ‘Technology’ waves in the alternative investment space (league table via Absolute return+alpha). These latter two are also comfortably the highest returning longer-term strategies (or so suggests the downloadable data AR make available).




For the purposes of this blog, vanilla US long/short returned a respectable 14% or so - which truly lets the smug-times roll for DBS (pending the inevitable disaster). But then vanilla probably has less volatility.

May 2010 keep you healthy, happy and curious (at least oeneologically-speaking)!

Short (and drink) 1977 Warre, long GSI Technology

SHORT 1977 WARRE'S
LONG GSIT@$4.42

Is this the year to open the '77 Warre's? Certainly little point leaving it behind in a dusty cellar for another 30 odd years during prime eating season.

Port is easy to understand (Wikipedia have one of their better entries on it) and its "vintage" incarnation has always been the outstanding bargain of wine world. And still is - the price of the 1977 is the same as it was 5 or 6 years ago (with a little shopping around). With that kind of price appreciation it better be delicious.

Some companies, it can be said, exhibit similar 'delicious' financial characteristics and remain similarly unloved. I have one before me that holds 30% of its share price in cash; has a free operating cash yield of over 13%; trades at x1.3 book; and has been profitable for the last 14 quarters. The last 14 quarters - not easy.

The cheapness, much like that for vintage port, can be explained by a perceived lack of 'sophistication' (OK, and size). GSI find it hard to explain that they are not producing a commodity product. They don't, if you like, just produce port - they also produce the equivalent of a quite special vintage port.

A few days ago, this perception problem appeared to change when the firm announced what appeared to be a technological breakthrough on performance. Cue massive buying followed a remarkable drawback - but on much lower volume. Short term plungers got theirs and done left. We could talk technical analysis guff about "the key $4.50 level" but it really won't matter a rat's backside to DBS.


Separately, the woes with the tracker continue. Where is the freaking portfolio?!! Plus, there can be no way that label in the picture is an original from 1977...

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