Fructivore Investments

John Maynard Keynes described speculation as essentially trying to guess what other people are going to guess, and doing it better than they guess how you’re going to guess. I think this also describes macro-level investing, i.e. allocating capital based on economic data. As I stated in my last article, focusing on a decent cash flow avoids many of the problems that come from market correlation, leaving you with only the strength of your own analysis to worry about. However, the New York Times has given us a macro indicator that even the most cynical and suspicious of us can get behind. And it’s not even in their business section.

It is, in fact, the New York Times Bestseller List. In a classic investment comedy book, Rothchild’s A Fool and His Money, the author found a newsletter that went through the bestseller lists, and found that the optimum strategy was to peruse the lists for finance and investment books and then do the exact opposite of what the books recommend:

“In the early 1920s Edgar Lawrence Smith wrote…Common Stocks as a Long Term Investment. This book was ignored during the entire period when it would have been a good idea to buy stocks. Suddenly it became a best-seller in 1929…During the entire period from 1932 to 1967…not a single investment book became a best-seller…until Adam Smith’s Money Game was published in 1968, after which the stock market promptly topped out and collapsed. In 1974 Harry Browne’s You Can Profit from a Monetary Crisis…turned half the reading public into gold hoarders, and was followed by a severe decline in the price of gold. Gold didn’t rise again until there were no gold books on the best-seller list…Then it hit $800 an ounce. In the early 1980s, several national bestsellers (most notably Howard Ruff’s How to Prosper During the Coming Bad Years) predicted high inflation forever…a sure sign that inflation had abated. Later in the decade, Jerome Smith’s wildly popular book The Coming Currency Collapse, a terrifying rationale for the total collapse of the US dollar, sold out several editions just as the dollar began its remarkable three-year bull market. Megatrends, a summer favorite in 1983, predicted the triumph of high technology and pronounced the smokestack industries dead. Along…came a genuine depression in the microchip and computer industries and a huge drop in the value of technology stocks, while smokestack industries revived.”

The book was published in 1988, but a sequel would bear up this conclusion. During the dot-com era, Dow 36,000 was published in 1999. The next year the Dow hit 11,750 and then fell to 7286, hit an all-time high of 14164 in 2007, and it looks right now like 36000 is decades of inflation away. And, who could not have predicted the death of the real estate market from the popularity of the Rich Dad series? In 2007 one of Amazon.com’s bestselling books was Bogle’s Little Book of Common Sense Investing, which advised focusing solely on index funds, right before the indexes collapsed, prompting a swarm of articles  about a negative return over ten years (although counting from a bubble to a collapse is kind of cheating).

Right now the New York Times list is devoid of financial books, which is tentatively a good sign for the financial public. Although Rothchild and his newsletter deemed it significant that books on a given subject were not on the list, I think the presence of a book is more important than its absence. #19 this week, however, is Fareed Zakaria’s The Post-American World, about the rise of China and India and the global middle class. It is more optimistic than the title would suggest (and why not? It was first published in April 2008 when the world was better stocked with optimism).

As an aside, China has pegged its currency to the United States dollar for a number of years, in order to perpetuate the trade deficit and build up a substantial pile of Treasury holdings. We ran the price of oil up to $140 a barrel just to shake them off, and now they have the flaming nerve to complain about inflation and suggest that the world needs a new reserve currency. Interestingly, that article also talks about China seeking to switch from export dependency to internal consumption. The trouble is that China’s rapid growth built half of an economy, with the United States and its other importers providing the other half. Since demand creates supply, but supply does not create demand, it’s fairly clear who got the right half. So, for everyone worried about the decline of America’s economic influence, rest assured that when we go down we can still take the rest of the world with us. And, if the New York Times indicator works true to form, the global middle class is doomed anyway.

If you have been reading the financial news since about last May, journalists have been disturbingly preoccupied with the level of the indexes, and have been calling for, say, the S & P to correct from 900, as it sailed merrily past 1000 just to spite them. One imagines that they’ve been going for the stopped clock being right twice a day approach, and after yesterday, (Sept. 1), it seems very much as if they got their wish, at least for the moment.

Should a value investor care about the level of the broader market? Benjamin Graham himself counseled us that when the market is overvalued, even safe investments can be caught in the retreating tide. Warren Buffet, for his part, told his investment partnership in 1969 that nothing he knew how to do would make money in the present environment, so he was liquidating the partnership.

Obviously, when the market is in a depressed mood bargains are more likely to be available, but the central tenet of value investing is that a security’s price and value behave like a comet orbiting a star; they’re locked together as if by gravity but only on rare occasions are they close. However, it is the nature of all financial assets that they turn into cash sooner or later; for bonds, it’s not only sooner but according to schedule, for stocks, often but not always later because they are constantly selling, buying, and shuffling around assets.

If an asset produces cash, now or later, it is worth the cash it produces, and if it does not produce the expected amount of cash it gets written down when that becomes apparent. No matter what happens, cash is always worth cash (although Damodaran, in Damodaran on Valuation, cited some studies to show that this is usually but not always the case). That said, our desire for high current and potential cash flow will insulate us from temporary disruptions in the market, and if our time horizon is shorter than the duration of these disruption, we should be invested in something other than securities.

This cash flow is why CMO, one of my earlier recommendations, has a floor built in to it. With the government explicitly guaranteeing all of its holdings, there is a frozen limit below which its price cannot go (which happens to be about $2 a share below its current price), and that is the present value of the cash it can produce, either from the mortgagors or from the government. If the price does drop below that limit, we can buy it literally without a second thought. Or even a first one.

So, is this yesterday’s action the start of a new leg down for the market, a correction, an event that enough people think is a correction that it will become a self-fulfilling prophecy, or just a coincidence? I don’t know, and whatever the answer is I’m not worried.

I was on vacation last week, but I’m back and I brought Compass Minerals (CMP) with me.

Compass Minerals operates a number of salt mines, and sells rock salt for road de-icing and more refined salt for industrial purposes and consumption by humans and animals. They also produce potash fertilizers. Compass claims to be one of the lowest cost salt providers in the nation, and in the last three years has produced excellent earnings growth, although last year’s high earnings may have something to do with the high price of salt last year.

Their PE ratio is 9 ½, which to me implies that the recent growth they have experienced is not built into the share price. However, it does assume that the recent growth is here to stay. This is a bold assumption since rock salt purchases will be constrained by lowered municipal budgets and fertilizer purchases by diminished demand, but when the economy returns to normalcy as it most likely will eventually, Compass will remain a low-cost provider in an excellent competitive position. They also claim to be diversifying into consumer and industrial salt. Between 2006 when they shipped 8000 tons of salt, and 2008 when they shipped 12000 tons, their cost of production increased from $180 million to $318 million, making a ratio of 1.5:1 for volume and 1.77:1 for costs. This suggests that most of their costs are incremental, which seems to me to be a good thing for a mining company.

They have also been deleveraging their balance sheet, which is most likely a good idea in this environment. On paper, they have $836 million in assets and $692 million in debt, and in prior years their debt has exceeded their asset value. However, this $836 million in assets produced $274 million in operating income and $144 million in 2007 (compare Rayonier, which produced $223 million in operating income based on $2 billion in assets), so there is an argument that Compass’ book value understates the productive capacity of its holdings (or perhaps Rayonier’s is overstated). Certainly the market thinks so; Compass’ market cap is $1.7 billion against $144 million in book equity.

Compass’ capital expenditures have recently exceeded depreciation charges, but they are well covered by operating cash flow. However, apart from last year’s excellent results, operating cash flows  less capital expenditures have covered dividends less than twice, even with Compass’ modest dividend, currently yielding 2.7%. But, if they can keep their current position in the market (on their last 10-K they estimated that the areas they service consume 21 million tons of salt in a year, of which they sold 12 million tons last year), their pricing advantage should carry them through.

At any rate, Compass is a well-positioned company at a reasonable price, and salt is cheap and useful enough not to have many replacements, so Compass Minerals is definitely worth considering.

My loyal reader(s) who have been following this blog may recall that I called Coinstar a candidate for shorting . At the time it was at 25.91, and it is now at 36.15. So, that’s probably not my best work, although I maintain that the company’s return on its investments is too low to justify its prices. Anyone can spend 97 cents to earn a dollar; if they can do it with 87 cents I’m satisfied and if they can do it with 77 I’m intrigued.

Part of the runup was from the announcement that they reached an agreement to spend 80 million a year on Sony DVDs, and had a promising-looking earning announcement. A similar deal from Lions Gate films announced yesterday, though, failed to excite investors.

However, when Coinstar can’t reach an agreement they are perfectly willing to sue. They announced this morning that they were suing 20^th Century Fox for not allowing their distributors to sell new releases to them for 30 days after they come out. This suit parallels an existing one against Universal Studios that was filed five months ago. The grounds for the suit is violation of antitrust law, which, although a lawyer, I’m not an expert in. Much of the law about trusts and monopolistic behavior is fairly nebulous and open to clever argument, but at least in the intellectual property field there seems to be enough articulated law to guide the investor.

Antitrust laws in the US forbid generally any attempt to monopolize, and this includes attempting to maintain a monopoly by any means other than competition on the merits, including a refusal to deal with competitors.  Assuming that some clever economist expert witness can conclude that this denial will harm competition, 20^th Century Fox can still easily claim that they have the legitimate business reason of protecting the perceived value of their own products in the marketplace.  There is broad support for the view that antitrust law permits holders of intellectual property to unilaterally refuse to license it. After all, the Constitution provides for temporary monopolies for patents and copyrights, and although this does not provide a blanket immunity for antitrust actions (just ask Microsoft), most legal commentators allow them to retain that monopoly as long as they do not try to leverage it into a non-monopolistic area, although the 9^th Circuit has ruled that even this is permissible unless the owner is “not actually motivated by protecting its IP rights.” Since they have a legitimate business reason, which they seem to, they should be in a fine position for this suit. There is caselaw to suggest that there is a heightened standard for situations where a monopolist refuses to sell a product to one competitor that it makes available to others, or has done business with a competitor and then stops, but this seems to be more of an indicator of monopolistic action than anything imposing a higher legal standard, and a legitimate business reason will still defeat it. There is also case law to the effect that there is no difference between selectively granting a license and refusing to grant it all, so no worries to Fox and Universal on that front.

So, it would appear that Coinstar is facing an uphill battle in this area, and will probably have to deal with Universal and 20^th Century Fox on their terms. And, now that those companies and the rest of the market know that Coinstar will go whining to the courts whenever it doesn’t get its way, one can imagine those terms will end up more restrictive than bargaining from a clean slate.

My good friend Mike (here and here) recently left a comment about copper mines, which got me thinking about copper pennies. In 1982, the US Mint stopped making pennies out of 95% copper, and started making them out of copper-plated zinc. Even now that the price of copper dropped back down, copper pennies presently contain 1.8 cents worth of copper apiece. And some people are in fact sorting copper pennies out of the new zinc ones. Better than stealing copper from foreclosed homes, I suppose.

Copper penny enthusiasts pride themselves on what they see as high returns on investment. I suppose, at a .8 cent premium and perhaps 20% of 95% copper pennies left in the typical mix, they see themselves as making 16% on each lot of pennies they get—if they place absolutely no value on their time. And making 16% on a handful of pennies is not like making 16% off a wise stock purchase. Now that melting pennies is illegal, it is even less easy to turn a dollar’s worth of pennies into $1.80 cents in copper, not to mention the expense of the melting. If they cannot ultimately realize the value of the copper they have made -20% by taking perfectly good pennies and hiding them away somewhere.

But, where there’s a will there’s a way. There is a device called the Ryedale that can sort the two types of pennies out of each other, allowing people to get pennies in bulk from banks, run them through the machine, and fill their basements with copper coins at a vastly increased rate. It also puts banks to the trouble and expense of shipping a lot of very cheap coins around; after all, $100 in pennies weighs 64 pounds. Naturally, many of the penny people, unlike me, think a great deal about hyperinflation, but they almost seem to be looking forward to it. After all, in Zimbabwe during its hyperinflation they allowed old coins to trade at the new value when they revalued (i.e. chopped ten zeroes off of)  their currency, which was a nice bonus. And, well, without hyperinflation turning all your money into copper pennies would seem like kind of an odd thing to do.

Well, everyone needs a hobby, but there are easier ways to get something for nothing. Retail Ventures Inc. (RVI), market cap of $163 million, owns 62.9% by value (and 93.1% by vote) of DSW, market cap of $565 million, and this relationship has curiously persisted for some time. This implies that the remaining assets of RVI are worth negative 192 million dollars, which is not really possible. Instead of arbitraging pennies, we could arbitrage these two companies by buying RVI and shorting 59% as many shares of DSW (one of RVI’s 50 million shares is one 75 millionth of DSW, and 44 million shares of DSW divided by 75 million is .59). By virtue of their relationship, the two companies are unlikely to permanently shoot off in opposite directions, and so the fructivore who makes this trade should profit when this value discrepancy is resolved. There is, of course, a risk that a corporate relationship is severed before then (unlike merger arbitrage, here the risk comes from the restructuring happening instead of not happening). You may also find it difficult to borrow the shares; DSW has a 28% short interest and because a lot of them are doing this arbitrage, it would take dynamite to dislodge them.

So, for the diligent fructivore investor, there are easier ways to wealth than by one copper penny at a time. But in all fairness I must admit that I found two silver dimes in my change within the last year, and I still look. But I look harder for valuable opportunities in the securities market.

It now appears that the Department of Energy has agreed to defer a ruling on USEC’s loan guarantee application until “specific technological and financial goals have been met. The general consensus before the announcement of the pending denial a week ago was that the legislation for the loan guarantee program was tailor-made to allow USEC to pass it, and apart from the upstart French company Areva, no one else even bothered to apply. It seems very much as if the Department is waiting to make sure USEC qualifies for the guarantee before they rule on it, which is a good sign.

However, I am not sure what this implies for the timetable. During the initial denial, the Department had a schedule of 12-18 months before USEC could reapply (possibly also signaling that Areva is not going to get it, I hope). But it does save USEC the trouble of withdrawing its application, which allows the CEO, who publicly refused to pull it, to save himself some embarrassment.

The stock is up after hours, but I sold half of my position after the dead cat bounce over the last couple days. I’m a little better than even overall, which is surprising considering how dramatically the “story” of USEC changed last week. This either shows the wisdom of buying a stock for less than its working capital minus all its debts, or shows that I’m pretty lucky. However, value investors seem to get lucky often enough that something other than luck must be involved.

With $787 billion in stimulus, $700 billion in TARP money, deficits projected to hit $1.8 trillion, the Federal Reserve cutting rates to effectively nothing, and Neil Barofsky, the government’s inspector general of TARP estimating a $23.7 trillion total risk exposure to the financial crisis, it is only natural to worry about inflation. Of course, that $23.7 trillion figure would require absolutely everything going wrong, but recent events have surely convinced us that betting on the modal result and ignoring the other possible outcomes is reckless, a fact that seems destined to be rediscovered every few years.

Inflation, of course, is simply an increase in the money supply that outpaces an increase in the size of the economy (actually, that’s stagflation, but stagflation is really the pernicious aspect of inflation). The purpose of money is to facilitate transactions, and as the number of transactions increases the size of the money supply should increase accordingly. Now, of course, the economy has shrunk even as all this stimulus is being thrown at the market, and we are still worrying about deflation. This implies one of two things, either that inflation is going to come later, or that the inflation has been avoided.

I fall in the inflation avoidance camp. In a modern economy, credit serves almost as well as cash, and we are now witnessing a massive evaporation of credit. The appetite for securitization products that created a pool of liquidity that so many lenders were counting on turned out to be a mile wide and an inch deep. Now that every lender in the country is reining in its operations, and many people are unwilling to borrow or incapable of borrowing against their houses, trillions of dollars of credit that used to be bouncing around the financial system no longer are. Next to this unprecedented deleveraging of America, Congress has finally managed to make a couple trillion dollars look like a small number.

Of course, it never hurts to have a backup plan in the form of inflation-protected investments. Our choices include gold, TIPS, and land. For our fructivorous purposes, however, we want an investment that produces a decent return with or without inflation. Gold or other precious metals has no baseline return, or even a negative one when counting storage, insurance, etc. TIPS pay a low rate but increase their principal value alongside inflation, which is better than gold, but I still think there are more potential opportunities in the land category.

In terms of land, obviously single family homes are far too speculative as events have indicated. In fact, using Seth Klarman’s definition that a speculation, as opposed to an investment, produces no current or potential cash flow to its owner, single family homes are not an investment at all. Rental properties are closer, but I think the ideal land for an inflation hedge is land that produces something: farmland, mines, oil fields, or timber. Any of these has advantages and disadvantages, but I’m going with timber, and with Rayonier in particular.

Rayonier owns 2.6 million acres of timberland, and also produces lumber and wood products, and wood fibers for hygiene products and also specialty fibers for industrial use running the gamut from packaging to LCD displays. Naturally the decline in demand for construction materials has hurt them, but even at this low ebb of their business, they have managed to squeeze out at least $25 million in earnings per quarter lately. Their free cash flows are approximately equal to their dividends, currently yielding 5%. This puts them at risk of a dividend cut, but for inflation hedging purposes this is not really relevant, as it is better to keep the money in the firm to buy more timberland with in that event.

The advantage of timberland is that when, as now, demand is down, producers can simply decline to harvest. Unlike farmland, and especially mines and oilfields, not harvesting for a time allows the product of the land, trees in this case, to grow and produce a greater yield when conditions return to normalcy. And given their vertically integrated fiber business, they are not wholly dependent on the construction market.

Rayonier also is getting a nice little bonus from the tax system this year from black liquor, a byproduct of the fiber refining process that contains the nonfibrous parts of the wood and the leftover chemicals used in the process. The refining of wood into wood pulp for their fiber business produces some nice long usable fibers, and a great deal of black slime. A highly toxic black slime. When dried, a highly flammable black slime. When dried and mixed with a bit of diesel fuel, a highly lucrative black slime, since the government pays a subsidy of 50 cents a gallon for its use under an alternative energy program. The program expires at the end of this year, and there is a movement in Congress to cut off the eligibility of pulp mills immediately, on the grounds that black liquor is not really an alternative fuel. (It has been used since the 30s and nearly every pulp mill uses it, meaning that it is not an “alternative” to anything.) To date this year, Rayonier has benefited $86 million from this subsidy, and there are two more quarters. Since the program will expire if not extended (which extension is not outside the realm of possibility), we cannot count on this $43 million a quarter as part of the firm’s operating income, but it is a nice little enhancement that will cushion the blow of the business slowdown for the moment.

However, without counting the black liquor subsidy Rayonier’s PE ratio is hovering around 20, which is generally too high to qualify as a low-hanging fruit considering the lack of growth (not that a fructivore lays too much emphasis in growth anyway given the difficulty of predicting the future). But as an inflation hedge, timber companies like Rayonier are definitely good places to look into.

Remember what I said about the dangers of event-driven trading? USEC has been denied the loan guarantee for their centrifuge enrichment plant construction, for reasons of concerns about commercial viability (which is unusual because the technology is already in use  by other uranium enrichers) . As a result, the company seems to be making good on its vow to cancel the project, although they claim they are now investigating strategic partners or buyers. The Department of Energy has taken the unusual step of asking USEC to withdraw and resubmit the application in 12-18 months, although I’m not sure to what end.

Naturally, the stock has fallen by about a third as of this writing. I’m as surprised as anyone, but as I’ve stated, this rush for the exits is a common enough reaction to an event coming out the wrong way. I should also point out by way of shameless bragging that, since I purchased it at a low price when it was still a net-net situation, I’m actually about even on this one.

If we neglect the new construction project entirely, we are left with the existing plant, which will probably not be competitive in the marketplace once the Urenco’s centrifuge enrichment plant is finished in a projected 2013, or perhaps Areva’s Eagle Rock facility, which will be fully constructed in 2018 or 2022 but like the Urenco plant, can operate without being fully operational (one of the awesome things about centrifugal enrichment is that it’s modular), or any of the other centrifuge plants around the world. Of course, since centrifuge technology is already being used at some overseas enrichment plants, the demise of USEC’s competitiveness has already started. It is still operating at a profit, but as centrifuge technology becomes more and more common their operations will most likely be squeezed out. USEC also takes weapons-grade uranium from Russia and dilutes it to fuel grade, but that program also comes with an expiration date.

However, as I stated, without R & D on the plant, which the company may have to follow through on their promise and put on standby, the company has average earnings of $180 million a year. After this price collapse, their PE ratio is down to 3, so it might still be a hold. But I was definitely more optimistic yesterday.

How many times have we heard the above advice? Usually, it gets people to burn through their savings by starting ill-fated businesses, but that is not the only thing to love. We Fructivores love buying and selling at the right price. The right price is when a security is fairly valued, since at that point there is no longer any advantage to holding it. When a security is fairly valued, sell it off and find one that is unfairly valued. We also are familiar with stocks that went up before we had the funds to buy them, or worse, we bought them, gave up, and then they went higher.

Writing options allows us to squeeze a little extra money out of both these situations. Specifically, writing covered calls and naked puts. I know, most people would advise small investors not to write naked options, or they’ll never become large investors, but there are ways. Larry McMillan, in Options as a Strategic Investment, talks about the difference between having essentially a stock strategy and using options to augment it, and having an option-based strategy. He advises the second one, but this strategy sticks with the first.

With our value investing approach, we know what our exit target is because we had to value our holdings in order to be sure that we got a discount from that price. So, if we know when we are going to sell it, we can write a covered call at that price. If the stock exceeds that price at expiration, the stock will be called away from us and we will have made the money we were going to make anyway, and also collected option premiums while we waited. A related, but riskier proposition, is writing a naked put on a stock we like but that is at too high a price. If the stock declines below the price of the put, we are forced to buy it (make sure you have ample margin), but we would have bought it anyway at that price. It is riskier because if the company deteriorates during the life of the option, the price that we thought was low enough to make it a bargain could now be hugely overpriced. However, for a company with stable operations, like Windstream, or better still, a company like CMO that can never be worth less than the government-guaranteed securities it owns, this strategy is safe and reasonable.

For example, suppose that I think Capital One is worth at least $30 a share based on my sense of its minimal earning power after the economy and the markets get sorted out. The January 2010 $30 calls are at $3.40 now, so by writing them I take in $340 less commissions per hundred shares, and expose myself to no risk other than selling when I would have sold anyway. It also removes from me the agonizing over whether I should take my profits now or hoping it will go up (If it does go up it will do so for reasons unrelated to its bargain status and therefore this is an unfruitful waiting game). If, however I did not own Capital One but wanted to, I would consider writing puts, perhaps the January 2010 $20 puts at $1.75. This takes in $175 less commissions per hundred shares, and if the stock drops below $20 I will be forced to buy a stock I would have bought anyway at a discount I chose in advance. Of course, the choice of the January options was arbitrary; my focus is on valuation, not option pricing theory, so picking the date of the options is less important to me than the strike price.

So, this fundamentals-based option strategy is a way to make other market participants pay you to take the actions you would have taken anyway, thus bringing in extra money and it also has the advantage of making decisions in advance, thus freeing up your limited investing analysis time to focus on the really important matters like valuation.

Event driven trading is never as simple as people think. The concept is simple enough: identify an event that is likely to change the price of a stock, determine the price of a stock after the event does or does not occur, determine the probability of the event occurring, and take a position accordingly. Of course, the ending price and the odds are difficult to predict, but the real problem with event driven trading is that if the event fails to occur the price of the stock will typically drop precipitously, since everyone else is watching for the same event. The typical event is a merger, but a spinoff, divestiture, or even a bankruptcy filing can create an event.

USEC Inc. has an interesting one; a loan guarantee from the Department of Energy that they applied for in order to construct a new facility. USEC is currently the only uranium refinery operating in the United States. It turns mined uranium into low enriched uranium for use in nuclear power plants, and presently employs archaic and inefficient gaseous diffusion technology. Ironically, one of the biggest inputs to producing fuel for electric plants is electricity; 65% of USU’s operating costs come from electricity, and centrifuge technology requires an impossible-seeming 95% less power. For this reason, most nuclear fuel enrichers have switched over to centrifuge technology, and USU wants to open a new plant in order to join them.

To that end, they applied for a $2 billion loan guarantee from the government, and since then they have been looking forward to it like Australia has been looking forward to rain. They have recently announced that they expect the announcement from the Department of Energy in early August, and that they may consider mothballing the entire project if they do not get their guarantee. Since there are two other centrifuge plants proposed to be built in the United States in the near future, and both of them foreign owned, their strategy is probably to embarrass the government into approving their request. Still, calling the government’s bluff like that is a dangerous strategy.

I have to admit that when I discovered USEC, it was because it was a net-net situation, not an event driven trade. At the time, they had enough cash on hand, and uranium inventory, to redeem all of their debts, repurchase all of their stock, and still have money left over. (Such a situation is the holy grail of value investing since Ben Graham started hunting them up)  Now, a couple years later, this is no longer the case because they have sunk $1.4 billion into the centrifuge project already–which, if the project is shelved, will have been wasted. In the last couple of years, the stock has produced on average $70 million in earnings ($110 million more than that if the R & D spent on the centrifuge project is capitalized). It now trades at a PE ratio of 10 without capitalizing the R & D and 4 with it capitalized and amortization of the R & D is deferred until the plant is operational. However, those figures are largely meaningless because the existing plant is going to be shut down. If they keep the same volume of business, their operating earnings (not counting R & D) goes from $180 million to $850 million, but the existing $200 million in plant is thrown away, and the $28 million they now have in depreciation and amortization is going to expand to, say, $300 million, plus the interest on the loan of $160 million at 8%, plus taxes, produces a bottom line of about $270 million, which stacks up favorably to the $70 million they reported making now, after the construction and transition periods.

So, it is easy to see the optimistic case that comes from getting the loan guarantee. (Assuming the company can keep the same margins and laser uranium enrichment, the “new” new technology, is not significantly more efficient). It is equally easy to see that cancelling the project would leave USU stuck with outdated technology against two centrifuge-using competitors in this country. So, there is the case for USU, and the basic problem that comes from trying to predict the future better than everyone else in the market. I should point out that USU is up nearly 20% since they announced that they demanded a decision by August (I hope for their sake they have a contact in the Department of Energy that gave them the date), but still has a PE ratio of about 2.6 for the company once the project is completed. So, if you like the odds, go for it.