Wall Street looks 6+ months ahead, and it likes what it sees. The proof is in the stock market’s behavior: A choppy, rising foundation-build.
Why choppy? Because we are in the middle of the negative news that produced the stock market’s large 5-month decline. It’s that news that keeps investors worried and the market volatile. Nevertheless, the rising stock prices are chipping away at the concerns.
Barron’s just described the action in its June 2 “Review & Preview” email:
“A Different Market. It may still be a temporary bounce, or a bear-market rally, but investor sentiment has made a significant shift in the last two weeks. Since the Nasdaq Composite bottomed on May 24, it’s now up 9%. Seemingly bad news is no longer tanking stocks. In fact, in some cases, stocks are going up despite it.”
This rising market is neither a temporary bounce nor a bear-market rally. And the choppiness is a key characteristic of the stock market climbing a wall of worry.
As to a bear-market rally, that already happened in March. It was a fast, dramatic jump that seemingly, but falsely, indicated the end of the months-long decline. (See my March 31 article, “Stock Market Bulls Attempt To Resuscitate Ailing 2021 Favorites – Don’t Get Trapped”)
So, what’s an investor to do?
Own stocks – but…
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… this bull market is going to be different. Therefore, forget the 2021 bull market’s views, thoughts and strategies. The new environment has the Federal Reserve slowly resuming its traditional (AKA, “neutral”) position (that is, sitting on the sidelines as a lender-of-last-resort). And that will produce the return of healthy, market-driven interest rate setting and capital resource allocation.
After 13+ years of Fed control, benefits of this change will be dramatic and new to many investors and even Wall Streeters.
Important – The Fed (actually, the 12-member FOMC or Federal Open Market Committee) is not a Solomon-like entity. It is simply a government agency made up of a few politically appointed individuals, mostly economists. They are incapable of wisely overriding capital markets (i.e., capitalism’s superior resource pricing and allocation system), and they are misled by relying on econometric models built on past data. Their attempts to help have been the cause of many past economy and capital markets problems. Today’s inflation is the latest fiasco.
But, what about that inflation and the Fed’s rising interest rates – and maybe a recession?
Those three issues are real, but they are being viewed and interpreted incorrectly.
First, today’s inflation
It has two drivers: Demand/supply mismatch and excess money (the Fed’s doing). The high demand and supply shortage mismatches are producing higher prices in specific areas (e.g., automobiles), but they will eventually self-correct. Prices will decline when demand and supply are in line again. Therefore, there will be no permanent inflationary damage. (These double-digit inflationary areas likely represent about one-half of the ~8% CPI inflation rate.)
However, the Fed’s creation of excess money (AKA, printing money or debasing currency) is a serious problem. It has simply thrown $trillions in cash into the system. The result is called fiat money inflation (“fiat” means currency not backed by something of value like gold).
The absolute, proven, major problem is: Once fiat inflation starts to increase, it infects all aspects of the economy and financial system, thereby instigating a push-me, pull-me cycle of price-cost, wage-productivity and demand-supply shifts. This non-productive activity seeks to take advantage of or seek protection from a currency losing purchasing power.
It’s what happened in the 1966-1982 inflationary period. The cause? It was initiated and fostered by the Federal Reserve and the Federal Government believing John Maynard Keynes’ theory: Increased money supply and government deficit spending could produce, in multiplied size, private sector growth and employment.
Sound familiar? You’re right. The knowledge gained from that period has faded away, so here we go again.
Instead, prices rose everywhere, undermining any supposed real growth effects. Worse, instead of admitting it was a failed experiment, the Federal Reserve began a series of flawed attempts to control inflation by tamping down economic activity through money tightening. Instead, the Fed produced a series of recessions, and yet inflation kept rising to new heights. This graph shows what happened prior to the big monkey wrench – OPEC’s October 1973 U.S. oil embargo. The loss of oil supply caused a huge demand/supply mismatch on top of the ever-worsening fiat money inflation that eventually led to the extremes of stagflation and double-digit inflation.
Second, rising interest rates
The Federal Reserve’s actions today represent a public approach. Prior to 1965, the Fed was silent. It would set the discount rate, but all the deliberations and money supply actions were kept secret. As a result, the capital markets set interest rates according to observable conditions. For example, tightening would begin to affect capital supply, so rates would start to rise. Eventually, those actions would affect economic activity.
Today’s rising rates are nothing like those of the past. Previously, the Fed tightened money, thereby pushing up the capital market rates. Today, it’s all determined by the Federal Reserve. Moreover, the rates are significantly below what the capital markets would set. Therefore, we need to discuss the current interest rate situation’s effect (and non-effect) on the economy and, therefore, the chance of a recession.
Third, a coming recession caused by those rising rates?
Sure, it’s a possibility. More likely, though, growth will slow down, not reverse, because the Fed’s rate raising is nothing like in the past. The main difference today is that interest rates remain abnormally low. Until rates get to the capital market-determined level (i.e., without Fed interference), the Federal Reserve is still running a loose money period.
How to know when normality returns? When the key short-term rate (for a 3-month U.S. Treasury Bill) is above the fiat-money inflation rate. Normality is defined by investors demanding and getting positive “real” (inflation-adjusted) interest income. Today, that would likely be above 4%, far higher the “new high” Fed-controlled 1.2% level. That paltry rate is a negative real return of about -2.8%, even worse than the negative -2% during the Fed’s years-long near-0% nominal rate.
So, the Federal Reserve has a long way to go before it allows that rate to get anywhere near normality, much less higher to produce a tight money environment. Therefore, real recession worry will likely not occur until the rate hits 5% or more.
Compare this graph to the one above…
The bottom line: Focus on the new, emerging bull market and ignore everything else
Today’s past economic data analysis and in-arrears market evaluation are irrelevant. The Fed-caused fiat money inflation is here to stay, and the 2021 bull market drivers have ended. And yet, good times are coming – it’s just that they will be significantly different from before.
How different? We cannot know yet. It will be evolutionary. Therefore, “hiring” Wall Street experts now is a good strategy. See “A Very Different Bull Stock Market Is At Hand – How To Adjust” for an example of the actions to take.
How One Founder Is Helping DIY Investors Navigate Risk
August 14 is National Financial Awareness Day, and I had the opportunity to chat with John Duffy, founder of Trending Stocks, who went from personally absorbing the 2000 and 2008 market crashes to launching a risk-adverse stock market platform for DIY investors. Here, I chat with Duffy about trend following and investment risk management.
WHAT GAVE YOU THE IDEA FOR TRENDING STOCKS?
It took me 14 years to “get even” after two huge downturns in the stock market – first in 2000 (down 50%) and then in 2008 (down 56%). Losing 14 years of investing time and money was the impetus for me to research a better way in the market. I learned about the ancient trend following strategy – and while it worked well – there was no simple software or program to apply it. Spending hours upon hours charting and graphing doesn’t interest anyone, so I programmed and launched TrendingStocks.IO to automate the research time and hassle on the backend.
HOW DOES IT HELP INVESTORS AVOID RISK?
The trend following strategy inherently has a focus on risk management, so I applied that into the new platform. The risk management helps investor avoid riding the market down. You pre-set a fixed stop-loss amount based on your personal risk tolerance. As a stock goes up, which it should based on the trend following strategy’s identification, so does the stop-loss amount; it rides up. While the stop-loss amount fluctuates up and down causally with the stock, if it gets down far enough to cross below a bottom threshold – we flag you to sell and get out.
WHAT’S YOUR BACKGROUND?
Aside from studying finance, economics and business, I’m a Vietnam Navy Veteran. Oddly enough, this was my foray into programming and coding. I bunked with the first IBM IBM programmers in the world. Their expertise interested me, so I asked a bunch of questions and they taught me the science.
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Not to date myself, but this was before when computers could be owned, only leased. IBM recruited me to program after the war, so I entered as one of few who had learned how to program back then.
IS THIS FOR DAY TRADERS OR DIY INVESTORS?
This is definitely not a day-trading solution. Trending Stocks provides analysis at the end of every business day and therefore, it’s not suitable for day trading. It’s after-hours based.
The tech is suited for a long-term, DIY investor and anyone who’s a newbie or wants to get involved in the market. Aside from managing risk, being a diligent trend follower helps with wealth growth over time.
Once an individual has confidence they’re working with good investable trends and a solid risk management process, it’s an easy plan to follow and platform to supplement that plan.
Difference Between CFD and Shares
Contracts for Difference (CFD) trading and share trading vary primarily in that when you trade a CFD, you speculate on a market’s price without acquiring ownership of the underlying asset, but when you trade shares, you must do so.
The main distinctions between a share and a CFD are ownership and leverage. You become the owner of the shares when you purchase shares. Investing in shares is equivalent to acquiring a modest ownership share in a business you support. You must pay the whole share price when purchasing stock shares.
Contract for Difference is referred to as CFD. Without holding the underlying asset, you can speculate on the price of a security by engaging in online CFD trading. A stock, stock index, currency, commodity, or cryptocurrency might all be the underlying security for a CFD. With CFDs, you may join a trade with a lower initial investment because they trade on leverage.
Trading CFDs involves taking into consideration leverage and margin, fees and charges, instrument categories, going short, and asset ownership, which is one of the primary difference between CFD and share trading. Let me elaborate more.
What are Leverage and Margin?
Leverage and margin go hand in hand when trading CFDs. By using leverage, you may acquire exposure to an underlying asset without having to put down the whole amount of money needed to purchase and hold the real asset; instead, you just have to contribute a portion of the position’s overall worth.
The amount you must initially have available to begin a position, known as margin, fluctuates based on the contract size and the underlying asset you want to trade. Margin is not a cost. Based on the pre-determined leverage for the asset class, the first margin need is expressed as a percentage of the contract value. Risk is increased while trading on margin.
When you trade on the Invest trading platform, you must have the full asset value accessible, and you buy shares without applying leverage to your available funds.
Variety of Assets
You may trade on more than 2500 different assets on the Traders Union CFD platform, including shares, forex, commodities, indices, cryptocurrencies, ETFs, and options. You may do this to diversify your portfolio and get exposure to major exchanges across the world.
The Invest trading platform is a marketplace where you may buy and sell stocks and ETFs (ETFs). You may purchase and hold shares of your favorite businesses or any listed ETF on the platform, as well as benefit from the newest IPOs when firms go public, thanks to your access to over 1200 equities and 90 ETFs.
You may acquire exposure to an underlying asset, such as Gold (XAU), Apple (AAPL), or EUR/USD, without really holding it by using a CFD. Due to changes in the underlying asset’s price, you will either gain or lose money. The goal of CFD trading is to bet on changes in an underlying asset’s price. The size of the stake and price changes determine any profit or loss.
In contrast, when you purchase a stock on the Invest trading platform, you become the owner of the physical asset and look for a potential longer-term rise in the asset’s value before selling it.
A Little More About How CFDs Can Differ From Investing
If your position remains open overnight while trading CFDs, you will be charged an overnight fee. While CFD trading is frequently utilized to speculate on near-term events like earnings announcements or the release of U.S. data reports, stock trading is typically favored for constructing portfolios.
In summary, both CFD and share stock trading offer benefits and drawbacks, and both let you profit from price changes that might result in either a gain or a loss. You should be able to choose which Traders Union platform best matches your trading preferences after you have an understanding of your trading goals. Which trading platform—CFD or Invest—does best for you?
Hillenbrand Should Spinoff Their Casket Business. It Would Mean 50% Upside For Shareholders.
As humans, we find death a difficult topic as it brings up a lot of feelings of anxiety, fear and awkwardness. As well as sadness. It’s extremely unsettling to think of our mortality. We tend to put it out of our minds, but as with taxes, death is an absolute certainty, as Mr. Benjamin Franklin so succinctly put it.
Here at The Edge, we to seek out untapped shareholder value as well as underperforming companies for Activist investors. Furthermore, when we find them, we also need to explain exactly how that can be achieved. Sometimes companies are sitting on hidden value and at other times, they just need to be given a push to consider looking more closely at finding and ultimately realizing that value for shareholders.
One company that came across our radar two years ago was Hilllenbrand (HI), currently trading at $45 a share. This Indiana based company is listed on the NYSE and has a market capitalization of just over $3 billion. It has many businesses in the industrial sector that complement quite nicely together. The business it has that sticks out like a sore thumb and that doesn’t fit with the rest of the company is its “Batesville” business, which is involved in the manufacturing and sale of funeral service products, including burial and cremation caskets, cremation containers and urns, other personalization and memorialization products and technology applications for funeral homes. The following is all from our March 31, 2022, report with some recent updates and is available on request.
Timing is Everything. Why Now?
Over the last two years, the management at Hillenbrand HI have continued to progress with the transition away from just selling caskets in the death care business to becoming a large diversified industrial company. At the time, we acknowledged that with the help of an activist investor, the company can come off its 2008 lows and create value for shareholders. However, a lot has happened between then and now that has made a Spinoff of the casket segment even more compelling.
If HI’s stock price hadn’t doubled, there would have been a risk that the market cap size for Batesville would have been too small and been kicked out of the SmallCap 600 Index, and shareholders would have incurred index selling pressure. Likewise, HI’s debt at the time was around 4x and would have presented a challenging split. Now, using the stable and predictable cashflow from BATES, the debt has been brought down to about 1.5x as of Q1 2022. And finally, with someone new at the helm who has seen first-hand what kind of value a Spinoff can create, there is a greater opportunity for a Spin today. This doubling of the stock actually puts Batesville at the right size (larger market cap) and the right leverage point for a smooth break-up;
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HI has increased its industrial focus from a 70/30 revenue split to an 80/20 split. Over the last two years, the management at Hillenbrand, Inc. have continued to progress with the transition away from just selling caskets in the death care business to becoming a large diversified industrial company. The move away from HI’s 100+ year old legacy death/burial business first began after a string of acquisitions starting in 2010. Initially, the Batesville Casket business was the only segment, contributing to 100% of the business. Now, after recently acquiring its Molding Technology Solutions business (Milacron Holdings Corp. (MCRN) for $1.9 billion) which closed on March 30, 2020, this has increased the percentage of the industrial side of the business from 70% of the revs to just over 80% (or on the flipside, Batesville previously contributing to 30% of revs to only around 22% by FY21 and 9M2022).
Revenue Break-Up: Latest Fiscal Year End
Batesville in 2022 is the Right Size for a Spinoff
In March 2020, HI was a $1.4 billion Market Cap ($3.1 billion EV) company. Today, HI is a $3.3 billion Market Cap company, with a $4.1 billion EV. Back in 2020, while the minimum market capitalization restrictions would have been lower than what it is today in order for both the RemainCo and the SpinCo to remain in the S&P SmallCap 600 Index to prevent any near-term index selling pressure, other complications surrounding its debt would have arisen. Therefore, the SpinCo (suggested ticker BATES) is in a much better state to be listed today, creating a pure-play, high free cashflow generating business. See below for our different market cap scenarios.
A separation in March 2020, based on the revenue distribution, would have resulted in a higher leverage for Batesville (BATES) on a standalone basis (4.3x). Furthermore, the split would have led to Batesville leaving the S&P SmallCap 600 in March 2020 as the criteria for inclusion required a minimum market cap of $600 million to remain in the SmallCap Index.
If the management wanted to shift debt in such a proportion to allow Batesville to remain a part of the SmallCap Index, it would have required a 42% distribution of debt, which would have led to a higher leverage of 6.2x for Batesville, making it even less appealing for investors as a standalone company
If HI plans to split the company based on the revenue contribution in today’s terms (as of February 2022), even though the leverage seems more appreciable than in March 2020, the market cap would still lead to Batesville being kicked out of S&P SmallCap 600 Index, as the most recently updated criteria requires the minimum market cap to be around $850 million, which is higher than our scenario putting Batesville’s market cap at around $619 million. However, if we adjust the debt distribution to allow BATES to remain in the S&P SmallCap 600, the below table is the ideal debt distribution scenario:
Based on the above scenario, a 73%-27% split would lead above the minimum $850 million market cap needed for BATES to stay in the S&P SmallCap 600 Index and will also give a leverage of 2x, which is less than the combined Parent’s 2.3x. At a leverage of 2.3x (Scenario 3) or 1.4x (Scenario 2), the leverage is way lower than the peer average of 3.7x (CSV: 5.4x, MATW: 3.8x and SCI: 3.6x). Therefore, this gives HI’s management even more room to manage and distribute debt among the RemainCo and the SpinCo.
If we assume management decides to assign enough debt on BATES that the leverage trades in-line with peers (around 3.7x), this requires a debt distribution in the ratio of 51%-49% for Advanced Process Solutions & Molding Tech Solutions and BATES, respectively. This would lead to a market cap of around $1.6 billion for BATES and a $1.7 billion Market Cap for the RemainCo (with a favorable leverage of 1.4x).
Enticing Proposition of BATES Expanding Its Business as a Standalone Entity
After HI’s biggest acquisition of Milacron in March 2020, the company’s debt was around 4x and therefore why we mentioned this higher leverage would have presented a challenge for a break-up at the time. However, over the last two years, the management have used the stable and predictable cashflow that Batesville (BATES) generates to bring that debt down significantly to about 1.5x as of Q1 2022. This was made clear in HI’s most recent transcript (Feb 3, 2022), where the management said that “our next strategic pillar is to manage Batesville for cash.”
However, when asked about the long-term shift towards cremation (as peers have been), this topic is never fully explored, and the management highlighted a slight decrease in the revenues was due to an increase in families opting for cremation. In fact, close to 55% of all funerals in the US currently are cremations. The real question is whether BATES becomes an independently listed company and uses this predictable cash to expand and improve their FY22E margins (20% compared to over 30% like its peers SCI and CSV), especially to pivot from the relatively high mortality rate seen in 2020 and 2021.
The table above highlights the high conversion rate of FCF HI has achieved, which proves their superior debt-paying capabilities and ability to manage higher operational scaling (if required) based on its own funds. Furthermore, the management has proudly highlighted they have been able to achieve a 100% FCF conversion rate over the past decade, which shows both BATES and the remaining HI business (Advance Process & Molding Technology Solutions) are high free cash flow generating divisions.
Batesville (BATES) derives 89% of its business from the sale of caskets, whereas its peers have a mixture of casket sales and funeral services, and we believe the services business is helping these peers achieve better operating margins compared to BATES. Currently, BATES is expected to report a margin of around 20%-21% for FY22E, primarily through selling caskets. Peers SCI and CSV are expected to make around 30% and 33%, respectively, owing to their revenue mix. We believe a separation into an independent company will allow BATES to leverage on its operational performance and potentially venture into the higher margin Funeral business and Services as well as the cremation space, thereby improving its operating margins and increasing investor wealth.
HI has Underperformed Its Peers and the Broader Market
From 2020 to 2021, HI’s stock price went from as low as $14.29 (March 18, 2020) to over $45 by the end of February 2021. This was reflected in its 2-year TSR annualized (shown below), but historically HI has always been on the lower-end of the TSR chart versus its peers and Index with respectfully a better performance recently.
Total Shareholder Return: HI Vs. Peers & Index
Finally, the management are no strangers to value creation from Spinoffs. There is a new CEO on board after the previous CEO of HI was there for the last eight years and with the company for 27 years. Joe A. Raver retired at the end of 2021. HI’s new and current CEO (as of January 1, 2022) is Kimberly K. Ryan. Ms. Ryan has been on the board of a company that previously performed a Spinoff. She was a board member of Kimball International KBAL (KBAL) since January 2014, which performed a Spin of its Electronic Manufacturing Services business called Kimball Electronics, Inc. (KE) on November 3, 2014. KE jumped +128% in its first year from the Spinoff, so Ms. Ryan has seen first-hand and can appreciate the value creation potential following a break-up.
With a stock market that has taken a bashing, companies need to think of their shareholders as the economy tightens its belt and further consider how they are going to offer value for the holders of their stock. Hillenbrand seems an obvious candidate for hidden value release.
Our one-year Base case target price is $67.36 for HI, implying a potential upside of +45% from the current share price of $46.57. However, our Sum-of-the-parts target price comes to around $78.99, which implies a potential upside of +70%.
Peer Comparison Matrix for the Advance Process & Molding Technology Solutions
Peer Comparison Matrix for the Batesville Segment
Finally on July 20, the company have announced a strategic review of their Batesville business. We believe the correct route for them is to Spinoff the business to existing shareholders to maximize value.
If you are an Activist investor looking for companies like this or you are a regular investor looking to take advantage of price moves due to corporate change, please contact me and experience our service.
The author owns shares of Hillenbrand Inc.
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