Motley Fool on FMD

Motley Fool has a very good and accurate article out today on First Marblehead (FMD). As I've said here before, the risk/reward characteristics of this stock are extremely compelling right now. It is my largest stock position at this time and I anticipate being a very long-term holder. Here is the link:

Motley Fool article on FMD

Peak Oil, Price?!

Jeff deGraaf had some interesting and insightful comments this morning:

"Energy weakened Tuesday, and none too soon. We've maintained a bearish stance on the commodity, and drew a line in the sand at $67 (see last week's daily), believing that a multi-year top may be in the making. We cynically believe that governments buy assets at peaks and sell them at lows (part of their social and moral duty), and as such we believe that Venezuela's expropriation of oil fields is a classic example of yet another government "buying" near the peak. The stocks look more vulnerable to consolidations than bear markets, but we expect underperformance at a minimum through most of the summer."

What do crude oil prices and Chinese stocks have in common?

Massive amounts of speculation are driving prices higher!

Global OTC commodity derivative exposure figures were released last night by the Bank of International Settlements. Open positions hit a new record as of December 2006.

Assuming just half the OTC exposure is in oil and that the average transaction price was $60/bbl, the size of the outstanding position equates to 53 billion barrels of crude which is about 21 months of what the world actually consumes and more than 20-times the size of current open interest for NYMEX oil. Guess what happens when this position eventually unwinds! Personally, I can't wait for that to happen.

Yield Curve Steepening a Positive for FMD

The 10-year Treasury minus the 3-month T-Bill is now a positive 3 bps. This is good news for FMD as management was worried on the last conference call about the inverted yield curve causing increasing prepayments (borrowers consolidating short-term variable loans for long-term fixed). At the time, management thought that the inverted yield curve would persist for some time so they increased the prepayment assumption which lowered earnings marginally and caused analysts to cut estimates somewhat.

I continue to believe that all of the worries about FMD - potentially increasing defaults and prepayments, potentially lower loan volume with BofA and JPM because of a pending minority private equity stack in SLM, and potentially lower profitability from new legislation - are way overblown creating one of the best risk/reward opportunities that I've seen in years.

Refiners and Utilities Suck

I'm a free market guy and not a big conspiracy theorist, but damn it, it's time for the Feds to investigate the refiners for price collusion! These gasoline prices are beyond ridiculous and costing consumers billions. There is no shortage!! It's also time to ease regulations. There is additional international capacity coming on-line next year, but something needs to be done now.

My local utilities need to be investigated too. For example, my gas company raised my usage fee by 100%! How can a regulated utility get away with what amounts to a big rate hike! Slimy bastards!

FMD

The stock is up today on takeover rumors in the mid 50's. Don't be surprised if it happens as FMD is a splendid company with tremendous value at these levels. I would buy this whole company if I could.

I'm out

After sleeping on it, I sold CCRT this morning and bought more FMD. The earnings miss and a couple other things (fee rebates and lower return acquisitions) really bothered me. At this point I think management will have to execute perfectly to make over $4 in managed earnings and this is a very tough business with lots of uncertainty. I might own the stock again at some point but I like the risk/reward of FMD much better here.

CCRT reports weak first quarter

How ironic....CCRT basically misses earnings estimates because credit quality was better than expected resulting in lower late and over-limit fees....so the shorts who thought credit quality was a major issue get rewarded anyway. And to really piss me off, a stock that I sold to buy CCRT....FWLT, is up at 18% today. These are the days that I wish I just had all of my money in funds. It's just not worth the aggravation!!

VLO and HANS

The refining cycle is very close to its peak and margins will likely fall significantly. Get ready to short VLO....it's over-extended and fundamentals are deteriorating. The bulls have a blind eye to this one.

HANS looks like a super growth stock and trades at a reasonable 19 times forward earnings. The Monster drinks are a huge hit and the company has other potential home run products like "Java Monster," a coffee/energy hybrid drink that could explode.

Good news for global growth

Nicolas Sarkozy has won the election in France, beating his socialist rival. Some things on his agenda are cutting taxes, opening up markets, reforming the welfare system, rolling back the 35-hour work week and making over-time pay tax free.

FMD = Super Value Stock

I ran a dividend discount model on FMD today and its shocking how undervalued this stock is on that valuation basis, and FMD doesn’t even pay a large dividend. Here were the assumptions that I used:

Growth rate = 20% for 5 years (this is much lower than their historical growth rate and in line with the 20%+ industry rate)

Growth rate at maturity = 8% (tuition increases + enrollment gains will probably always grow faster than GDP)

Transition years to growth rate at maturity = 15 (basically assumes about a 1% decline in growth per year)

Risk Premium = 7% (means that investors will demand a 7% return over the risk-free rate in order to compensate them for owning the equity)

Payout during growth years = 13% (current payout rate)

Payout at maturity = 45% (slower growth means a higher payout rate)

The theoretical price was $115 per share or 210% higher than the current $37 share price. I actually made these numbers more conservative than what Bloomberg suggested. Go ahead, find a Bloomberg terminal and plug these numbers in to see for yourself!

More on First Marblehead (FMD)

Tom Brown at Bankstocks.com once again wrote a fantastic piece on FMD. One thing that I was not aware of was how quickly First Marblehead is growing their highly profitable in-house Astrive brand. This is absolutely amazing! Here is what Brown had to say:

"As I mentioned earlier, Marblehead’s in-house test Astrive brand has gained considerable momentum. So far in fiscal 2007, Astrive has accounted for roughly 10% of facilitations; that implies it’s done roughly $300 million year-to-date, and will finish the year at around $375 million. By my reckoning, that would make Astrive bigger than Bank of America for Marblehead in the direct-to-consumer channel. Recall, too, that this is extremely profitable business, since Marblehead doesn’t have to pay out a whole loan premium to a lending partner.

The emergence of Marblehead’s Astrive business in the past few years is highly significant, in my view. Ever since we started talking about this company, the skeptics have worried that Marblehead would be toast if BofA and Chase ever severed their relationships with it. In fact, that hasn’t happened; both BofA and Chase have continued to grow their business with Marblehead very rapidly. And yet at the same time, Marblehead has been able to build up its in-house Astrive brand, from basically zero three years ago, into a business that now generates earnings that rival the earnings Marblehead gets from those same worrisome Big Two. Tell me again how reliant the company is on them?"

This is a much more significant data point than the minimal prepayment assumption increase. The more FMD can reduce customer concentration, the lower the risk premium (and higher the P/E) should be on the shares since investors typically pay up for less risk.

Here is a recap of why I like I love the stock:

FMD has declined from $57 into the $30's based on a number of misperceptions, including 1) that new legislation will significantly hurt profitability 2) that BofA and Chase will move their business to Sallie Mae and 3) that increasing prepayments, defaults and competition will materially harm profitability.

These misperceptions have generated a ton of fear and caused a fire sale. Right now, you can buy the shares at about 9 times earnings or a PEG ratio of about 0.45 based on their 20%+ growth rate that could last for many years given 20% to 30% industry growth and FMD's extremely strong competitive position. To put the icing on the cake, FMD generates high returns and a boat load of cash to give back to shareholders in the form of dividends and repurchases. The stock should probably trade in the 13 to 14 times earnings range, maybe higher.

First Marblehead (FMD)

FMD missed Q3 earnings estimates the other day, but their results were actually very strong. The reason the company missed was because management proactively increased the prepayment assumption to 8% from 7%, thus reducing earnings by $16 million. The initial reaction by investors, of course, was to panic once again. Forget that the company still increased earnings by 21% and revenue by 20% while the stock sold for a ridiculously cheap 9 times earnings!

After listening to the replay of the conference 3 times, I continue to be highly bullish on the name. Management actually states on the call that prepayments have gone down and stabilized, but they are worried that if the inverted yield curve persists, the prepayments will go up based on history. While I appauld the proactive and conservative approach, the other side of me thinks that they are being overly cautious. I don't think that it's necessarily the inverted yield curve that causes prepayment activity, but rather very low long-term rates, and the latest inversion was caused by short-term rates spiking higher not long-term rates falling.

I have a lot more to say about FMD and other things but I'm very pressed for time so good-bye for now.