Looking at China; Tesla Shareholders, Beware: Best of Kass

TheStreet.com

NEW YORK (TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.

Among the posts this past week were items about whether the economy is in a recession and signs of a market topping process.

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10 Reasons I'm Looking at China

Originally published on Friday, May 9, at 7:18 a.m. EDT.

I plan to initiate a small starter position in FXI (long) this morning.

As is very well known, the Chinese stock market has performed poorly both in a relative and an absolute sense over the last five years.

Here is a chart that depicts the conspicuous difference in the performance of the iShares China Large-Cap ETF  and the SPDR S&P 

There is no reason to rehash the multiple reasons for the weak performance of China's stock market, such as slowing domestic economic growth, a property bubble, opaque reporting/accounting, etc.

I have spent the last week researching potential opportunities in China and I have concluded that the almost universal (and consensus) hatred for the region's markets and skepticism of China's economic growth trajectory could resemble the consensus (and wrong-footed) short bond thesis that existed at the beginning of this year.

I am seriously considering a meaningful long position in this contrarian play (FXI) based on the following 10 observations and conclusions.

  1. The main risk to China's stock market and economy is a weakening property complex that leads to a 10% (or more) decline in construction activity, which will adversely impact related commodities, the industrial complex and local government finances, serving to lower real GDP by 2% (or more).
  2. China's property downturn may be more manageable than the consensus believes. The valued economists I speak to are looking for more balanced economic growth of 7.2% real GDP in 2014 and about 6.7% next year.
  3. The  probability of a property downturn that leads to real GDP declining to 5% or less (in 2015) is likely only about one in five (20%).
  4. Despite general concerns, most indicators of the state of housing (prices/activity) in Tier 1 cities are fairly stable, but fears of Tier 3 cities' inventory-to-sales ratios have risen and have to be monitored.
  5. An important positive relating to housing is that the Chinese household sector is not particularly leveraged as most Chinese consumers are using their homes as a vehicle for savings, given the better-than-10% wage growth trends and a favorable taxation of property income in China.
  6. The threat of a financial crisis in China might be overplayed given the high degree of liquidity. Non-performing loans in the banking industry are only about 1%. In the public sector, the Chinese government is capable of issuing bonds to battle any liquidity problems at that level.
  7. China's labor market has a lot of slack, even though stated unemployment is low, as nearly one quarter of the employed are in the agriculture market. These employed can be transferred into other sectors. Moreover, productivity is still low, leaving room for improvement and sustained economic growth.
  8. China's political leaders will not allow too much of a slowdown as they fear social unrest. Property market weakness can be buoyed by easing credit.
  9. Political corruption is slowly receding, serving to reduce business costs and improve profitability. Until recently, companies had no discipline on expenses with unlimited spending on corporate boondoggles and gift giving.
  10. PBOC is lowering interest rates, doing unsterilized intervention and is comfortable with the current value of the country's currency. 

China price-to-earnings multiples are low.

The sectors within the Chinese market I am looking to buy are in services, e-commerce, automation and mid-level manufacturing. 

For now, I plan to initiate a small starter position in FXI (long) this morning.

Probably the only thing keeping me more than my feet wet in China is my general stock market cautiousness.

At the time of publication, Kass was long FXI.

 


Tesla Takes Shareholders for a Ride

Originally published on Thursday, May 8, at 2:15 p.m. EDT.

Tesla's management received a multibillion-dollar transfer of wealth from the common shareholders.

Yesterday as we all know, Tesla Motors  released its first-quarter 2014 earnings report, and, based on my analysis, there was less than meets the eye.

But even more egregious (by a factor of let's say 400x!) was a line item in the Tesla's 2013 annual report regarding the company's issuance of stock options.

We all recall several months ago that my friend/buddy/pal David Winters began a public quarrel with Coca-Cola's  management.

David felt that there was an excessive transfer of wealth to management via a too-generous option program.

Based on my analysis below, I suspect that Tesla's Elon Musk was not listening carefully to either David Winters or Warren Buffett.

Buried deep within Tesla's 2013 Form 10-K, it was revealed that the difference between the value of the options issued and the market price (intrinsic value of the options) rose from $317 million to over $2.8 billion last year.

In other words, Tesla's management has received a multibillion-dollar transfer of wealth from the common shareholders.

The difference of nearly $2.5 billion (the benefit accrued by virtue of the price appreciation in Tesla's shares last year) obviously dwarfs Tesla's balance sheet and has entirely been ignored by the analyst community.

I reshorted Tesla on the rally at midday.

At the time of publication, Kass was short TSLA.

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