VALUE: After Hours (S08 E10): Tim Travis on Private Credit $OWL $OBDC and $MSDL; Energy $DVN, $OXY and $EPD; and $AGO

TRANSCRIPT

[Tobias] We’re live. This is Value After Hours. I’m Tobias Carlisle.

Jake is on vacation. So it’s just Tim Travis, special guest, and me. We’ll be co-host, special guest.

How are you, Tim? Good to see you again.

[Tim] I’m doing well. So happy to be here, Toby. Thanks for having me.

[Tobias] Tim is founder, manager of TNT Capital. He’s got expertise in financials and private credit. So that’s what we’re going to be talking about a lot today, plus other things in value generally, maybe some options discussion.

That sound good?

[Tim] Sure. Sounds great. Yeah.

It’s a crazy time, a lot of interesting and dire headlines. So it’s a good time to chat for sure.

[Tobias] Well, let’s start with private credit because there’s a lot of headlines about how bad private credit is. What’s your view?

Private Credit Panic Explained: What Investors Are Getting Wrong

[Tim] So I think there’s a lot of misunderstanding. So private credit is very broad. I mean, basically what these funds are, they’re basically bond funds.

And so it’s private loans to companies of different sizes, different of the BDCs have different size kind of requirements or size targets that they have. And they’re, for the most part, most of these like publicly traded, larger BDCs are really dealing with first lien loans. So like 90% or higher are first lien adjustable rate loans.

And there’s some confusion because you have the publicly traded business development companies like Blue Owl Development Company, OBDC or Morgan Stanley Direct Lending or Blackstone Secured Lending. You have those where it’s permanent capital. And so there’s not the ability for investors to ask for their money back.

It’s just like a public company where a lot of the controversy is, are these private funds, these private BDCs that have been sold for many years. And one of the reasons why people buy those privately traded ones is because they don’t have kind of the mark to market volatility as much. I’ve never sold one in my life.

I don’t find it super attractive, but some people do. And so what’s occurred is that last year there was a couple bankruptcies. There was First Brands and there was Tricolour.

And what’s interesting, Toby, is they were bank syndicated loans. They were not private credit loans. And there was fraud involved with both.

Like with First Brands, for instance, it was factoring loans. So basically people buying their receivables that were double or maybe even triple pledged. So there’s fraud, they’re bank original loans, but that impacted private credit stocks sold off in relation to that.

And then going into this year, you have the AI hysteria. And so it’s like, okay, well, AI is growing so fast. It’s such a big unknown of what the final impact will be.

How is this going to impact all these software companies? Are you still going to need Salesforce? Are you still going to need Adobe, HubSpot?

And then there’s obviously there’s so many smaller software companies that have kind of mission critical or not mission critical tasks that are associated with them. So as software stocks sold off, so did software loans. The growth has been in technology.

So there’s been a lot of private equity buyouts of technological companies, including software. And so if you look at some of these business development companies, they might have like 20% or even 30%, not so much 30. There’s one or two that might have that exposure to software companies and a variety of different types of software companies, of course.

Now, what’s interesting is historically, Toby, those have been the best performing loans in the portfolio. But everything’s kind of getting painted with the same brush. And these privately traded business development companies that you don’t see stock tickers for, they have gating requirements about how much money can be taken out each quarter.

And so because there’s all these negative headlines, you have a situation where because you’re seeing so many headlines, people are trying to rush out of these funds. And these are not super liquid assets. And so you create this mismatch of liquidity.

And that’s really what the hysteria is in a nutshell, kind of went on a long time there. But that’s it in a nutshell.

[Tobias] That was a good explanation. So private credit has this issue with headline risk from first brands and TriPoint. And then Blue Owl’s in the news a lot, but that’s their private fund.

Blue Owl (OWL) and OBDC: Hidden Value in Private Credit Stocks?

[Tim] Yeah. Well, Blue Owl’s got a variety of different. So Blue Owl itself, OWL the ticker, they’re an asset management company.

Okay. So they’re collecting fee income. The asset management company itself is not taking credit risk.

And what’s unique about their model is that they have a tremendous amount of permanent capital. So like 85% of their fees are from permanent capital. And so 300 billion is in locked up AUM.

So their fees are very durable. But people are worried about one segment of the funds that they manage, which is private credit, but they’re forgetting about they’re also financing the data centres. They’re financing a myriad of, they have asset-based lending.

So there’s all these things associated with them. But what’s interesting is to see an asset manager trade down so radically. I mean, I think when they went public, they had some, don’t quote me on the exact number.

I think it was something like 65 billion under management. Now it’s well over 300 billion. I think it’s like 360, 370 or something like that.

And the stock is actually cheaper than where it was when it went public. These companies like a Blackstone, they trade on distributable earnings and it’s trading at about 9.4 times distributable earnings. And it has a dividend yield of 10.3%. So really, really cheap. I think it’s a fantastic long-term investment opportunity. You don’t really get this type of quality. This is a much higher quality business than like a bank, right?

I mean, where you’re taking a lot of credit risk, it’s more heavily regulated, all of these things. The margins on Blue Owl are four to five times higher than most banks have. So it’s an interesting environment for sure.

[Tobias] So there’s some sort of bank run then going on in Blue Owl’s private credit fund.

[Tim] In the private credit fund. Yes. So what happened was on these private funds, where it’s not permanent capital, they might have something written in the prospectus where it’s like, okay, in 10 years, we’re either going to liquidate the fund or we’re going to merge it.

And so their initial plan was they were going to merge it with their publicly traded BDC, which is ticker symbol OBDC. And at the time when they came up with this idea, OBDC was trading around book value. So it’s like, okay, not a big deal.

When these private funds redeem, it’s at net asset value historically. And so it’s like, okay, we’ll merge it with that. We’re going to cut some costs associated with it.

It’ll be a good thing. Similar portfolios, just different size, that sort of thing. But then what happened was with the bankruptcies that occurred last year in the bank syndicated, which is different, the valuation sold off on OBDC.

And it’s like, okay, now I’m going to take a 20% haircut if we do this merger, that’s not going to work. So Blue Owl was working on solutions. Some of these people wanted money more quickly than others.

And so basically what they did was they sold 1.4 billion of loans from the private BDC and then also the publicly traded BDCs because they have similar portfolios. And they sold it for 99.7% of par, which is phenomenal, phenomenal result. And so they basically said, okay, we’re going to accelerate.

We’re going to give you back 30% of your money now. So you’re going to get that check, but then we’re going to stop the normal gating process and we’re going to unwind this portfolio over time and pay you out over the next months and year, year or so. And the media just kind of picked up on, oh, well, look, they’re restricting redemptions now.

They’ve always restricted redemptions because there’s a liquidity mismatch. You’re getting a higher yield because this money is not as liquid. And so it’s just really kind of taken on a life of its own.

And then there’s other elements to it, Toby. This is private debt. So like these software loans, for instance, that everyone’s so worried about, they’re written at 30% loan to value.

So guess what? There’s 70% cushion before we’re losing any money on these loans. But what about private equity?

I mean, what about the stock market? So if all of these were to come into trouble, there’s obviously way bigger issues at hand. And I think when you think about it, these are very sophisticated people.

Like if Blackstone has a private equity company that runs into trouble, let’s say a software company that runs into trouble, what they’re probably going to do is maybe inject some equity into it, maybe negotiate with the lenders, including the BDCs for maybe a lower interest rate or something like that. But these aren’t loans that are going to zero. They’re first thing loans where they would take the keys over for the business.

So it’s just, I think that the hysteria does not match up with the reality whatsoever. I think it’s a huge difference.

[Tobias] So the names that you like out of that, Al, which is the owner, the manager of all of the funds, and OBDC, which is the publicly traded BDC of Al, and Morgan Stanley Direct Lending.

[Tim] Yeah. So Al is the asset manager, and I love that as a long-term play. I remember when Blackstone went public, and I think it was right before the financial crisis.

And then everyone was like, oh, well, that was the top or something like that. I mean, it’s almost 20 years ago now. So forgive me if I don’t get everything right there.

And then they kind of ran into hard times and the stock sold off quite a bit. And it was like, oh man, Blackstone, they went public at peak dollar amount. And then really since the stock got hit a while, hit pretty hard, it’s been a phenomenal performer.

I mean, it’s rallied dramatically until very recently. And I think you could see a similar thing with Blue Owl, where they’ve grown really rapidly and they have a really nice footprint in a lot of different niches, good relationships, like with advisors that help distribute their funds. And I think when people actually see the quality of the earnings, the quality of the cash flows, the company going into the year was expecting to grow revenues by a faster rate than they grew last year, which was 20%.

So you’re getting that at 10 times distributable earnings, 10% dividend yield. That’s very bizarre. Honestly, it’s very bizarre.

So I like that. But then you go to the business development company. So think bond funds and OBDC, we’ll start there.

It’s trading at around 30% of a discount to its net asset value. So 30% discount, we’re talking about a 13% dividend yield. A lot of these have 12 to 13% dividend yields.

And what… Oh, excuse me. I apologise.

It’s about 25% discount to its net asset value. It’s about 30% below its 52-week high. And so what we’re doing is we’re buying a loan portfolio at a very, very, very large discount to its net asset value.

Yes, there’s some management fees associated with these funds. You can make assumptions that their marks aren’t going to be perfect from time to time and credit could weaken a little bit, but you can make some pretty dire assumptions in relation to defaults and recoveries that are made up for the fact that you’re buying this thing at such a large discount. If you’re buying it at 65% to 75% of net asset value, that’s really attractive.

And the thing that I’m watching, Toby, and I think the thing that other investors should really advocate for if they’re in this space whatsoever, is these management teams need to think long-term and not short-term. Buy back your damn stock. You know, buy back the stock of both the BDCs and your asset management company if you’re Blue Owl.

And they are doing this. Insiders are buying as well. So they’re eating their own cooking, but I think the more of that you see, the better it’ll be.

And even if the losses get a little bit worse with the private credit loans, you’re going to offset a lot of that by buying the whole portfolio at 70 cents on the dollar. Think about it. If you have 10% defaults and you have 50% recoveries, that’s 5%, right?

But you’re buying the portfolio at 65%. Now there is a little bit of leverage. There is a little bit, but not that much.

These are not banks. These are not 10 to 1, 5 to 1. It’s like leverage is 1 to, well, some of them, like Blue Owl technology is like 0.75 to maybe like 1.25 on the high side. Not heavily levered investment vehicles.

[Tobias] So a lot of those asset managers have sold off over the course of the last six months. I think Colbert Kravis has sold off and a lot of them have sold off. Is that associated with private credit?

Yeah.

Why Asset Managers Like Blackstone, KKR, and Blue Owl Are So Cheap

[Tim] So they all have pretty much. So Blackstone sold off, KKR, Aries, and then Blue Owl, of course, and there’s others as well. And so I think it’s an interesting opportunity in a lot of the space.

We’ve sold some cash-to-care puts on KKR, on Blackstone, on Aries, because you’re getting, with the volatility as high as it is, you’re getting to get some, you’re getting to manufacture some pretty low valuations for high quality managers. And once again, these are way better businesses than banks. Like banks, I’ve been, you know me, I’ve been an advocate for Citigroup for a long time when everyone was saying how terrible it was and when you could buy it at 60% of tangible book value.

And it’s like, well, you know, if they get to 10% return on tangible capital, it gets the book value again. And it’s at 100. Now we’re at 110 on Citigroup.

These are nothing like the banks. These are way better businesses, way higher margins, way better growth prospects. And it’s interesting because these are so cheap.

And I’m not talking about the BDCs, by the way, I’m talking about the asset managers, the manager of the BDC are way better business. BDC is a loan portfolio. It’s a bond fund.

But these are way better businesses, way better growth prospects, way higher margins. And the banks are trading pretty expensively. So you’d think that if there’s credit issues on first lien loans in private capital, you’d think you’d see some of these banks trading at discounts to book value or at least low multiples.

And that’s not the case at all. And I’ll grant you, it’s a good environment for banking with M&A and with the yield curve. And I think the administration’s pretty bit favourable towards banking.

But I think that there is a disconnect there.

[Tobias] Let’s come back to the yield curve in a moment, but just walk us through the mechanics of the cash secured put sale. So for folks who don’t know, that’s a bullish bet on the stock, but it sounds when people hear put, they probably think that you’re buying protection, but you’re selling the protection. And so just walk us through the math of that transaction, the way you think about it.

Just in broad terms.

Cash-Secured Puts Strategy Explained (Simple Example)

[Tim] Yeah, I’ll do an analogy. So let’s say you have a stock that’s trading at $13 per share, and you like the stock. You think it’s attractive, but maybe you’re conservative, you’re retired, and you want to be conservative.

You’re kind of bearish on the overall market. And so you say, I’d like to target double digits, but I want less risk than just owning the stock outright. What you could do is you could sell a put option at let’s say $10 per share.

And in this example, and this is, believe me, we have stocks that meet these pretty much exact criteria. We’re going to collect a dollar, a dollar per contract. Every contract’s 100 shares.

And so basically you’re collecting a hundred dollars up front for a maximum risk of 900, because it’s a $10 strike price. And remember we’re talking about- That’s if it goes to zero. That’s if it goes to zero, that’s what you’d lose is $900 because you collect a hundred bucks up front.

Now, keep in mind, we’re talking about a $13 stock that you’re bullish on. You’re bullish on for fundamental reasons. And so you get this situation where, and to get that type of premium, you’re probably going to go like about a year out.

So we’re in March right now. I’m going to say this is a January 2027 option. And there’s two things that can happen.

If the stock’s above 13, then you make a hundred divided by 900. So you’re making nice, whatever that is, almost 12% return on your money. And you don’t even end up having to own the stock.

Tails, if the stock’s below 10, you’re going to end up owning this stock that was trading at 13 at a break even of nine. And now you have all the upset or downside associated with that, but you’ve just endured more than a bear market in the stock before your break even point. So it’s a really, really powerful tool for long-term investors.

For short-term traders and stuff like that, it’s not as good because what really matters is just the next couple of days. We’re not trying to necessarily time it except for maybe nine months out on the options, and we’re happy to own it anyways. So I don’t recommend doing that unless A, it’s cash secured, or B, you’re willing to own the stock, which we are in all circumstances.

[Tobias] And so the outcome is that it’s trading at 13 and you’re underwriting to buy it at nine.

[Tim] Correct.

[Tobias] And you’re paying a dollar for the risk that you take it out at nine and you want to buy it, but you’re bullish on it at 13 anyway.

[Tim] Exactly. And so right now with all this volatility in the space with stocks like Blackstone, like Blue Owl, like KKR tanking, you’re able to get really attractive premiums way below the current stock price. You’re catching a falling knife to some extent, but that’s what value investors do.

And this is actually, it’s a nice kind of protective element for a value investor because as you know, Toby, our ilk tend to be too early, right? And maybe sell too early too. And so it provides kind of a discipline to take your time.

And it also provides some diversification in that these are strategies that can work well, even if the market’s relatively flat, which is, I mean, unless the market does anything close to what it’s done in the last 10 years, which I don’t believe will happen. I think that having those types of variety of strategies in your portfolio can make a big difference.

[Tobias] Good stuff. Let’s go back. Let’s talk about the yield curve a little bit.

The yield curve was inverted for a very long period of time from 22 until I think late last year. That might be the longest one. The data doesn’t go back that far on the Alfred website.

It might be to the sixties or something like that. And when I raised this with somebody else, they said, there are longer inversions if you go back further in the history, but I haven’t been able to find the data series for that. But it’s a very long one going back to the sixties anyway.

And I don’t think there’s been one deeper. And there has been this theory in the past that those yield curves inversions precede recessions and so on. And I don’t know if it’s the Fed lifting the front rates and creating things.

It makes it difficult for the banks to make a lot of money because they tend to make their money on that spread. So the normalisation is great for banks and has been better for the banks. Are you seeing that sort of flow through?

[Tim] Yeah. I think that it’s a really good environment for the banks, but I think that the stock valuations for the most part, especially of the larger banks, I don’t think there’s a huge margin of safety there. I love Bank of America.

I love JP Morgan. I love Morgan Stanley. Citigroup, I don’t think it’s a great company, but it was a great stock at a low valuation.

I think where there is some value on the banking side is some of the smaller ones. I feel like Ally around $35 is pretty cheap. Obviously, people are getting worried about higher oil prices and hindering people’s ability to pay their car loans.

So that’s probably why the stock sold off a bit. That’s valid. You and I were talking earlier about the economy and you have good capex with all these data centres and stuff like that.

But for the average person, it’s not a great economy. It’s really hard. It’s such an expensive economy.

Even if you’re making pretty good money, the cost of living is super high and that’s before oil prices have rocketed higher. So I could see why something like an Ally would sell off. I think that that’s rational.

I think there’ll be an opportunity there. But yeah, that’s what’s interesting. One other comment I wanted to make about the BDCs is that, remember during the financial crisis, it was kind of a one-way bet on an asset class, which was housing.

It was housing, you had fraudulently underwritten mortgages. So that was huge. A huge part of that that doesn’t really get properly explained is how large of a percentage of the losses were due to fraud.

But it was all kind of related to housing, mortgages, and then there were synthetic bets on it. CDO, CDO square, that sort of thing, where it was all the same way bet. These BDC portfolios, these are different companies.

And the average portfolio position size is like 40 basis points, so 0.4%. So it’s not a systemic issue. They’re not all going to be zeros. They’re going to be kind of non-correlated, one-off type issues for the most part, is how I would imagine.

But yeah, I could see areas like one main financial, which is subprime lender, even though they’ve done some pretty good things over the years as far as from a business perspective. And then some of the car lenders, they’re going to be pressured from the higher oil prices, I would say.

Housing Market Crisis: Why Home Sales Are at Historic Lows

[Tobias] I put this little chat up this morning on Twitter from Nick Gurley, who’s ReVenture. He tracks the … Let me just get exactly what that chart was, because it’s just escaped my mind at the moment.

But basically, he’s looking at pending home sales hit the lowest level in history in February. And it’s all … There’s been a series since probably 22, 23 maybe.

And they’re all tracking beneath the global financial crisis lows. So since 22, 23, home sales have been below the global financial crisis lows. I find it’s an extraordinary statistic, because we’re almost 20 years later.

The economies should be substantially bigger. There should be more people.

[Tim] There should be more home sales, there’s not- I agree with you. As someone that’s bought and sold in the last year, I can explain it. Affordability is terrible for buying a home.

It’s a terrible time to sell your home because you’re giving away an interest rate that’s way lower than what you had. And and the gap between buying a home and renting. Renting is so much more affordable than buying right now.

And sellers are just realising that there’s not the demand for their home at the current prices. There has to be some type of correction, whether it’s on listing prices or mortgage rates for you to see more transactions. So it’s just a stagnant, stagnant market.

And these higher oil prices are not going to help. But I don’t think it’s anything just beyond that. It’s more just affordability from both housing prices and from interest rates.

It’s just not a convenient time to sell. There’s not the demand to meet the supply. A lot of people want to sell, but they list their house and then they take them off market.

I’ve had several houses in my direct neighbourhood that have done just that.

[Tobias] Yeah, I think that’s why the consumer sentiment figures seem to be so in the toilet, just extended. So they’ve been crushed for a very long period of time, years now.

[Tim] Oh, yeah. Yeah. And the gas prices, I mean, you’re already seeing people post about it and stuff like that.

I mean, that’s just like another nail in the coffin of just how expensive this economy is. And as you and I were also mentioning, you have tremendously exciting things happening with AI, but you also have the negative human side of this, where companies are laying off significant numbers. We talked about Meta, we talked about Block.

And I have friends of mine that are really successful salespeople, and basically their companies are recording their workflow. And it’s very likely that they’re going to, at some point, use AI to replace them in some way. Sales, you’re probably more protected than you are, and maybe as an engineer or something like that.

So it’s scary. It’s a scary time for a lot of people. I think it always is to some extent, but I think there are a lot of negatives that aren’t really reflected in the overall market valuation.

[Tobias] I think that has a knock on for the consumer. The consumer cyclicals have been really smashed up. Anything that’s like mass stage, or I think the top end of the market is doing fine.

And the very expensive goods seem to be, all those businesses seem to be doing okay, but it’s the mass stage, like Lululemon, that kind of level of brand that’s really struggling through this period. I’ve got a host of these names in my portfolio that they’re trough earnings on. I mean, the earnings are doing fine.

It’s just that the sentiment around the stocks is terrible.

[Tim] Lulu is interesting, because if you go to the Jaguar gym every day, as I believe you do too, and it’s interesting because it used to all be like women in Lululemon, and now there are some real competitors there. But then you actually start to see some men wearing that. That’s the big opportunity.

That’s the upside, I guess.

[Tobias] What’s the competitor to Lulu? Aloe is big.

[Tim] Aloe, that’s right. And then for men, it’s like Vori is big. But yeah, I mean, look at Walmart though.

It’s like Walmart’s at I think like 45 times earnings, Costco’s at 55 times earnings, and then Amazon’s at 26. And then you look, like I said, I’m a huge bank. I’ve been big in the banks for 15 years, but I barely own any right now because the valuations really aren’t that compelling.

And yeah, I mean, I think that a lot of people that have money, they’re delivering groceries from Walmart. They’re not spending as much at like a Whole Foods or something like that, that’s more upscale. For basic necessities, they’re trying to economise.

And yeah, so it’s an interesting economy, very top-end, K-shaped economy.

[Tobias] For sure. It’s why the Uber pickups are always done in very nice cars, I’ve noticed recently. That’s true.

That’s true. Let me give a quick shout out and then let’s talk inflation. All right, come back.

Valparaiso, what’s up? Cleveland, Tennessee, first in the house. Valparaiso, Kennesaw, Georgia, Boise, Idaho, San Diego.

What’s up, New London? Snohomish, Bethesda. Petitique, Israel.

What’s up? Orlando, Florida. Madeira Island, Portugal.

I think you’ve won there. I think I might have to come to Madeira Island at some point. Tallahassee, Prague.

Good one. Tampa, Monterrey, Mexico, Toronto. Amazing.

Appreciate it. Hey, Mick. Thanks for calling in.

Inflation, brother, what are you seeing?

[Tim] It’s worrisome. I mean, I wasn’t as optimistic about the inflationary environment as the president was, or I felt like a lot of economists were. Obviously, the situation is so bad right now.

I mean, this war is crushing the energy market. I mean, as far as those prices are so much higher, it’s going to be so inflationary. It’s going to impact other areas of shipping.

I mean, they’re talking about it even impacting chips, chips shipping, because a lot of those do go through the Strait of Hormuz. I mean, a year ago, we thought that the tariff thing was going to be a huge, massive issue for the market. We were in a bear market right around this time last year, and it kind of reversed quick.

I’m not saying that there wasn’t an impact, but right now, this war looks really bad, but maybe there’s a reversal that it comes sooner than later, but I really hope so, because otherwise, it’s going to be really hard to get the cuts that are needed to boost housing, for instance, to boost the mortgage market, because how do you cut into $100 oil? I don’t know how that works.

[Tobias] Yeah. Do you track any of those shadow stats or any of those other trueflation or anything like that?

[Tim] What do you think their records like in terms of- I feel like it’s decent from what I’ve understood. I don’t follow them closely enough to be able to commentate intelligently though, but I feel like those predictive markets have been reasonably good.

[Tobias] There’s a weird reflex of the Feds when oil spikes, they seem to read that as inflation and jack up rates into an oil spike, which I find, they read that as being higher inflation, and the way that they combat higher inflation is with higher rates, which just seems to me like would be disastrous if we move in that direction.

[Tim] Well, you could understand what they’re reacting to, but I think you’re alluding to the secondary impacts, which are how does it impact the consumer and jobs, and that’s it. If unemployment spikes, then that will necessitate Fed cuts really irrespectively of where oil is, but we haven’t seen that in the data yet. It’s not an amazing job market, but it’s not a bad one.

It’s not a terrible one either. That’ll be another thing to watch. I think that absolutely should be the first and foremost thing on the Fed’s mind is what happens with unemployment.

[Tobias] I check in on it occasionally, that long-term unemployment chart, and you can certainly see around every recession, there’s a big spike. That’s really the thing that I understand that that’s towards the end of the cycle. It’s not a leading indicator, so I just check in to see where it’s at, but it’s been running a little bit negative.

In terms of that means there’s more unemployment for a few years now, but it’s only been running slightly negative. It hasn’t had that massive spike that defines the other ones, and that could easily just be getting back to normalisation from the pandemic whipsaw that went through that whole period.

[Tim] You also have the multiple jobs phenomenon nowadays where people are working multiple jobs. I don’t know how the immigration enforcement impacts that number either. There’s some different things there, but yeah, that’s the key data point.

That would break the economy if unemployment were to skyrocket. I think there’s enough positive things going that if this war’s relatively short in nature, as difficult as it is envisioned, I think you could see a relatively positive economic backdrop. I think that that is why the banks trade at high valuations and the market trades at high valuations.

I definitely do think that this could be the straw that breaks the camel’s back as far as the consumer if these energy prices stay this high for a long time though.

[Tobias] Let’s talk energy producers though. On the other side of that, they seem to be the beneficiaries of slightly higher energy prices here, and they’ve all had a pretty good run since the start of the year.

Energy Stocks Rally: Devon, Occidental, and EPD Breakdown

[Tim] They really have. Yeah, absolutely. I know you posted a lot of stuff on energy and the undervaluation relative to oil.

I thought you were right on. We’ve got decent exposure to energy. We’ve been big in Devon for quite some time, Devon Energy.

I really like the management team there. I feel like I like that they focus on intrinsic value per share. They look at that, okay, what’s the valuation of the stock trading at?

Is it better to buy back debt or to buy the stock back, dividend? On the mergers too, when they do these acquisitions. That’s a management team that I think has built a lot of trust over the years.

It’s nice seeing the stock being rewarded again, obviously bolstered by the war. Occidental, which was Buffett’s big pick, it languished for quite some time. Then it was interesting last year when Berkshire had the deal for the chemicals company.

I don’t think the market loved that for Occidental necessarily, but that stock’s had a really great run. Then another area where we’ve been heavy in is I like the MLPs and the infrastructure plays. I feel like those were really cheap going into this.

EPD, ET, energy transfer. ONIOC is not an MLP, it’s actually an LLC like Kinder Morgan is, which is nice. You don’t have to file a K-1 or anything like that, but along with that, you have a slightly higher, a lower dividend yield.

That one’s had a really nice run. Those are great because even if commodity prices dip pretty substantially, if you do get some key steel or something like that, the pipeline company should still do quite well. I think it just reinforces more than anything.

How do you argue against developing our local energy infrastructure when you see the crappy situation that Europe’s in? Look at Europe. They are backs against the wall because of some of the political choices that they’ve made in relation to energy.

[Tobias] It’s to America’s great fortune that we have that huge shale in the middle of the country. I think they describe America as the Saudi Arabia of gas as well.

[Tim] Yeah. We’re super lucky for so many reasons. There’s a lot of stuff beyond that.

There’s a lot of oil off California. If they ever wanted to tap into that stuff, they could. But energy security just has to be the key takeaway.

You cannot be reliant on these nations. It’s a lot more dangerous environment shipping through the Strait of Hormuz than your own pipelines in your country. What do you make of that merger that Devon has going on?

I think they’ve done good, smart acquisitions over time. I think that they prioritise reducing their debt loads after them. Like I said, they’re one of the few companies that really is vocal and has a long-term history of looking at intrinsic value per share and what creates the most value for shareholders.

There’s a logical basis there. A lot of these other companies don’t do that. They’re empire builders.

I think that that’s where the biggest mistakes occurred. I think that a stock like Devon, a company like Devon, a management team like that, you can invest a lot more confidently than you can with some of those. Exxon is a wonderful company, but remember when they bought XTO at the peak of gas prices?

They’ve done that a couple of times. There are so many transactions like that. Even Occidental, that acquisition that they made right before oil collapsed that caused Buffett to step in with the preferred stock investments because they had screwed up their balance sheet so royally.

That’s a mistake that has cost so much to shareholders and taken years to try to rectify and clean up.

[Tobias] I do sometimes worry that the oil and gas guys are a little bit like precious metals in the sense that when the prices are low, they all get religion and they all make these really great capital allocation decisions. Then prices get higher and they all lose their minds and start doing all this silly stuff again. That’s why I like XTO.

[Tim] That’s been the history for sure. I think it was a while ago, but we invested over the last five, six years quite a bit in trans-ocean bonds. They’re high-yield bonds.

For a while, they were going for 12%, 13%, and then 10%. Those have worked out just fantastically well because they have a capital structure problem, not a business problem. They’ve had a good backlog.

They just had a lot of debt relative. It wasn’t an environment for offshore drilling where they could use all of their rigs, so they had to cold stack some of them. They just combined with one of their largest competitors.

The balance sheet looks a lot better after this acquisition. Those bonds have done really well. It’ll be interesting to see if now the equity could be a play.

It’s run up quite a bit now. I think it’s doubled not too long ago. It’ll be interesting to see how some of that stuff works out.

[Tobias] Do you want to talk about EPD?

[Tim] They’re utility-like in that they can invest a few billion dollars each year at a solid rate of return. When you combine that with a 6% or 7% or 8% dividend, depending on when and where you buy these things at, you get a little bit of growth on top of that. It’s a nice low double-digit type returning investment with a lot less risk than the overall market.

If you think that the market’s going to do what it’s done over the last 15 years, you’re going to lag behind in something like that. But if you’re like me and I would imagine you where you think that the next 10 years might be more like 2000 or 2013, where you get a few bear markets, big bear markets, and you get a lost decade, those types of investments can do really well.

[Tobias] I don’t hope for the bear markets, but I do hope for a better market for value.

[Tim] Before I forget, I wanted to mention something. You just talked about capital allocation. We’re going back to the BDCs, but I wanted to give an example of just how stupid some management teams can be.

There’s a company, it’s FSK. KKR took over the management of this really badly performing BDC a while ago, and they’ve reshaped the portfolio a little bit. But basically, the stock is trading at about 50% of its net asset value, 50%.

Every year, what people also need to realise is these loan portfolios are returning hundreds of millions or billions of dollars of cash depending on the size of the BDC. They’re returning all this money. Analysts rightfully, in the last conference call, the quarterly conference call, they said, well, why aren’t you buying back your stock at 50 cents on the dollar?

How does that not make sense? The answers were horrendous. It’s like, well, we have bought a lot of our stock in the past, and it’s just nothing applicable to the current environment whatsoever.

One of the reasons why some of these companies don’t want to do that is because they’re earning management fees based on the asset size of the BDCs. If they were to buy back stock, that’s going to reduce the management fee a little bit. But that is just such short-term thinking because the market is going to reward the best performing managers and the best performing companies.

If you’re buying your stock back at 50 cents on the dollar and showing that you have your shareholder’s best interest, that’s going to go a long way. Mark my words, I think that that will be a major catalyst once that starts full-fledged. In whatever asset class, but especially in that private capital space.

Assured Guaranty (AGO): A 20-Year Compounder Still Trading Cheap?

[Tobias] While I’ve got you, one stock we have to talk about is Assured Guarantee, AGO. That’s one that I know you’ve been tracking for at least a decade, more than a decade, because we’ve been talking about this since 2016.

[Tim] Oh, yeah. I think I started investing in it maybe the end of 2008 or beginning of 2009. It’s almost been a 20-year journey there.

That’s another case of just phenomenal management. You have a bond insurance company. They’re the number one bond insurer in the world.

Not a great business. It’s not an amazing business by any stretch of the imagination. It’s decent, but demand hasn’t been tremendous.

They benefit more in a higher rate environment for their investment portfolio, but lower rates, you get more bond issuance. It’s just not been a great environment. But what management has done- It’s got terrible headline risk.

[Tobias] Terrible headline risk.

[Tim] You had Puerto Rico, you had CDOs during the financial crisis, you had all this stuff.

[Tobias] Anytime there’s some big financial crisis blow up there in the paper is being somehow- They’re not in private capital yet.

[Tim] I haven’t heard them named in that yet. But what’s so good is they have a great CEO, Dominic Federico, who’s been with the company since they IPO-ed in 2004, 2005, or even before that, but he’s been the CEO. He’s bought back stocks.

They buy back about $500 million of common stock each year on average, I think over the last seven years. Their current market cap is something like $3.7 billion. They’re retiring 12% to 13% of their shares each year.

Every single dollar of these stock buybacks over the last decade has been at a large discount to their book values and adjusted book values. Right now, the stock’s trading at something like 45% their adjusted book value, 66% of their book value. It’s really cheap.

If you look at the actual portfolio, the troublesome credits are kind of like water utilities in the UK, for instance. Even with Puerto Rico, the water company paid its debt. The UK is a very sophisticated economy.

They’re doing all right. Just like I talked about with the BDCs, if you’re buying back your stock at 66% of net asset value, you can make up for some of these added credit losses in the future. Good capital management can really reduce some of those mistakes on the underwriting side as well.

I do think it’s a buy at these levels. I actually bought some today, just because I think the valuation is cheap enough where you can.

[Tobias] They publish these figures too. Adjusted book value and adjusted book value are figures that they publish in their reports. You can track those numbers and you can see how they’ve done.

[Tim] The growth has been extraordinary. You’ve got to look at it. It’s so interesting to see.

There are very few insurance companies that have grown their book value like AGO has, but AGO has a way lower return on equity than some of the other ones that would come up in that type of screen. It’s not the best business in the world, but I would say he’s as good of a capital allocator as any other. He’s got that kind of bulldog personality where it’s like, screw it.

If you’re going to give me my stock at this price, I’m just going to buy it back. He does it consistently. I give him a lot of credit for that.

I think that’s so rare. How much of the business does he own? I don’t think a tonne, because he’s getting older.

He has bought at times, but he’s in that systematic offload. They do pay a decent amount in compensation to their management team. Overall, I think he’s done really well.

It’s one of those where it’s like, look, it might not be the best company in the world, just like Citigroup, but if you’re buying at the right valuation, it’s super attractive. Once again, I’m not Mr. BDC. I didn’t own any of these things for a long time, but if you’re buying them at 20 to 35% discounts to the liquidation value of their loan portfolios, a lot has to go wrong before you lose money if you’re a long-term investor.

[Tobias] I think I heard him say once that he wanted to be the last shareholder. He was going to have the last share.

[Tim] Yes. I used to talk to him, and we’d joke about that. Absolutely.

Maybe he told me. Yeah, yeah, probably did. I love that attitude.

It’s like, that’s fine. We know what the value of the company is, and so we’re going to keep doing that.

[Tobias] Let’s talk about the market in general. How do you feel?

[Tim] I feel like it would make a lot more sense if the market was down 10% from here. I think that that would make a lot more sense. It’s interesting because the Mag 7, they’re all down on the year quite a bit, but really, we’ve had oil up.

What is it? It’s like the oil companies are up like 35%, 40% energy companies. Utilities are up.

I think some types of consumer staples are up. I know a lot that aren’t up. It’s interesting.

It’s hard to see where the indices are finding stabilisation from, especially with the Mag 7 down. I don’t think the index is attractive at all, but it’s durable. I’ve thought that for a long time, and it’s done really well.

We’ll see.

[Tobias] The timing’s up. Last year, the argument was Mag 7 is really the only game in town. The other 493 are sucking wind.

They’re the only thing keeping the index up. Since Mag 7 stumbled in Q4 last year, it’s been the other 493 that have been holding the index up. It’s incredible.

[Tim] It really is incredible. It speaks to the power of index funds, for sure. I will just say, as someone, my first job out of college was Vanguard in the early 2000s.

That was right after the financial crisis. During that time, people had just lost 50% in the tech bubble. They weren’t feeling super optimistic about the indices, even though the 90s and 80s were fantastic.

Then you had 2008, when the market went down 50% again. It was like, okay, buying holds dead. Let’s talk about gold coins, which probably would have done pretty well in hindsight, or annuities, or blah, blah, blah.

The people that are advocating for index funds and saying how great they are, did they go through those times? Were they as bullish on them during those times? I think that that kind of stuff matters.

A lot of people aren’t going to feel the same way. If they get a lost decade, they might not have that really long-term mentality. If you’re retired, can you afford a lost decade?

That goes unnoticed a lot. You and I both know that index funds can be phenomenal. If you’re 20 years old and the market’s relatively cheap, index funds are a great way to go.

Then just focus on your job and your family. If you’re 70 years old and you’re depending on your investment portfolio to finance your retirement, how does a lost decade look? A lot of clients that we see, a lot of portfolios we review, Toby, are like 90% equities for people even in retirement.

I think that that’s a big risk that’s out there.

[Tobias] Yeah. There was that period from 2000 to 2015, something like that, where even the best companies in the market, Microsoft and Walmart and all those sort of companies were, by the time 2015 rolled around, the underlying … I looked at these and I looked at them with leaps at that period in time because there was so little volatility in the equity that the leaps were super cheap too.

The stock had done nothing and the underlying businesses were still … There wasn’t much of a difference between the run up to 2000 and the period from 2000 to 2015. The business were comparably good through that period.

The only thing that Microsoft had that one year where they had the step back in revenue in 2010 or 2011, something like that, and they had Steve Ballmer was the CEO.

[Tim] Steve Ballmer. I was going to say that. You had the Steve Ballmer risk when he was making some of those acquisitions.

Those were scary for all shareholders. But I remember the time well. I agree.

That was an amazing time when you could buy some of those. But you know what? They didn’t all work out great because Intel was really cheap too.

GE was another one. Well, GE ended up working out, but it took 15 years after that when they finally did all the divestitures and everything like that. But yeah, I mean, Microsoft paid off.

Azure, their cloud platform really did it. You had kind of a similar scare. Right now, people are worried about software in relation to AI, but the cloud was a big risk for a lot of those software companies too.

Remember? I mean, when they were flipping their business models from selling actual physical software where you own something to the subscription model, there was a lot of risk there. I remember the stocks did have some blips during that time, but it actually ended up being a big profit driver for those companies, for the Adobe’s of the world.

So we’ll see. I think that it looks like a lot of these AI tools are going to be leveraging the software as tools. But I’m not Elon Musk.

I don’t have the brain capacity to that one out for sure.

[Tobias] What do you think about, do you follow something like Constellation? Do you have a view on the Canadian software?

[Tim] The software one?

[Tobias] Yeah.

[Tim] Yeah. Yeah. I’ve looked at that one.

I think it’s, I mean, it’s not super cheap, but I like kind of the management strategy there. I think that a lot of their softwares seem to be mission critical. So actually I have bought a tiny, tiny bit of that, but it’s not something I’m big into yet.

It’s not something that I feel, you know, I think I’m still learning about how that’s going to be impacted by some of the transition in there. But I do look at Adobe. I do own some Adobe and like they had a really nice quarter actually, but the CEO stepped down.

And so the stock kind of sold off in unison, sold some puts actually on like salesforce.com when that had a big sell-off just because it’s going to take time for this displacement to occur. If you’re a big company, it’s really hard to just say, tell your whole salesforce, Hey, we’re going to get off salesforce.com and we’re going to try this, you know, vibe coded option. You know, that’s not going to be attractive.

That’s how these people are paying their bills. They’re paying their mortgages through their sales and stuff like that. So yeah, I think that that’s opened up some markets and those stocks have started to rally.

It’s really kind of the private credit worries that, that has spooked the market. But some of those software companies have had a nice little stealth rally, salesforce included. What about something like PayPal?

Do you track PayPal? I do. I do.

I think PayPal is attractive. Look, the business is not amazing. There’s a lot of competition there, but I think that payments are pretty cheap right now.

So PayPal, there’s Fiserv, there’s global payments that are all pretty cheap. I could see someone coming in and buying PayPal out. I wouldn’t be shocked by that at all.

A lot of these are cheap, but then you look at the stock-based compensation stuff and that’s like the depressing element of it is that, you know, it’s not like an AGO or a Devon where you can really trust, you know, the management teams to act in the best interest of shareholders. PayPal’s had a big buyback, but some of it’s to buy back, you know, the shares that they issue. Just like, I mean, look at what Nvidia does with that.

That’s crazy. So, but yeah, I do. I do like the payment space and I’m actually in that.

It’s cheap. It’s really cheap. And I think, you know, it’s got a good chance of working out well, especially if a buyer does step in there.

What about something like Intel? Have you tracked Intel? It’s too, I don’t love it.

I’ve tracked it a lot over the years and I’ve just too many misfires. And now then you have the government ownership element of it. So, for me, it’s not my cup of tea.

I’d rather buy Nvidia than I would Intel personally. I think Nvidia, you know, I don’t know that those margins are sustainable. I think not.

But like, I think you could make an argument for it, a credible argument for it, you know, even at these levels. Whereas Intel is just kind of in the too hard pile for me right now. They have a lot of hurdles to overcome.

[Tobias] What else haven’t we discussed? What are we missing?

[Tim] Well, I think that’s been, you know, a pretty good comprehensive discussion. One other thing I’d say is one area that’s kind of been left for dead a little bit is our real estate investment trust. You know, in this AI driven world, real assets are going to have real value.

And so, I’m not talking about office like properties, but, you know, some of these attractive companies like Avicii Properties, for instance, that owns a lot of the Las Vegas casinos, they own a lot of regional casinos as well. A hundred percent of their rent was paid during the lockdowns of 2020. And you can get it at, you know, six and a half percent dividend.

They’re growing that dividend over time. That could be really attractive. So, you’ve got, you know, two, three percent growth over time plus a six and a half percent dividend.

You know, some of those real estate investment trusts are really cheap. I got burned last year on Alexandria. It’s a biotech lab and adjacent office space company that, you know, it has a really great history.

The stock traded over 220. It got down below like 90 and it started looking really interesting at really cheap valuations. But that market has just been oversupplied.

And the administration’s policies have just kind of spooked a lot of these biotech companies from wanting to grow their office and lab footprint. So, it got hit pretty hard. But I think that’s really cheap here.

So, I think that there are some opportunities in the real estate space. It’s a great way to add yield and diversification to your portfolio if you’re really heavily in more traditional equities or tech.

[Tobias] Tim, tell us a little bit about TNT Capital Management.

[Tim] Yeah. So, we’re based in Arizona. We were in California for a long time too.

But we managed close to $200 million of assets. And we combine our deep value investing strategies with conservative income generating option strategies like the covered calls, like the cash secured puts. You know, they’re strategies that your advisor at Morgan Stanley or Merrill Lynch is probably not going to do for you.

And they can really be beneficial in more adverse market conditions or range bound market conditions. So, yeah, you can reach us at ttvalueinvesting.com and my Twitter’s Tim Travis value.

[Tobias] Good stuff. Well, that’s all we have for this week, folks. We’ll see everybody back next week.

Jake will be back from vacation. And we’ll be here same time, same time. Tim, thanks so much for spending time with us.

[Tim] Thanks, Toby. Appreciate it.

[Tobias] Crush it as always.

VALUE: After Hours (S08 E10): Tim Travis on Private Credit $OWL $OBDC and $MSDL; Energy $DVN, $OXY and $EPD; and $AGO

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