Good times ahead for airlines and cloud players
2014 saw a sharp drop in oil prices, Russian annexation of Crimea, the Ebola epidemic, regime change in India, elections in Brazil, a power shift in the Congress and positive returns for the S&P 500 Index.
Last year our winners in the Long Term Value Portfolio were Southwest Airlines (LUV), Spirit Airlines (SAVE) and Berkshire Hathaway (BRK-A).
Laggards
Google (GOOG) and Holly Frontier (HFC) were our laggards.
Holly Frontier, in my opinion, has properties at strategic locations and has excellent cash flow, trading at lower multiples yielding nearly 10 percent with special dividends.
In my opinion, the company may be an acquisition target by bigger oil firms.
Though Google had lackluster year in 2014, new product innovations, market leadership and lower price multiples might improve the company’s price this year, though I have no way of knowing for sure.
We are still holding both Holly Frontier and Google.
Outlook
Last year, the Long Term Value Portfolio returned 15.1% net of fees versus the 13.69% (dividends included) of the S&P 500.
Year 2015 is going to be very interesting year due falling commodity and oil prices, lower unemployment rate, the strengthening dollar, lower trade and lower fiscal deficits and wage inflation and possible interest rate hikes.
At the beginning of this year all leading economic indicators are showing a positive trend.
There is an improving trend in average weekly hours, a decline in initial unemployment claims, and an expansion in manufacturing with new orders.
Oil
The recent oil correction is well deserved and shot in the arm for many global economies. It all started when we waged two-pronged war in the Middle East.
Oil prices spiked up due to fears of supply constraints, though they were never realized.
However technological innovations in shale oil extraction, slack in global oil consumption, advances in energy efficient automobiles and electric vehicles reversed the oil price trend.
We have started producing more oil domestically than we are importing from the foreign markets.
Eventually a glut in the oil supply made its magic in the market. Finally we are at a stage that we don’t need to worry too much about exogenous shocks related to oil on our economy.
OPEC
Oil producing countries relied on petro wealth and never diversified their economies. They spent their excess wealth mostly on public spending, oil subsidies and wage increases.
In order to balance their fiscal budget, the price of the crude oil needs to be at above $100 for many Middle Eastern nations.
As you can see in the above IMF chart, the breakeven prices are ranging from $55 for Kuwait to $180 for Libya to balance their fiscal budgets.
It will be difficult for them to cut production, so in my opinion, the next stop for oil is below $50 or even at the $40 range.
Consumer boost
According to AAA, the average gas price per gallon last year was $3.301. Now, it’s $2.168.
In 2013, the average family spent $2,418 on gasoline.
Falling gas prices will add up to a $90 billion boost to the economy. If we add jet fuel and diesel from industrial consumption, the impact on our economy is tremendous.
Some of the economists arguing that capital expenditures from energy companies will decline in 2015 due to lower profits may have negative impact.
In my opinion, the net gains from consumer spending has lot more impact on the economy than reduction in oil industry capital expenditures.
Winners
As a result, the excess marginal spending may benefit grocery stores like Wal-Mart (WMT), Costco (COST), Kroger (KR) and Supervalu (SVU).
The next level of beneficiaries are casual restaurants like Panera Bread (PNRA) and Starbucks (SBUX).
Other big winners are going to be in the transportation industry particularly corporations like FedEx (FDX) and Southwest (LUV) airlines.
Predictions
According to a recent survey by Barron’s, analysts predict an 8% return for the S&P 500 Index. However, in my opinion, the S&P 500 return may be higher than last year’s double digit return (again including dividends.)
We see lot of tail wind to our economy due to decline in energy prices and accelerated consumer spending and real wage growth which is stagnant for the long time.
In my opinion, the airline industry will have another exceptional year (third in a row) due to lower competition in the domestic market and lower oil prices. However, this year all airlines may not end up winners.
Open air agreements with foreign carriers bringing heavy competition to major carriers in the transatlantic market from gulf airlines. That will put price pressure and vigorous competition among airlines.
The Cloud
We also foresee 2015 is going to be the last year for Sears (SHLD) and Radio Shack (RSH) companies. Their cash burn rate does not justify their existence any more.
With same kind of high cash burning rate, sooner or later J.C. Penney (JCP) may also join the cliff jumping party.
With cheaper internet data plans now available, 2015 is going to be a remarkable year for cloud players. All new personal computers, tablets and electronic devices will come with thin hard drives and heavy cloud drives.
Eventually cloud storage players like Google (GOOG), Apple (AAPL), Amazon (AMZN) and IBM take major chunk of consumer business.
Finally, in my opinion, Apple Pay will be adopted by all mainstream retailers.
If Apple can bring department of motor vehicles in their customers list, there is no need to carry our wallets because you have your driver’s license, insurance card and all electronic cash stored in the Apple phone.
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DISCLAIMER: The investments discussed are held in client accounts as of December 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
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