Bought CTOS Digital

CTOS Digital is a Malaysian Credit Bureau, part of an oligopoly selling credit reports.  They had a 71% market share in Consumer reports.   I got the idea from the Asian Century Stocks Substack (1) (2).

They had a cyber security incident recently, and their services have been suspended until further notice.  Their chart is a falling knife:

I bought some on Monday and some today, average price 38.3c.  Its a 4% position.

This is a profitable company with recurring revenue, a sustainable competitive advantage, and a gross margin in the 60s.  Some notes:

• Their tax rate will rise in 2027 as a tax exception expires. 
• Malaysia is implementing Bank Negara's Open Finance Network next year.  This will allow 6 months of anyones bank statements to be downloaded by another bank, with the consumer's consent.  However a bank statement only gives payment details, it does not say if payment was full or on time.    I don't think this is a thread to CTOS.  But it would be better if CTOS had access to these statements as well - currently it seems like they don't - only banks can request the statements.
• At current price, I get a forward PE of 10 to 11.  Excluding the suspension.

Its not part of EWM.  Its a mid-cap, part of a few Malaysian indexes, so stock price might still  be affected by an overall market correction.

The big unknown is how much their longer term market share and revenue is affected by the suspension.

Sold Japanese SAAS Companies

My Japanese SAAS stocks were 2 cloud accounting companies: Freee (4478) and Money Forward (3994).  Got these ideas from Asian Century Stocks.  Since I bought them in Feb, they've been pushed up by good results, a buoyant Japanese stock market, and a recovery in software stocks being hurt by AI.

Sold them today.  Average over 40% gain in 8 months.  Supposed to sell Friday but busy at work.

Why did I sell?

• Market share data is hard to come by.  There is a big private competitor (need Japanese VPN), Yayoi, that has a large market share in legacy (desktop) accounting software.  They claim to have 560,000 active contracts (one or more users per contract) which is more than either Money Forward and Freee, and probably more than both.
• Both Freee and Money Forward are still in early growth stage, where PEs are not meaningful.  Price to sales.  The story is that they will grow profitable by converting greenfield users.  They may - recent growth figures have been good.
• I think we're at the end of the economic cycle, the current AI boom is ending.  Like 2001.  Stocks probably get hit, especially growth stocks.  I don't want to hold "Price to sales" stonks into a downturn.
• One of Hedgeye's signals for Japanese equities turned negative. last week  It was on a day that everything fell (Oct 15th), so it could be a false alarm.  But given everything else, now's a decent time to sell.

I may be missing out in two multi-year compounders.  But I also may be missing out on a market correction.

Bought Nice Information Services (030190 KS)

Bought a 5% position in Bought Nice Information Services (030190 KS), a credit bureau in Korea.  See the Asian Century Stocks writeup (paid).  Its sells mostly consumer credit scores, and is part of an oligopoly, with past 6% CAGR, trading at single digit PE.  It pays a 4% dividend, or half its profits.  The risks are: Korea is already heavily indebted, the corporate structure, and the stock is illiquid (buying 50 shares can move the price 1%).

Sold Nam Cheong

A Malysian OSV provider that went bankrupt 3 times.  I bought some in July 2024 and again in July 2025.

Name Cheong is a cyclical, not a long term compounder.  It has no moat.  

Trying to estimate their long term operating profit:

I get RM 30c per year, at the current utilisation rate is 58%. 

Increase utilisation to 70% and I get 50-55c per year.  At a maximum possible 85%, I get 80c.

The above does not take into account increased rates, which can push it up more.

The company should do well as the OSV cycle keeps improving.  We may be halfway through - we are nowhere near a the top of a bubble like 2008.  Although the easy money has been made, there's still some meat on the bone.  Main reason for selling is to buy something else.

Its up 3 times since I bought from my average price.  Been a good ride.

Lloyds Bank

Quick Notes on LLoyds Bank in the UK.

Competition

Lloyds is the largest local bank with a 16-19% share in mortgage lending, the next largest is NatWest (formerly RBS) at 12-13%.  The largest 5 banks have a 60% market share.  Lloyds has ~20% market share of current account balances.  From these numbers, the UK market has 6 large players with > 5% market share.  So there's limited competition, but its not as comfortable as the Australian or Singapore market, controlled by 3-4 banks.

What do they do?

• They primarily make their money from interest (~70% of their Net Income in 2Q).  Primarily mortgages (book size of 307m mortgages, 40m other retail loans and 88m commercial).   Their deposits are 2/3rds retail, 1/3rd commercial (slide 16).  All pretty standard stuff - they are a traditional bank doing savings and loans.
• For their ~30% non-interest income ("other income - slide 18"), 75% of it is from commercial and retail banking.  I assume bank fees.  The remainder is Insurance, Pensions and Investments.

Balance Sheet

• CET1 ratio is 14.1%.  But they want to reduce it to 13% by 2026 and return excess capital to shareholders (slide 24).
• Loan to deposit ratio is 95%, which is on the high side compared to Singapore (low 80s) or US banks (10-year average of 72%).
• They have a large "structural hedge" (slide 17) from the pre-covid zero-interest rate period.  It yields around 1.35% interest, as the hedges expire in a 4% interest rate environment they'll yield more.  The hedge reduced 2023 profits by an estimated 800m (page 4), or 10% of 2023's PBT.  It depends what the interest rates are (actually what the forward curves are) when they expire.

Risks

Digital banks like Starling, Monzo and Revolut have been growing and taking market share.  Especially among young people.  Now 10-15% of the population has bank accounts with each of them.  Lloyds bank fares badly in customer satisfaction, trailing behind them.  But I'm not sure how much money they manage to capture, or how many people use them as their primary bank account and deposit salary - banking is a 2-sided market and you need scale to be profitable.  Only Starling is profitable.  Although the newcomers have made banking easy with mobile app features, its not a moat and can be copied by the incumbent banks.  (FT article).

The UK has been suffering through a recession in the past 2 years.  I think they will tax dividends on foreign shareholders.  Its a no brainer.

Biggest risk is the UK's long term prospects.  It has recovered from its recession, but may continue with weak (below 1%) growth as the past 2 years.  The UK's long term prospects look gloomy due to cheap energy from the North Sea running out, the end of Russian gas, and Brexit.  Politically and economically, they are probably going to become the 51st state - not a bad thing, but a big step down from being Europe's financial centre, or the old "empire on which the sun never sets".

Capital allocation

I like their capital allocation:

There are around 66bn shares issued (p302).  Buying 2bn pounds per year at a price of (lets say) 1 pound each removes 3% of shares every year.

Business Cycle

Banks are cyclical.  Where are we in the business cycle?

UK has been in a tough spot due to rising energy prices from the Ujkraine war and Brexit.  You can find YouTube videos of boarded up sops and houses.  They do have some structural problems to work through.

1Q24 just exited a recession, putting an end to almost 2 years of low/negative growth:

Source: Trading Economics

Hedgeye predicts the UK will have increasing yoy GDP growth in the second half of this year.  But that can change tomorrow.

Valuations

Price to book is 0.85.

At 70p, it would have a 1H annualised PE of 10.2.

Using 2023 numbers (a period of sub-1% growth but very high rates), the PE would be 9.2

Summary

The leading bank in a not-too-competitive market.  Its been recovering and recapitalising from its 2008 blow-up, and is now starting to return money to shareholders.

The stock shot up 6% yesterday when results were released.  I may be late to the party, is a recovery already priced in?  Biggest risk is that the UK recovery is weak.

Review of Williams Companies (WMB)

Williams Companies (WMB) has doubled since I bought it in mid-2020.  Should I sell it?

Business Segments

What do they do again?  And how are they affected by energy prices and inflation?

Based on 1Q24 EBIDTA (slide 8):

• 39%: Interstate Gas Pipelines.  Mostly Transco (30%) running through the east coast, bringing gas from the Appalachians and GoM to consumers and LNG export terminals.  Smaller pipelines in the Northwest.

Regulated long-term contracts: "The rates are established primarily through the FERC’s ratemaking process, but we also may negotiate rates with our customers pursuant to the terms of our tariffs and FERC policy."   In general, FERC gas-transmission rates are often adjusted for cost-of-service (bottom p1), so its like a "delayed" inflation adjustment.

• 38% Gathering and Processing from gas fields.  Collecting and treating gas (eg: removing NGLs) from producing fields so it can be transported in pipelines.  Mostly volume based.  So indirectly affected by price (eg: revenue drops during warm winters).  Management mentioned these contracts are often inflation protected (bottom p19).  A few of them have exposure to gas prices (bottom p18).

• 13% Gathering and Processing from oil fields: onshore (7%) and GoM (5%)

• 4% Marketing.  Deliver gas to customers, bear the risk of price movements in-between the time of order and delivery.  Very volatile.  Was 10% of EBIDTA in 2023, -ve in 2022, and negligible in 2021.

A 2022 Fitch Report estimated that 50% of revenue was from regulated or take-or-pay contracts.  so rough guess: maybe a quarter of their G&P revenue is covered by take-or-pay. 

Cashflows

CFO covers dividends.  But not always CFI and dividends together.  ie: They are investing for expansion:

They rarely sell assets, last made substantial disposals in 2018: 

Maintenance capex was 820m in 2023, and is guided at 800m and 1.2b for 2024 and 2025 (p11).

Growth

Growth capex was 1.9bn in 2023, and is expected to be 1.6bn in 2024 and 1.8bn in 2025 (p11).

The above "growth capex" excludes acquisitions of new businesses.  Following this, I'll take the words "capex" or "growth capex" in this post to exclude acquisitions, which is pretty strange.

Lets put it in a table.  AFFO below is CFO (excluding some working capital changes and minus a few things) - think of it as "Smoothed CFO" ¹:

AFFO easily covers maintenance capex plus growth capex, and almost covers dividends after that too.  It doesn't cover acquisitions in 2024, so debt will go up.

They say they've gotten 19.5% ROIC on their 2019-2022 investments (p12).  Seems ridiculously high, but these are usually small "bolt on" projects.  e.g.: small pipelines adding off their main lines, adding new takeaway or feeds to new customers.  Or adding incremental G&P capacity to their existing network.

And thats probably only for growth capex, as recent acquisitions were bought at 7-10X EBITDA (1), (2).

Overall they aim to grow EBIDTA and dividends by 5-7% in the next 2 years.

The background is growth opportunities from the expected US LNG export boom (slide 16):

Management comments on the urgency of this (p17): "Our issue is that our customers, which are some of our best and biggest customers on Transco are –their demands are very urgent. And for us to sit around and wait to finalize any more of the demand that was pending out there, really, it doesn't serve those customers very well." 

To summarise, they are still growing, and taking on debt to afford to both pay dividends and make acquisitions.  At some stage of the cycle - years later - that may become a bad thing, but its good today.

Valuation

Taking FCF to be "AFFO minus maintenance capex" ², it is projected to average 4.2bn over 2023 to 2025. At a share price of $42.5, thats a price to FCF of 12.x.  Fairly priced for a long term growth rate of 5-7%.

The yield is 4.5% before tax (or 3.1% after tax for me).   AFFO payout ratio is just under half.

Conclusion

Its not cheap anymore - growth is priced in.  I wouldn't buy now, but its not clearly overvalued so I'll hold.  We're probably still at the beginning of the US natural gas export boom.

1 AFFO is defined by them as "cash flow from operations excluding the effect of changes in working capital and certain other changes in noncurrent assets and liabilities, reduced by preferred dividends and net distributions to noncontrolling interests. AFFO may be adjusted to exclude certain items that we characterize as unrepresentative of our ongoing operations".^↩

2 Their definition is different - slide 34^↩

Bought Malaysia Smelting Corporation

Update on this company - it hasn't changed after my initial post more than a year ago.

Start with the tin price - it was stable in 2023: lower than 1H 2022, higher than 2H 2022:

The company has 2 segments, Tin Mining and Tin Smelting:

Smelting profits should be more stable, but were impacted by Covid in 2022 and the closing of an old smelting facility in 2023.  Its hard to tell which of the 4Q23 costs are one-offs or which are normal operating costs (either recurring or randomly occurring ones).  They have moved to a new smelter in P. Indah, which started operating in 2021.  They will start dismantling the old Butterworth smelter in 2024. 

The biggest risk seems to be that smelting profits/losses are inconsistent (especially Q423's loss), and we don't know how long this will continue.

Mining profits tend to follow the tin price, with variable revenue and fixed costs:

Don't overthink it.  Its a company that primarily makes money from Tin Mining - the profits and share price follow the tin price.

The company has adopted a dividend policy paying out at least 30% profits.  The 7 sen dividend is 34% of 2022 profits.  2023 earnings look "normal" - not too peak-ish.  At RM 2.10, it would be trading at 10 times 2023 earnings.

I bought MSC this week on the KLSE, making up 5% of my portfolio.

Bought Philippines Stock Exchange

I bought half my position (2.5%) in the Philippines Stock Exchange (PSE).  I love stock exchanges - they are simple, inflation-proof businesses.  Most are expensive, but PSE is reasonably priced: ex-cash PE around 12 with a 5% yield (before 25% witholding tax for Singapore residents).  Its a dirt-poor, growing country and their stock market is cheap and unloved, with some catalysts (paid link).  Long term the key metric to tracks is the number of listed companies.  In the short/medium term, it depends on the cycle.

Why buy now?

• We are nearer the end of the bear market (started end 2021) than the beginning.
• Hedgeye's trend signalled the Philippines stock index is in bullish trend.  And the country has expected increasing yoy gdp growth in the next 2 quarters.  This trend might last for months, quarters, or change tomorrow.  But since I was intending to buy a some anyway, buy a little now.

Why buy only half?

• I'm expecting a US recession and bear market in 1H24, if this happens, other countries' indexes and stocks will probably follow it.  Final leg down.

Long term, the key metric to track is the number of companies listed.  The market will go up and down when it wants, but long term, you need to have companies listed for people to invest/trade.

PSE is a *very* illiquid stock, even buying a few thousands dollars worth can set the price.  Long term holding, not a trade.

Aker BP

A quick look at the second largest Norwegian oil & gas producer.  They operate purely on the Norwegian Continental Shelf (NCS).

Cashflows

They pay taxes every two months, so even quarters have higher taxes.  The current quarter has one tax payment, the next has two: however they made an additional $500m tax payment this quarter (p6) to smooth it out.

For each calendar year, their percent of FCF (CFO-CFI) paid out as dividends is:

The payout ratio increased after the Lundin acquisition.  Maybe they are transitioning from a growth company to a cash cow, or maybe its because of lower energy prices.  Their dividend policy is to payout 20-30% of CFO.  Negligible share buybacks.

Lundin Acquisition

They acquired Lundin Petroleum's NCS assets (excluding renewables), in a deal announced Dec 2021 and completed June 2022.

Debt increased 60%, shares outstanding 75%:

Production and reserves doubled:

Source: Acker BP 2022 Q4 presentation (p9)

With hindsight, the acquisition may have been timed wrong: 2Q22 was the peak of the energy market.  But there are a only a handful of listed players on the NCS so opportunities like this are infrequent.  They did not stretch themselves financially.

Balance sheet

Debt is a bit high, but all fixed and long drawn out.  I think we are at the peak of the interest rate cycle anyway.  93% of their debt is fixed-rate long term bonds:

                                                        Source: Company Website

The 6% bonds were issued June 2023, so their interest payments will have been included in the current quarter.  Total interest expense this quarter was 41m, easily covered by 300-500m quarterly profits.

Future growth

Production is expected to decline from 2023 to 2026, before picking up with new projects in 2027/28.

Source: Q3 2023 Presentation (p11)

"Between now and 2028, this will require the investments of approximately $20 billion pre-tax, corresponding to around $3 billion after-tax. This CapEx estimate has remained unchanged since we submitted the PDOs to the Norwegian authorities approximately a year ago" (p4)

ESG

Their climate transition plan is less ambitious (more realistic) than Equinor's:

By 2030:

• Reduce scope 1 (energy consumed on rigs and spills/flares) and scope 2 (energy purchased) emissions by 50%
• Net zero (scope 1 and scope 2) emissions.  Offset emissions by carbon capture.

By 2050:

• Reduce scope 1 and scope  2 emissions to zero.  By electrification: using renewable energy produced onshore to power rigs.

They are not making investments in "renewables" (outside of their own use).

Valuation

TTM EPS is USD 2.04 (which contains $1/share impairments in 4Q22).  At a price of NOK 300, the PE is 14.3 (counting impairments) or 9.5 (not counting impairments).

Misc

• They Hedge commodity and currency exposures.  They hedge energy by buying Brent puts.  They may hedge up to 100% of next 12 months anticipated oil production, up to 75% for the subsequent 6 months, and up to 50% for the subsequent 6 months.  I could not find the amount of oil hedged (Only the current P&L of the hedges).
• Presentations/reports are not as well-presented as Equinors.  But I thought relevant numbers were easier to find.

Conclusion

The numbers and business plans look good.  Similar to Equinor but without the ESG risk.  Short term I bearish energy, but I think it'll be worth buying sometime.

Equinor Update

Update and Review of Equinor.  I may buy some more energy producers in a few months if we get a downturn.  Here I look at their latest numbers and their ESG plans.

Segments

Equinor is primarily an Norwegian energy play, with 90% of 2022 Net Operating Income from E&P, and three quarters of that from Norway.  

How much is oil vs gas?  In dollar terms, usually more oil, but it varies with prices.  In the first 9 of months 2023, they sold more oil than gas, but in the same period of the previous year, more gas than oil (page 29).  Due to the massive spike in European gas prices in 3Q2022:

Source: Equinor 2023 3Q Financial Statements and Review (p51)

Cashflows

They've been printing money in the past 2 years due to high oil/gas prices.  2022 was a bumper year, 2021 more normal:

Quarterly cash-inflows vs cash-outflows:

Notes:

• Quarterly CFO does not correlate with oil/gas prices, because taxes (payable) seem to be accumulated in Q1 and paid out in other quarters.
• Since quarterly data is noisy, calculate the payout ratio (CFO divided by dividends plus buybacks) for each calendar year: in 2021 it was 35%, 2022 was 48%, YTD 2023 is 94%.  In 2022, they spend almost all their generated cash on dividends/buybacks.

Balance Sheet and Capital Allocation

They've paid off their debt in 2021, accumulated cash in 2022, and have been returning capital in 2023:

But not all their cash and financial investments can be counted:

• Their 28bn financial investments "mainly relate to investment portfolios held by Equinor’s captive insurance company and other listed and non-listed equities held for longterm strategic purposes" (p177).  We don't know how much is required for insurance.  2020's annual report says the same thing for 12bn of financial investments.  I'll take a wild guess that 12bn is required for insurance, leaving 16bn as long term investments.
• For their 15bn cash, 6bn is required for hedging (p179).  Lets deduct another 2bn in case oil volatility increases. Leaving us with 8bn excess cash.
• With debt of 25bn, net debt would be ~ 1bn.

Long term liabilities are 13bn provisions, mostly asset (rig) retirements.  Plus 3bn pensions.

There is no fixed policies for dividends or buybacks - appropriate for a cyclical industry.

The company previously mentioned they would like to return to a 10-15% leverage ratio (p10) - they count all cash and financial investments in this ratio - so that would entail a massive capital distribution.  I'm skeptical about this in today's world: any leverage is too much when you have 5% interest rates and a product whose price can go negative when people catch a cold.

Their main form of capital distribution is dividends.  Not tax efficient, but better than stupid acquisitions.  Overall I think their capital allocation is quite good.

Reserves 

They had 7 years remaining based on 2022 production.  The reserve replacement ratio has averaged 62% in the past 3 years.  Meaning replacement was below production.

Reserves in Norway have remained steady over the past 3 years (p7).

By boe, over half of the reserves are gas:

Source: 2022 Oil and Gas Reserves Report (p6)

Business and Political Risks

Very few risks, which makes it a rarity for an energy producer:

• Norway is a developed, democratic country with rule of law.  Most resource rich countries are shitholes (eg: DRC, Saudi Arabia) or simply poor & corrupt (eg: Indonesia).
• Seabourne oil can be shipped anywhere.  The production areas and outbound shipping lanes are not in a potential war zone, like the Persian Gulf.
• Norway's oil tax is 78%, though investments can be deducted over a few years.  This high rate is already priced in, and is actually an advantage, because: 1) Its safe and predictable, they have not changed it eg: like the UK did, and 2) the government is already getting 78% of profits, they're unlikely to take shares away from minority shareholders.
• Norway is an net energy exporter, so they are unlikely to put a windfall tax on energy producers or restrict energy exports.
• Offshore oil has low decline rates, unlike American shale.
• Norway's oil is less carbon intensive to produce compared to Canadian oil sands.

Valuation

Getting a reasonable valuation for energy companies is hard because energy prices have been so volatile.  Lets base it on 2021 and 9M2023 results.  2022 was too much of an exceptional year.

"Cash generated" is CFO minus "capex and investments".

Based on the current stock price of USD 32, the PE would be 8 or 12.  Reasonable, but not dirt cheap,

ESG Risk 

Equinor has an Energy Transition Plan, which I think is the biggest risk to its business:

The first item (reducing carbon use when producing oil) and third item (CO2 storage) are OK.  The second one (spending lots of money on renewable production) worries me:

• Equinor aims to direct "30 of gross capex to renewables and low carbon solutions by 2025" and " more than 50% of our annual gross investments in 2030 towards renewables and low-carbon solutions" (p21).  It was 14% in 2022 and 11% in 2021:

Source: Material Topics, Equinor Website.

• They had to write down their US wind power projects this quarter.  Their UK wind farms are OK because prices are inflation adjusted.
• In negotiations, they said they "would like to see 4% to 8% real unlevered return from our businesses in -- within renewables" (p12)

Lets do some numbers.  Based on 2021 and 2022 capex:

• 2021 capex was 8bn, 2022 was 8.7bn.  Of that, 0.9bn and 1.2bn was spent on renewables and low-carbon (11% and 14% respectively).  
• To bring it up to 30%, we need to spend an additional ~2.3bn by 2025.  To bring it up to 50%, we need to spend an additional 5.3bn by 2030.  They don't need to just bring it up to 50% of current 8bn capex, they need to bring it up to 50% of new ~12bn capex....after they spend more for renewables.
• These additional sum could make low returns (4-8% real returns) in a much more risky investment.  Essentially we can see FCF (and therefore dividends/buybacks) reduced by this amount.
• Based on 2021and annualised 9M2022 estimates, the 2030 aim would reduce the cash generated (CFO minus "capex and investments" by 15-17%).  It could wipe out their Net Operating Income (before tax)....though they could now claim back the new investments over several years at a 78% tax rate.

Conclusion

Everything looks good except for the ESG risk.  Time to explore other companies.

Notes on TC Energy (TRP:TSX)

I love gas pipelines, like Buffet's toll roads.  This company owns pipeline throughout North America.  The stock has fallen due to crappy management, and is below its 2020 price.  Its got world class assets, and I don't think bad management can destroy it no matter how hard they try.  Lets take a look.

Segmental Breakdown and Pipeline Details

From their 2022 AR.  "EBIDTA" below means "2022 Comparable EBIDTA".

The business is transporting gas over a continent, so we gotta look at a map to understand it:

Source: 2022 AR (p40)

US Gas Pipelines (41% EBIDTA):

• Columbia Gas (6): Transports gas from the Marcellus to markets and pipeline interconnects throughout the U.S. Northeast, Midwest and Atlantic regions.
• ANR (7): Transports natural gas from various supply basins to markets throughout the U.S. Midwest and U.S. Gulf Coast.

Canadian Gas Pipelines (28% EBIDTA):

• NGTL (1): gathering and processing from producers in the WSCB to the Canadian Mainline.
• MainLine (2): Transports gas produced in East Canada to West Canada.  
• Costal GasLink (26): Pipeline under construction to ship gas from WCSB to the west coast for LNG export.  Its construction has had bad cost overruns, but is now 91% complete.  Expects to be operational 4Q23.

Mexico Gas Pipelines (8% EBIDTA).

Liquids Pipelinse (14% EBIDTA):

• Keystone (not shown above, see p62).  Transports crude oil from Canada to and through the US for refining, down through Oklahoma to the GOM.  Canada cannot refine most of its crude, which is exported by pipeline to the US (87% of total crude in 2020), and Keystone transports around 14% of that.  There were (costly) expansion plans (Keystone XL) approved by Trump which were cancelled by Biden.

Nature of Revenue and Pricing

Nearly 80% of their EBIDTA is regulated (p28):

• Meaning that rates negotiated with customers have to be approved by government agencies (FERC - US, CER - Canada) to prevent price gouging. 
• The Canadian Mainline (7% of EBIDTA) was built before US shale gas was discovered, and has since struggled to compete with cheap US gas coming from the Appalachian Basin (Marcellus).  It has no pricing power.  In this case prices drop - regulation doesn't matter.

So regulation does limit upside a bit, while not protecting downside.

I think the 2020's will be the decade of inflation.  Are TRP's revenues protected against this?

Some FERC rates are automatically-inflation adjusted.  Depending on the pipeline classification, rates are automatically adjusted every year, or inflation adjustments are written into the contract with the customer:

Source: Invesco. Why Inflation cam be a tailwind for midstream

I could not google any information on wether the Canada Energy Regulator adjusts rates for inflation.  The company says NGTL "operates under the terms of the 2020-2024 Revenue Requirement Settlement which includes an ROE of 10.1 per cent on 40 per cent deemed common equity." (p178)  To me, this does not sound like it adjusts for inflation.

Here are some hints that it does take inflation into account:

Source: finchat.io

I could not get any details.  Not sure if they will adjust the entire tariff by the inflation rate, or only the part reflecting increasing maintenance costs (while excluding build costs from the past).  This would be a small adjustment as maintainence costs are low for gas pipelines.

So for inflation protection:

• US pipelines adjust for inflation.  Yearly if its a "non-compeditive" pipeline.  For "compeditive" pipelines, its based on the contract, so will depend on if you have pricing power.
  
• Not sure if/how Canadian pipeline tariffs adjust for inflation (?)
• If an area has too many pipelines and not enough demand, prices will go down, regulation and inflation adjustments don't matter.

Cashflows

Dividends are lower than CFO, but CFI is very high due to capex on new projects.  CFI plus dividends has exceeded CFO in many years:

Projected capex is below.  Maintenance capex (part of CFI) is approximately ~2bn per year.  I've annotated for their later Costal GasLink blowout:

So its not until 2026 that they'll start paying down debt.

Debt

At end 2022, debt was 51bn: 41bn in loans or notes, plus 10bn in  Junior Subordinated Debt.  Thats unsustainable, at 8X 2022 CFO, or 12X 2022 FCF.  CFO should grow (probably another 3bn in the next 5 years) as the new projects come online, so that makes it a bit better.

Debt maturity (I have not broken it down into USD/CAD debt):

What is the effect of rising rates on their debt?  I went through years of annual reports - they did not make it easy - to consolidate their debt issuance.  They have:

• 30bn fixed rate debt
• 8bn floating rate
• 3bn unknown
• 10bn Junior Subordinated debt. (p195).  These are fixed rate for the first ten years,before converting to floating rate.

If all debt due by end-2027 is refinanced at 9% (The 20 year risk free Canadian rate is ~3.7%, the US one is 4.5%.  I'm using a high rate for high debt and shitty management)...then their 2022 results would have ben lower by 900m, a 20% reduction in FCF.  The same stress test for WMB and KMI give 10% and 7% reductions respectively.

The key thing for this company is no more cost blowouts till 2025, then being able to pay down debt after that.

Risks

• Canada's carbon tax is $20/ton today, but due to increase to $170 by 2030.
• The company has a history of operational problems: Milepost 14, Keystone pipeline leaks, Columbia gas line pressure drop. Concerned it may be a cultural issue.
• To much debt, especially when the Junior Subordinated debt converts.
• They may move into ESG and renewables, which have lower returns.

Valuation

At CAD 48, its trading at a 7.75% yield.  Thats paying out 75% of their 2022 FCF.

New projects coming online should increase CFO by half in 3-5 years, but they need to pay down debt.

Misc

I don't know the withholding tax rate.  Interactive Brokers usually charges me 15% for Canadian stocks, but TRP has significant operations in the US, so it may be higher.

Edit: Nov 2023: Confirmed my witholding tax is 15%

The stock plunged three weeks ago on news of the Keystone spinoff, then recovered.  It looks like capitulation, so that may be the turning point.

I have bought a 2.5% position, and would go up to 5%.  My max size for this is half that of WMB or KMI, who have less operational and financial risk.

References

A good intro: TC Energy shares have fallen too far (HFIR Energy Income on SeekingAlpha)

Introduction to Semiconductors

 An overview of the semiconductor industry.  Aims to understand:

• What are the moats in the industry?  
• When you are looking at a company, where does it sit in the ecosystem?
• Long term trends.  Trends in this industry take years of industry-wide cooperation and billions of dollars to play out.  Once you can see a trend start, you can pick tomorrow's winners.

Types of Chips

Memory Chips

Memory chips were a commodity subject to wild supply and demand swings. Now the industry has consolidated into 3 players: Samsung, SK Hynix (both Korean) and Micron.

Source: For the first time in Memory, have durable profits finally arrived?

China's YMTC recently entered the market, aiming for a 6-8% market share in 2022.  Their chips are state-of-the-art, but YMTC is on the US blacklist.

Despite its oligopoly structure, the memory industry is in a downturn (crash?) now due to falling demand from a post-covid hangover.  While Samsung is maintaining capex.  The memory industry is still irrational.

In the long run:

• The Koreans look like winners due to scale and predatory capex/pricing.
• Micron looks like a loser due to debt and lack of EUV.
• YMTC will operate in its own market, but will slowly fall behind from lack of EUV.

Logic Chips

Two main types:

• CPU's run general instructions to allow a computer to do anything.  They are designed by Intel/AMD (for computers), or ARM (originally for handphones - now also computers).
• GPUs are specialised chips to perform simple math calculations.  Used for graphics displays (eg: realistic games) and AI (matrix calculations).  The leading GPU designer is NVDIA - they have a moat from their CUDA interface being a standard, but its being challenged.

Logic Chips are built in Fabs, usually separate from the company that designed them.  The foundry industry has consolidated so that only three companies can build modern logic chips:

Source: Fabricated Knowledge Substack

Of the three leading-edge players:

• Samsung is fucked for high end logic chips.  They have a top down management culture unsuited to technology development and are serial liars.
• TSMC is the clear leader due to their partnership with Apple.  The risk for TSMC is a Chinese blockade/invasion of Taiwan - I give it a 30% chance before 2030.  Even without war, new foundries have to be built elsewhere, which has to be bad for the market in the long term.
• Intel has historically fabbed its own chips from when it was the leader in the 90's, but has now fallen behind both in chip design and foundry capability.  Intel has a bad capital structure and was bleeding to death.  They may have stopped the bleeding with their Feb dividend cut.

CPUs are currently in a downturn due to the covid-hangover, but not as bad as memory.  

GPUs (including ASICS for crypto mining) are in a downturn, but NVDIA's stock is in an AI bubble.

Analog

Analog chips are simple ones used to convert "real-world data" (eg: light/voice for camera/phone) into digital signals to processed by other chips.

Players are Texas Instruments (design and fabs), Analog Devices (design only) and Tower Semiconductor (fabs).  All these companies look interesting.  Haven't looked at their valuations or the industry cycle.

System on a Chip (SOCs)

Up until 10 years ago, we made computers faster by improving their CPUs: squeezing more transistors into a piece of silicon, and increasing the clock speed (time to process one instruction).

This stopped working, and we now combine CPU, GPU and memory onto a single chip.  The idea is to allow different parts of the chip to perform specialised tasks (eg: in your phone: a GPU for video processing, with a less powerful CPU for general processing).  It allows more tasks to be done faster with less processing and heat.  Apple's desktop M1 chip used this in 2020 to leap over previous generations in terms of performance.

Some consequences of this are:

• Expect the decline of Intel/AMD chip designs in desktop/server computing.  Intel/AMD's x86 or x64 chips use CISC (complex instruction sets) which are unsuitable for SOCs.  The only advantage of x86/x64 is that you can run legacy DOS/windows programs developed since the early 80's.  ARM chips (which are non-x86 or RISC) were not able to run them, but this has changed.  Apple now has an emulator to run intel-compiled programs.  Microsoft is developing an arm based server and tablet devices.  Expect Wintel to die.  Expect the majority of servers/desktops to move to ARM based processors, while x86/x64 chips become a specialised market for running legacy software.
• Big Tech (Apple, Google, Microsoft, Amazon) design their own in-house chips for their products/operations.  e.g.: Amazon's Nitro SOC runs the hypervisor (VM manager) in their AWS, freeing up resources for user operations.  Google's TPUs run AI calculations.  This vertical integration can be a way to extend their moats.  (...Or maybe over-optimisation just distracts them from their real business: Amazon, Google).
• Increasing importance of the "packaging" part of the chip production process (below).

Classifying Chips by Usage and Size

Another way to categorise chips is by size (nm).  When discussing chips, you need to place them by size and timeline to know what parts of the industry you are talking about. 

Roughly they can be broken down into:

• High End: For phones, PCs and Servers.  Produced in Taiwan, the US and South Korea.  Designed in the US.  Probably anything smaller than 28nm.
• Medium End:  Probably 28nm or above.  For automobiles, aerospace.  Produced in Malaysia, Thailand, Philippines, Singapore, plus the above countries.
• Low End: For the IOT.  To help your refrigerator keep track of your shopping list.  Produced in China.

This diagram shows it visually:

Source: S&P Global (2021): Analog chips - poised to become the next big threat to automakers?

There was a huge shortage of medium end chips for car manufacturers in 2021.  Foundries cannot easily add capacity for these older chips, which are sold so cheaply because their production facilities are fully depreciated. New production facilities require higher prices and long term agreements.

Node sizes for the 3 foundry businesses are not equivalent: Intel's 10nm is equivalent to TSMC's 7nm (so its now called "Intel 7"), and Intel's 7nm ("Intel 4") is equivalent to TSMC's 4nm.  See "Node Name Disconnect".

Production Process

The 5 steps of chip production.  Generally, the outputs of each step are the inputs to the next:

Wafers

Produce the silicon wafers that chips will be printed on.  The wafer market was an oligopoly, but may now be cracking:

• 5 companies produce(d?) 90% of silicon wafers (p5).  2 of those are Japanese: Sumco and Shin Etsu.
• 150mm and 200mm wafers are for older chips, 350mm are for newer ones.  A proposal for 450mm wafers was killed by TSMC in 2013.  The industry hasn't changed much since the 90's.
• Sumco expects no capacity expansion till 2024, despite a wafer shortage.
• This may give space for Chinese companies to enter the market, especially for 150 and 200mm.  Chinese firms expanded production in 2021.  South Korean imports form China almost doubled from 2020 to 2022.  Chinese wafers are reportedly 5-10x cheaper than Japanese ones.

Lithography (ASML)

Lithography is the process of etching circuits into a wafer.  A good description is in Doug O'Lauglin's Fabricated Knowledge.  Chips 7nm or below require EUV, which is from one company: ASML.

ASML's EUV machines are incredibly complex and precise:

• "molten tin droplets of around 25 microns in diameter are ejected from a generator at 70 meters per second. As they fall, the droplets are hit first by a low-intensity laser pulse that flattens them into a pancake shape. Then a more powerful laser pulse vaporizes the flattened droplet to create a plasma that emits EUV light. To produce enough light to manufacture microchips, this process is repeated 50,000 times every second."  
• ASML's supply chain is worldwide.  Their suppliers are small companies that each specialise in one out of the hundreds of steps required. (eg: A small company in Vienna selling equipment to produce photomasks).

No one can replicate this and integrate the work of hundreds of suppliers to the required precision.  Especially when the market is limited to three customers who all invested in ASML in the first place.  ASML is a monopoly for the next ten years.

If I was buying ASML, valuation is the only question and the key number is their recurring revenue for their installed base vs new sales.  The stock is too expensive now.  ASML or its suppliers may be a cyclical play later.

Applied Materials Sculpta process may halve the need for EUV.  Or maybe not.  Hard for lay people to judge.

Inspection

Covers non-intrusive ays to measure a chip to make sure its correct.  Theoretically it means using beams of electrons, x-rays or light to measure the surface of a chip.  The complexity is in interpreting information from the reflected beams to form a picture of reality.  More details from Fabricated Knowledge's Meterology Primer.

Packaging

Attaching the silicon chip onto a motherboard. From old to new:

• From the old days, a DIP chip package, with its iconic "spider legs":

• Wire bonding: Using copper wire to attach the chip to the circuit board.
• Flip Chip: Depositing an array of solder balls onto the board's pads, and "flipping" the chip onto it.

• 2.5D packaging: TSVs passing through the wafer (like underground cables) connect different chips on the board.  Used for SOCs.
• 3D packaging: Connect different chips which are all sitting on top of each other (on the circuit board).  Currently used in memory chips, not yet in logic chips.

See Fabricated Knowedge's Packaging Primer for more.

Testing

Theres two levels of testing:

• Functional Testing: Running a current through a chip to test input and output combinations.
• System Level Testing: Test the chips under the conditions they are expected to be used.  eg: Test at varying temperatures, or for long run-times (burn-in), structural tests, or software level testing (calling the chips functions/libraries in the same way that software wold).

The big companies involved in the last 3 steps are Applied Materials, Lam Research and KLA Tencor.  

2.5D or 3D packaging may be done more by the fabs (TSMC). 

Conclusions

Theres less than 10 big players forming the semiconductor ecosystem.

Things change slowly, but they do change.  eg: Wintel's fall and TSMC's rise.  These are not Buffet-like stocks to pass to your grandkids.

I believe China will not be able to make high end logic chips - they would have to replicate an entire ecosystem.  They can do high end memory.

Biggest moat is for ASML.  But everybody knows it and they are expensive.

TSMC is the clear foundry leader, and fabs have pricing power.  They are reasonably priced, though probably its not the right time in the cycle.  Big geo-political risk.

Intel was dying.  They have stopped the bleeding.  Maybe a turnaround play?  Can they get the money to build Fabs in a downturn, and as the market moves away from CISC?

Resources

• Fabricated Knowledge Substack.  Good introduction.
• Semi Analysis Substack: Goes into more details.
• SemiWiki: I can't understand their technical articles, but can read their business ones.
• Transistor radio podcasts.