Friday, May 20, 2011

Earthquake, Nuclear Crisis, and a perfect buying opportunity

There is no way to predict an earthquake. It is known that the "Ring of Fire" seismology puts Japan in one of highest risk places in the world for earthquakes. But no one can foresee a 9.0 earthquake or really prepare for all the outcomes. Yet TEPCO, the operator of the nuclear reactors, is currently facing the aftermath of that scenario. The company that provides 35% of the electricity sales in Japan has seen it's stock price fall over 85% from pre-crisis levels due to compensation claims related to the event. In fact, TEPCO is now at risk of bankruptcy due to massive claims and the unwillingness of banks to lend to TEPCO without government guarantees.

WSJ, May 20, 2011

"TOKYO—Tokyo Electric Power Co. said Friday it logged a net loss of ¥1.247 trillion ($15.28 billion) for the fiscal year ended in March—the biggest annual loss in Japanese corporate history outside the financial sector—as it was hammered by massive costs in battling the Fukushima Daiichi nuclear accident.

With compensation liabilities expected to run into trillions of yen (tens of billions of dollars), Tepco also warned that the "significant deterioration" in its financial position "raises substantial doubt about its ability to continue as a going concern."

Given the situation are two alternative paths for Japan to take toward TEPCO...

The negative alternative....

If TEPCO pushed into bankrupt, equityholders of this previously considered "orphans and widows" stock will be wiped out. Insurance companies, stock indexes, pension funds, and other conservative investors will be impacted at a time when Japan's financial system is precarious.

"Ms. Matsumoto is just one of the more than 741,000 individual shareholders
the embattled utility had at the end of March, many of whom had purchased the
stock in hopes of stable and high dividends. While equities are still not the
most popular investment tool in Japan, Tepco was perceived by many Japanese
families as one of the few safe investments to be handed over from one
generation to the next."

Yet these same groups will be responsible for recapitalizing whatever company takes the place of TEPCO, with no certainty of a better outcome for their new investment.

Bloomberg, "Japan to Help Tepco Pay Nuclear Claims; Banks May Have to Write Off Debt" May 13, 2011

“The government should make it clear that consumers will have to shoulder the burden,” said Kazutaka Kirishima, economics professor at Josai University near Tokyo. “Whether through increased electricity rates, tax hikes or government bond issues, the public will eventually have to pay.”
The positive alternative...

On the other hand, if the Japan government provides a financial backstop to TEPCO and returns it to stability, the "orphans and widows" and asset managers will recover and the government will be forgiven for whatever pain was incurred. The breadth of the electric company, TEPCO, that provides electricity to 25% of the nation, cannot be understated. The US nor the UK was willing to force BP into bankruptcy, and it is less likely that a public utility will also suffer such a fate. This is a national champion. As seen by the US financial crisis and how the Fed supported the whole commercial paper market, major industrial countries are top priority for support in financial distress.

In fact, the Japanese government has already established that it is stepping in to support TEPCO, spoken or unspoken.

Bloomberg, "Japan to Help Tepco Pay Nuclear Claims; Banks May Have to Write Off Debt" May 13, 2011

"Japan will create a body to handle claims against Tepco, as the company is called, and will issue bonds to fund them, according to a statement yesterday. As part of the aid, which may include taxpayers’ funds and purchase of shares in Tepco, Chief Cabinet Secretary Yukio Edano said lenders may be required to write off loans to the company."
The writing is on the wall. Japan will stand behind TEPCO and as an investor it is a viable investment opportunity.

Thus this blogger is going long TEPCO (TKECY.PK) at $4.9/share.

Yet to protect the downside, this will be hedged with the Japan index. If there is a nuclear blow up, it should happen sooner rather than later and take the whole Japanese stock market down with it.

Thus this long TEPCO position will be hedged by buying EWJ Dec 2011 $8 Put for .18.


Lockstep said...

The hedge did not work. The situation got much worse. But I think we have hit the bottom for TEPCO. Japan needs their utilities to recover. I still expect TEPCO to recover, despite its role in the meltdown last year.