A Bankrupt Company is Selling New Shares!

Let that headline sink in. Now scratch your head and read it again!

I had never heard of a bankrupt company come back to the secondary market, get approval to issue new shares which is potentially worthless, at a valuation of at least 5 times better than when bankruptcy was declared. Sure, there have been numerous instances of bankrupt companies raising risk capital via private investors who come with the expertise of turning around companies but collective expertise of day traders is stretching this argument too thin!

Here are three charts and some data points that stood out for me this week:

Hertz would warn buyers - “the common stock could ultimately be worthless” 

Hertz won approval to raise about $1bn by selling new shares. The money will be used to pay down debt as the company is facing an extraordinary loss of businesses during this pandemic and is unable to service it's $5.3bn debt. That is not stopping the shares of Hertz to go from 56 cents on May 26th to $5.53 (10 times) on Monday, the 8th of June.

Taking advantage of this euphoria, the company applied and won approval to raise equity and a committee of unsecured creditors readily agreed as equity doesn't come with high interest costs and fees that would have been applied to traditional bankruptcy loans. Better still is the fact the equity holders are last in capital structure and would most probably not get anything in a bankruptcy proceeding. The bondholders are happy, the 2021 bond closed at 85 from a low of 60.50 set in the beginning of May.

What driving this? As evidenced in the chart below, speculation by investors who treat investing like gambling are buying into small companies with very low share prices (often less than 1$ share price) and selling them in a couple of hours. For instance, Chesapeake Energy's stock nearly doubled on 8th June after 22 trading halts!

Robinhooders really took on the reins after the shockingly positive Jobs report (NFP) on 5th June and bet that the economy is well on the path of early recovery thus bidding up cyclicals, small caps, and bankrupt companies. The euphoria was bought down on Wednesday by the Fed who provided a more somber outlook on the economic recovery. I thought the Fed did a great job with its policy announcement. Some thoughts are here.

Trading stocks which has become a pandemic pastime to many is dangerous, to say the least. Markets have a way to draw you in with some beginner's luck and smack you right out of the park. With the kind of exaggerated moves we are seeing in stocks these days, the smack might happen sooner than later.

Pandemic's Retail Effect - Forced Acceleration to Online

Zara's owner, Inditex said it is permanently closing down 1,200 stores or 16% of its global outlets and will drive more aggressively towards its online presence. The current crises has only made the move online more critical and those who fail to adapt are closing down at a breathtaking pace. E-Commerce as a share of retail has been growing steadily and currently stands at about 12% of total retail sales in the US. UBS estimates that roughly 100,000 stores could close in the US over the next five years and e-commerce will rise to about 25% of total retail sales.

Inditex online sales grew 50% in Q1 and over 95% in April while Q1 total sales dropped 44% from a year earlier. This just solidifies the view that technology can no longer be viewed as a sector but an undercurrent that is going to drive change across industries. Walmart is a great example of how traditional companies have embraced online and continue to thrive and grow. In fact Walmart's 4,750 store presence across US makes it logistically better suited than even Amazon (75 fulfillment centers) to fulfill online orders.

The Rich keep getting Richer - True with Richly Valued Stocks as well!

While the headline S&P 500 index is only down 5.86% this year and NASDAQ is up 6.87%, beneath the surface there are tons of stocks that are down 20% or more. Even after cyclical and small cap rally in the past few days, the return disparity is alarming.

Below the broad indices, growth has been powering ahead with expensive stocks represented by high P/Es continuing to go higher while value stocks with low P/Es are still down sharply for the year. The gap in performance is the highest on record except for the Tech bubble in 1999-2000. The pandemic caused a risk aversion within equities where investors flocked to large tech companies with good balance sheets bidding up their prices more and more while shunning the smaller and cyclical names with relatively stretched balance sheets.

The below chart from WSJ captures the current disparity wonderfully.

Traditionally, such wide valuation dispersion is a good sign for value investors. Is it finally time for the value investors to shine? Do click here and cast your vote.

Disclaimer: The views and opinions expressed, if any, are of my own and do not necessarily reflect the official policy or position of the organization I work for.