The Federal Reserve has poured unprecedented levels of stimulus into the U.S. economy to deal with the pandemic, and most experts agree that inflation is just around the corner. David Einhorn has positioned his Greenlight Capital to benefit from inflation when it arrives.
Preparing for inflation
In his second-quarter letter to investors, which was reviewed by ValueWalk, Einhorn said an inflation bias had already been embedded in the portfolio prior to the quarter. The fund’s macro book has held gold for a long time. Einhorn adjusted the position during the second quarter by reducing the fund’s direct exposure and adding the VanEck Vectors Gold Miners ETF and a small position in a speculative gold miner.
He added that several of their previous long positions are exposed to rising prices in multiple industries. Green Brick Partners will benefit from rising home prices, while Brighthouse Financial will benefit as equity market prices rise and long-term interest rates increase eventually.
CNX Resources will benefit as natural gas prices rise, while Chemours will rise on higher titanium dioxide prices, and Buzzi Unicern will benefit from higher cement prices. Einhorn also added a new long position in Teck Resources, which should benefit from increases in base metal prices.
In addition to positioning the portfolio indirectly for inflation, Einhorn also made a more direct met on inflation with inflation swaps, which are a liquid derivative of Treasury Inflation-Protected Securities (TIPS). He noted that inflation has averaged 1.7% over the last decade, and inflation expectations stood at 1.3% for two-year inflation, 1.4% for five-year inflation, and 1.6% for 10-year inflation.
He expects “profitless growth stocks that trade at astronomical valuations” will be disrupted by expectations of rising inflation, even if Treasury yields don’t increase correspondingly.
Atlas Air Worldwide Holdings
Einhorn also added a new equity position in Atlas Air Worldwide Holdings, which operates the largest fleet of Boeing 747 freighters and owns, operates and leases other Boeing freighters. Before the pandemic, about 50% of airfreight was carried on passenger planes, mostly long-haul international flights.
These flights are down more than 90% year over year and will likely be the last part of passenger travel to recover. That has resulted in a historic shortage of airfreight capacity. Initially, demand surged for shipments of personal protective equipment, but now the market is transitioning back to more traditional airfreight products like electronics, capital goods, perishables and pharmaceuticals.
Market shipping rates grew more than 100% year over year in the second quarter and are expected to remain strong. Thus, Einhorn expects Atlas Air to see major growth in earnings per share this year. Greenlight acquired its shares at an average price of $36.28, and they ended the quarter at $43.03.
Einhorn: Tesla has been “abusing its stakeholders”
Einhorn also discussed Tesla, which he said has been “abusing its stakeholders” so much that he could write pages about it every quarter. This time he talked about once instance involving sudden unintended acceleration in Tesla vehicles.
He cited a study conducted by Dr. Ronald A. Belt which found an issue with how the Tesla braking system interacts with the battery regeneration system. The result is that in some situations, pressing the brake causes the vehicle to accelerate, and the harder the driver presses the brake, the faster in accelerates.
The National Highway Traffic Safety Administration said in January that it will investigate the complaints, although Tesla denies there is a problem. Einhorn said the more technologically complex products become with “intertwined hardware and software systems, the more difficult it is to design them for universal adoption in real-world large scale deployments.
He believes the combined software and hardware problem might be easily fixable and compared it to Boeing’s issues with the 737 MAX. Einhorn added that a massive recall on a defective product can financially ruin a company and end management’s career, but Tesla can’t be trusted to do it on its own. He added that it will be up to the NHTSA to order a recall of Tesla vehicles with safety-related defects.
Einhorn also noted that there is speculation about Tesla joining the S&P 500, but he believes the company has been abusing the accounting rules.
“Through what appears to be sheer abuse of the accounting rules, TSLA has now contrived reported profits to make it technically eligible [to enter the S&P 500],” he wrote. In addition to its routinely questionable accounting maneuvers, Tesla appeared to defer employee compensation, depreciation expense on its new plant in China, and research and development spending.”
He also called attention to the sharp increase in sales of regulatory credits in the automaker’s latest earnings report. The company previously included a statement that it recognizes revenue on the sale of credits at the time control of the credits is transferred to the purchasing party.
However, Tesla sharply increased its recognition of regulatory credits sharply in the first and second quarters. Einhorn said that in the past, Tesla received cash for sales of regulatory credits, but this year they have “piled up in accounts receivable.”
Further, he said Fiat Chrysler is the company’s primary customer for those credits, and Tesla’s recognition of the revenue from those credits isn’t consistent with Fiat Chrysler‘s recognition of expenses for those credits. He questions whether Tesla’s accounting and the way it handles the transfer of regulatory credits and payment for them conform to GAAP accounting.
“We suspect that TSLA changed its accounting policy during a non-audited quarter to manipulate eligibility in the S&P 500 index,” Einhorn wrote. “The consensus is that S&P will add TSLA to the S&P 500 index at the next opportunity with a large weighting, forcing millions of passive investors to sell the other 499 stocks to make room for TSLA at whatever the price du jour. We think the S&P 500 Index Committee has a tough decision to make as to how to respond to being gamed like this.”
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