That’s Goldman’s estimate of production shut-ins for the Middle East. We had pegged it around 11-12M bpd, so a smidge higher we suppose.

Our original assumption was that the US/Iran War would end on April 21, the day the ceasefire ended. We wrote that to be conservative, with diplomats winging their way back and forth to Islamabad, there was a chance some sort of agreement could come to fruition. Hence it was safer to assume that a miraculous agreement could be crafted to resolve the seemingly intractable issues between the US and Iran (i.e., the Strait of Hormuz (“SoH”) closure and Iran’s nuclear enrichment program).

The deadline passed uneventfully though. This week saw the ceasefire extended indefinitely and the resignation of Iran’s Head of Parliament Mohammad Bagher Ghalibaf from the negotiations team. News reports soon surfaced that Iran’s Supreme Leader Mojtaba Khamenei had reprimanded the Iranian negotiation team for the first round of discussions because they had placed the topic of nuclear enrichment on the table. Whatever the reason, the IRGC and the Ayatollah appear to be in firmer control, which should mean harder line positions prevail. So off we go, finishing up a 7th week of this campaign. We’ve likely lost ~700M barrels of oil as of April 21st, and now that it’s apparent negotiations may take more time, we’re in bonus time. Like soccer though, we’ve little clues how long the bonus time will last.

The US’ blockade of Iran’s blockade is an attempt to apply more economic pressure, but since Iran largely sells its oil to China, those vessels have been unmolested. There’s little reason for the US to anger the Chinese, especially as their own meeting is scheduled for early May. So if a majority of Iran’s oil continues to flow, we do wonder, when is a blockade not really a blockade?

A Day of Delay, Keeps Lower Prices Away

The question does remain though, how long do the combatants have to survive this? The US believes it has effectively as much time as it needs, and certainly more than Iran. The idea is that Iran’s storage will eventually hit tank tops and in a few weeks, they’ll be forced to shut down wells. In contrast, Iran sees the global economy and postulates that the higher oil prices go, and the lower the stock market moves, the weaker the US’ resolve in furthering this war. It’s obvious the US wants to TACO and that a ground offensive is unpalatable militarily, strategically, and politically. Despite the headwinds, the stock market has rallied massively in the past 19 days. Moreover, oil prices have remained below $100/barrel even as the physical market indicates tightness. In fact, the administration is actually quite pleased with the current state of events, as it gives them the perception of leverage in the ongoing negotiations. Whether it really does or not is questionable.

On Saturday, the US is sending Steve Witkoff and Jared Kushner to Islamabad to engage with the Iranians. Takes about 16 hours to get there, so figure they’ll start chatting Monday. What’s telling is that the US didn’t send Vice President JD Vance, who led the delegation last time. We think this speaks volumes, as there’s still a chasm between the two sides. Frankly, we’re not entirely sure they can bridge it, but the Iranians will be going as well, though the two are not meeting directly.

The US will certainly not give up control on the SoH to the Iranians, and accept a permanent tolling system. Granting such a concession would be viewed as a strategic loss and anger the Saudis/GCC coalition. It could also impact the sanctity of the petrodollar, as the GCC would view the US as unreliable allies.

Furthermore, the US is seeking an agreement that’s tougher than the JCPOA for nuclear enrichment, but can Iran actually swallow such a bitter pill? We don’t think so. We don’t think so because Iran actually thinks it’s winning militarily (note: they are). Not in the conventional sense, but from the strategic one. They still control the SoH even with a devastated air force and navy. Drones and mines are sufficient these days, and Iran has been effective in employing them.

The paper market and the stock market have been entirely dismissive of the supply outage. No thanks in part to the jawboning that’s created extreme volatility and higher margin requirements, which then dampen the risk appetite of traders. So oil languishes below $100/barrel, and it gives the generalists betting on technology, semiconductors, and AI, that all is well, and all will be well . . . because just look at the stock prices, we’re making money.

If so, then neither side has felt enough pain yet to force a compromise. Instead of malleability, we’re looking at recalcitrance and a prolonged period of negotiations.

So Monday it is . . . for the next round. April 27th. 6 days after April 21st. Multiply that by 14.5M bpd and we’ve just lost another ~87M barrels. For every week the SoH remains closed we’re looking at 100M barrels of crude never produced. That figure’s permanent, and it is real. Now the real drawdown in inventories will be less because of demand destruction (we think around 4M bpd) coupled with SPR drawdowns (3M bpd) will soften the impact, but SPR drawdowns are inventory reductions, just in a different pocket than commercial stocks. In the end, both pockets are on the same pants, and them pants sure be getting tighter.

In Totality

We’ve seen the tally anywhere between 700-900M bpd lost (not including the 200M bpd likely to be lost when the SoH starts to reopen because tankers are mispositioned and production restarts need to ramp). We’re also not factoring in any complications to restarting oil fields that have been laid dormant for a month, or refineries and infrastructure that need to be repaired.

This is fine.

This is fine right? No . . . fine is furthest from the truth. Asia’s cupboard is threadbare, and Europe is running dry. As US inventories drain in the coming weeks (because of the export demand as everyone pulls barrels away), prices will creep higher. Those that have not will buy from those who have, eventually pricing out the other have nots.

The US, the last location to drain given its distance from the Middle East has begun to see increasing draws. Product exports have recently hit an all time high.

Crude is following, as the weeklies have started moving.

In totality, our contemporaneous OECD tracker is starting to show the divergence overall (US/Europe/Japan/Fujairah).

Remember the above includes Japan, and Japan has stopped reporting product changes, but we can guarantee it’s down by tens of millions.

Inevitably, unless massive demand destruction kicks in, our global choice is between losing a historic amount of inventories . . . or unfathomable amount.

The first green dot is already set though. We’re in late April, so visible inventories will almost certainly fall to the indicated level. It’s shy of the 1B or more we think will be drawn from inventories because the above chart doesn’t fully capture the harder to see product stores. Again the safer assumption is 1B barrels lost as of now (inclusive of a 2 month ramp-up that sees the world lose 200M barrels), and every week thereafter another 100M barrels.

So at this juncture it’s really how much further do we bleed inventories down.

As the weeks play out and visible inventories start draining hard, we’ve little doubt that oil prices will recapture their highs on the front-end. Once the back-end of the curve starts to move, the E&P equities will also find a new floor. Contrary to commentators out there, we still think energy matters.

Molecules will rule over paper. While the paper market can hang on every Presidential tweet and distort what’s happening because volatility prevents market participants from seeking real price equilibrium, inevitably a stock-out will force the issue.

The haves will outbid the have nots, and you can take ours . . . for a rich price.

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Open Square Capital Quarterly Letter (Q1 2026)

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That’s where we’re at. Sure the price of oil is well above $100/barrel today, but it’s $70/barrel at the back-end.

It’s a reflection of what’s become of the market all these years. One where energy holdings cratered to about 3% of the overall value, more than halving from 2022, and multiples more from earlier before.

It’s what happens when you spend most of 2010-2014 lighting shareholder’s capital on fire under the pretense of chasing growth. Forget profits, and the market inevitably forgets you. It is the weighing machine after all, and this sector has been found wanting.

So slam the overall value of a sector to 3% of the S&P 500, and it becomes a nuisance. Well actually neglected, as thinking it to be a nuisance means you’d actually have to care about it. Most don’t, so neglect it is.

As an investment analyst, follow a neglected sector for long, and you can watch your career die. Besides, there’s no investment banking fees to be had, so why even bother. Similarly, it’s a trash bin of companies with terrible capital management, so if anything you can short it. Over the long haul, if there’s a way this sector can torch capital, it’ll find it.

So we’re left with 3%, and when the current energy crisis struck, there were fewer analysts to cover it, let alone to understand it. The only group remaining were those who’ve been buried in the sector for so long that they can instantly recognize the crisis for what it is . . . not short-term.

Others though will look at the futures market for confirmation. See? It’s predicting a cheaper price in the near future. Just look at the chart from Javier Blas.

$70/barrel by December! All will be well. Well . . . that’s not quite what it’s saying, but okay. Who are we to quibble, we’ve only been doing this for years.

We are the 3% after all.

The one great thing about social media (and especially Twitter) is the near instantaneous expert commentary (real or otherwise) that appears whenever a novel issue breaks out. As the US/Iran War wages on, market generalists have freely opined on geopolitics, military strategy, energy flows, and the nuances of the oil market. Aided by their preferred AI agent, the analysis has been delivered quickly, boldly and confidently.

This won’t last long they say, it will be painless, and once the Strait of Hormuz (“SoH”) is reopened, oil prices will plummet below the levels seen in pre-conflict. A peace dividend for all.

Frankly we don’t know. We don’t know what the day after will look like, the Day 1 after the all clear sounds. Can it end on April 15th? When Trump’s “2-3 weeks more” nears its end? Will Iran let him walk away, and reopen the Strait? As of now, we’re not entirely sure this thing doesn’t go far, far longer.

As this war drags on, the global energy situation will worsen. This is a 10-11M bpd deficit, and it will quickly carve-up the world. There will be the haves and have nots, those who can afford the exorbitant prices, and those who cannot. Those who produce energy domestically and those that do not. Third world and emerging markets like the Philippines, Thailand, Vietnam, Indonesia are going to feel the pain, but eventually that pain will migrate to Europe, and then the US.

Here’s some of the items we’re thinking through as the pain spreads, and why we think the pain lasts longer:

1. TACO - Trump Always Chickens Out works when things are unilateral (e.g., self-imposed tariffs), but in a war, it takes two to TACO and Iran has little incentive to eat and soothe the pain for the Trump Administration. This will drag on.

2. Abandon the Strait - Impossible. It would represent not only a strategic and tactical defeat for the US, it would subjugate Saudi Arabia, Kuwait, Oman, and the UAE to the whims of Iran in the future. Iran would effectively control nearly all oil flows out of the Middle East. In addition, given that China purchases most of Iran’s cargo, and Russia provides significant support, guess who benefits and gains further leverage behind the scenes? If the US was unwilling to let China gain an economic toe-hold in the Panama Canal, what makes you think they’d let Iran become a toll-taker in the Strait of Hormuz? Walking away isn’t a viable option.

3. Existential Threat - By removing the Iranian leadership and attacking Iran’s infrastructure, the remaining members of the IRGC know that this is a fight to the end. There’s little daylight to negotiate when everything is on the line, and they know the US/Israel could attack again in the future. If it’s a choice between our lives and your global livelihood, they’ll bet on the world blinking. This effectively extends the conflict and forces participants up the escalation ladder until the pain becomes unbearable.

4. The Price Gap - few appreciate the magnitude of this deficit because the prices aren’t accurately reflecting it. Whether it’s the jawboning, or the belief that this war can end immediately, there’s plenty of reasons for skepticism. Ironically, the artificially lower prices actually forestall real conflict resolution, and in fact allows the US and Israel to press their attacks. This reinforces the market’s optimism because all they see are successes of targets being bombed and the tweets about Iran’s inevitable capitulation. The war, however, continues, and the SoH stays blocked. Yet, since the back of the curve is at $70/barrel, then surely we’re fine? We are not.

5. SPR - the Strategic Petroleum Reserve releases aren’t a salve. It’s a bandaid on a bullet hole. The volume is insufficient, and the value is questionable. At full capacity, we think the SPR can release 2.5M bpd against a 10-11M bpd global deficit. In addition, much of the 400M barrels of SPR release (e.g., US’ 176M barrel release) was designed as a loan so refiners would need to pay back the loan at a later date with interest. Refiners are balking at that currently so the uptake on SPR barrels have been tepid. Eventually though, if there’s not enough barrels outside of the US, you can surely bet that US exports will ramp higher.

6. Immediate return - there’s a perception that once the SoH is reopened the barrels will quickly return. Logistically given sailing/discharge times, we put that at 2 months. So even if the war ended today, it would take 2 months to sort out the logistics of transportation, and for the first barrels to show up. The delta between supply/demand will shrink as the weeks move on, but we should expect inventories to fall further even after a ceasefire and detente is declared. Having said that maybe . . . and just maybe the curve is correct. It’s expensive today, but if it clears up, prices should fall, but stay elevated for a few months, and then head lower, though still remaining in backwardation, and still much higher than before.

7. Inventories - there’s also a perception that because there’s so much inventories on land and on-the-water, we can easily drain and handle a 1B barrel drawdown. That’s an illusion. If we continue this war until mid-April, we’ll have exhausted a significant amount of oil-on-water, and land inventories. By the end-of-April, analysts anticipate that close to 1B of barrels of oil are lost for the entire year when all’s said and done. This isn’t unreasonable given the 10-11M bpd of shut-ins, coupled with a slow logistical return. None of this is taking into account any damage to field integrity, etc. for oil fields that have been shut-in for so long. Kuwait estimates it would take 3-4 months to bring production back online. Hardly surprising as you’d need to repressurize the field and conduct tests.

For the time being, inventories are draining from oil-on-water first as the physical air pocket increasingly impacts other regions besides Asia. As the last oil is delivered, watch inventories on land drop precipitously. We’d expect to see product stocks fall first, and then eventually crude. For some OECD countries like Japan, they’ve already stopped publishing data on product inventories, which tells you a lot about the direction of their reserves already. Europe is next.

Sum it all up right now, and the charts don’t look that bad. The issue though is its early stages, and the data lags a bit. We’re most definitely hemorrhaging inventory here, and it’s only just beginning as the Western world will begin to see the impacts this coming week. The data’s starting to trickle in, but doesn’t fully capture the lost barrels. The irony is that the US, whose actions are causing the closure, will feel it last and likely feel it least. Inevitably though, energy is a global commodity, and despite being a net exporter, US prices will catch-up.

We believe the oil price curve is completely mispriced here given the duration and quantum of outage. A $5/barrel bump at the back end of the curve doesn’t adequately reflect the lost barrels. If anything, the minor bump represents hopium that immediately after reopening we return to past.

We completely disagree. Geopolitical uncertainty, inventory depletion, and supply balkanization/uncertainty moving forward means longer-term oil should be somewhere near $90/barrel even if the war were to end today. Given that it is not, and on track for another 2-3 weeks?

Expect triple digit prices to stay. Especially if the US does send boots on the ground (our base level assumption), and their stay isn’t short (also our assumption).

So price oil at the back end at $70/barrel (and energy equities too)?

We’ll see you on the other side of that trade.

God Bless America and our troops.

After a month of conflict, we can all assuredly agreed that the Iranian excursion was at best . . . ill advised, and at worst . . . well . . .

So we wait for the weekend as special forces (Tier 1 operators), a Marine Expeditionary Unit (“MEU”), the 82nd Airborne, land based fighters and bombers, and coalition forces assemble to capture some of Iran’s islands in an attempt to unblock the straight.

Will they succeed? Absolutely.

Tactically that is.

The tactical/military superiority of the US armed forces can’t be denied. They’ll almost certainly take whatever land, air strip, port, or oil infrastructure they set out for, and with minimal casualties. Of that we’re fairly certain given the poor training and degraded Iranian capabilities.

What we’re uncertain of though is whether a quick strike and victory, necessarily gives the US sufficient leverage in its negotiations. Negotiations that are seemingly getting more desperate by the day.

Among the few options floated include taking Iran’s strategically located islands in the Persian Gulf.

First, the US could take Kharg, Iran’s oil export terminal on the top left hand corner of the map above. Second, it could take Qeshm on the bottom right. Kharg, a major export terminal would be beneficial as it would shut-down the main spigot for Iran’s oil exports. Iran can divert its supplies, but not as easily, and not in full. Yet if the US was already willing to unsanction Iranian oil for fear of harming the oil market, it’d be inconsistent to then capture Kharg, and jeopardize flows there. Still, in trying to gain leverage, capturing Kharg would be the way to go. It’s much further in the Persian Gulf though, so would require a longer logistical tail to hold, which increases the military risk. Kuwait or Saudi Arabia’s assistance could help as they could resupply the troops from there. Still though, would the US be willing to completely shut-off flows when oil is already impacted? We’ll see.

Alternatively, the US could capture Qeshm. Currently, Iran is demanding that the US recognizes its right to control the strait (one of a list of 5 demands), and it’s using the waterway between Qeshm and the mainland as a toll gate. Capturing Qeshm would deny the Iranian’s the ability to use the facilities there. Issue with Qeshm? As you can see, it’s much larger. It would also likely mean ground operations in Bandar Abbas, and that means you’ve landed boots on Iranian mainland soil, which will take the entire war up the escalatory ladder.

Would it Matter Anyways?

Regardless of what the US does, what doesn’t immediately disappear is the asymmetrical threat posed by the Iranian drones and mines. If so inclined (and able), Iran can send enough drones to overwhelm the naval escorts when they cross the strait and/or at least pester the commercial tankers. Even if the escorts were successful, the disruption, logistical burdens, and insurance/economic costs likely means only 20% of the original traffic can be restored. Here’s Vice Admiral Kevin Donegan of the US Navy (in an interview with Goldman Sachs).

20% of normal flows? That’ll hardly make a dent in the supply outage.

Besides, we’re skeptical that sending boots on the ground means the Iranians will quickly capitulate as they only need to drag the war out for another few weeks. If Iran can keep the strait closed, or materially disrupted for 2-3 more weeks, we believe the global economy will come crashing down, deterring future aggression from the West.

So would they be willing to sacrifice a tactical loss for a strategic victory? Yes.

Today, we continue to have nearly 10-11M bpd of production shut-ins. Exports through the Strait of Hormuz are down by nearly 15M bpd, and SPR releases are just beginning. Despite accounts on Twitter sharing that some vessels have passed, it’s a far cry from the norm. Vessels traversing the strait are the exception and not the rule.

More importantly, production shut-ins are topping 11M bpd, and will take weeks if not months to fully come back if the war were to end today. You think we can last? Asia is already in full emergency mode:

1. Philippines - have declared a national energy emergency program, 4 day work weeks, and directives to limit travel and reduce power usage

2. Thailand - mandatory work from home for civil servants, strict air conditioning settings to save energy and subsidizing product prices;

3. Pakistan - 4 day work week for government offices, closed schools and cut fuel allowances

4. India - restricted LPG usage to ensure supply to households

5. Sri Lanka - limited fuel purchases and made Wednesdays a holiday for fuel consumption.

6. Japan - suspended public reporting of product inventories and intervening in the paper market to suppress prices. Restricting exports of petroleum products.

7. South Korea - implemented petroleum price caps and public energy savings program.

8. Australia - introduced export curbs on refined products (the country imports roughly 80-90% of its petroleum products). Relaxed fuel specifications.

Note that this is this week only, and countries are beginning to buckle. Even if the war were to end today, it would still take weeks to restore product flows and transport crude and products to the impacted countries. By next week, Europe will begin to feel the pain as the tankers that would normally show-up don’t.

This slow-rolling outage will accelerate in the coming two weeks, and by our estimates, if a resolution and immediate resumption of supplies doesn’t occur, we’ll have lost so much inventories (i.e., ~450M barrels) that inventory reserves will be depleted and prices will begin to moon. Any longer, and the scarring will be severe. Energy Aspects estimates if the outage lasts until the end of April, we’ll collectively lose 920M barrels of liquids. That my friends is nearly unfathomable.

Complacency

As of Thursday’s close, the SPY and QQQ are down only 5.6% and 6.4% year-to-date, respectively. Trump’s back and forth about striking and not striking energy targets in 5 day, and now 10 days, has flip flopped the market. After each TACO though, the market rallies are getting weaker, and oil prices have fallen less. It’s a dangerous indicator that the TACO-ing is becoming less effective. The paper market can be fooled, but the physical market is starting to discipline as the molecules just aren’t there.

Unfortunately, unlike the US’ unilateral tariffs, it takes two to TACO this time, and will Iran bite this time? Only to give up all of its strategic advantage just when the leverage will soon swing decisively in their favor? Only to negotiate with a Trump Administration that has already burned it twice (i.e., attacking during negotiations)?

We’re doubtful.

The nuclear option outside of developing a nuclear weapon was always to weaponize the Strait of Hormuz. It was simply unthinkable because of the global consequences. Who would decide on such a pyrrhic strategy? Apparently, someone facing an existential crisis.

They’ve finally done so, and that missile has been fired directly at the global economy. So fool them once, shame on us. Fool them twice? . . . they’ll let it burn.

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(Disclaimer, we hold plenty of energy equities, USO/BNO, and shorts on select tech companies. Due your own due diligence, but for the love of all that’s good . . . be careful out there in the coming days.)

Just not today.

We’ve stepped into Iran’s hurt locker, and now enclosed, we’re still swinging away.

Doubling down because that’s what people with strength do right?

So the USS Boxer joins the USS Tripoli and its MEU in the Gulf. We won’t speculate what the MEUs will be used for (e.g., Kharg Island or the shoreline next to Strait of Hormuz), but just simply look at timing. It takes about 3 weeks for an MEU to sail from the West Coast to the Gulf. USS Tripoli will arrive before that (sometime next week), but even if it’s successful in gaining a tactical victory and taking a strategic foothold, would that compel the Iranian’s to lay down and accept a full ceasefire and peace accord? Doubtful, which means this excursion likely drags on for another 3-4 weeks.

We doubt it because by the end of next week . . . we’re bingo fuel.

What we mean by that is we’ll have effectively wiped out the entire “glut” built last year. Moreover, we’ll be dipping into commercial inventories, the draining of which will make oil gains go parabolic in the West.

Oman is at $170, Dubai at $150, Asia at $150, Europe is at $110, and the US? $98. Whew . . . only $98. Don’t exhale though because it’s coming. A slow zombie horde of undead prices. Here’s JP Morgan.

Next week, oil prices will creep higher as the shut-ins continue and supplies falter. Despite the tumult, the S&P 500 and QQQ are only down 4% year-to-date. This insouciance will allow the administration to keep wandering down its chosen path. Fair enough, but every day this continues, means another dollar added to the back of the curve when oil supplies resort themselves. We think even if the all clear sounded TODAY, we’re looking at $80/barrel oil when the fog-of-excursion lifts. If you need marines to land and force a capitulation in three weeks? Triple digits. Goldman agrees . . . higher for longer.

So what’re we doing about it? Well, let’s just take a quick look at Occidental Petroleum (“OXY”) and one of our holdings, and how we’re positioned for the above.

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We’re trying to desperately find one, but the consequences are all unpalatable. Declare victory and walk away? Strengthen the enemy long-term. Give up? Never. Deploy the full power and might of the US armed forces? Embrace the tar baby. There are no good choices right now.

This was one of the worst strategic blunders, made on the basis of hubris, supported by faulty information. For months, the investment community and government agencies were peddling analyses that we were witnessing one of the greatest global glut in oil ever. JP Morgan, Goldman Sachs, the IEA.

Nearly everyone.

The IEA anticipated a 2.3M bpd build in 2026. Goldman came in below that at 0.8M bpd.

This narrative was so pervasive it stuck. So armed with wrong assumptions, and fresh off the back of a successful Venezuelan regime change, Gaza takeover, Hezbollah decapitation, and global economic arm-twisting, we ventured forth to pursue regime change in Iran. Quick and easy right? This my friends is the very definition of FAFO.

So here we are today, one where oil prices are ticking higher as the war, err excursion, no wait excursion to prevent a war plays out. Whatever this was/is, it’s a bad trip. The US can and has easily achieved some tactical victories, but strategery-wise? Not so much.

Since we last wrote, oil prices have climbed from $85/barrel to $120/barrel, only to have fallen back to the current $95/barrel level after President Trump shared that this will be a “short” war, and that Iran’s military capabilities are being materially degraded.

Fair enough, the market immediately sent oil plummeting to $80/barrel. In addition, the IEA in coordination with various countries decided to release 400M barrels of oil from their strategic petroleum reserves (“SPR”). In the US’ case, 173M barrels, to be available next week (for refiners to bid), and to be delivered over 200 days. Since SPRs in every country can’t deliver more than 3M bpd combined, we’re not sure how that fully offsets the nearly 15M bpd currently lost.

Even as these salves were prescribed to ease the market’s discomfort, Iran began mining the Strait of Hormuz and attacking ships anchored in the Persian Gulf or attempting to run the blockade. The escalation quickly eroded the market’s confidence that all is well, and that all of this will be completed in short order. Accordingly, oil prices have risen again.

Financial Impacts

The broader market though, has largely shrugged off this whole episode. For the most part, it’s flat. Sure there’s significant volatility, but here’s the performance of the indices since the beginning of the our excursion on February 28 to March 13:

S&P 500 -2.5%

Nasdaq -1.1%

Russell 2000 -4.8%

Other than the Russell 2000, the broader market has largely shrugged off these attacks despite the disruption to oil, petrochemicals, fertilizer, noble gases (e.g., helium in semiconductor industry), etc. Arguably, the US is better positioned to weather the energy supply shortfalls, but with its just-in-time supply chain, eventually the inflationary costs will rebound as manufacturers worldwide struggle with shortages and higher energy prices. The supply chain can hold-out for a brief pause, but as the days roll-on the damage gets increasingly exponential and calcified.

We think the market’s overly complacent here. The buoyant stock indices mean the market is predicting a rosier future, one where energy prices might come out of this whole debacle actually lower.

Is that possible? Maybe. Maybe if the US cowls Iran . . . but man-o-man, that sure seems doubtful right now.

What we do know is that each day the market fails to fall, it further grants Trump carte blanche to continue his attacks unabated. In turn, the longer the attacks continue, the greater the harm done to oil supplies and oil prices in the future.

That’s the calculus. It’s the US vs. Iran vs. the stock market/global economy. Who will capitulate first?

So let’s level-set again. Oil exports out of the Strait of Hormuz runs about 20M bpd. ~150 vessels of all types (i.e., petroleum, container, agriculture, etc.) traverse this 22 mile channel. It’s shallow, so the crossing corridor is only about 3-4 miles. Surrounded by mountains, Iran has numerous places to launch drones both in the air (UAVs) and water (USVs) to disrupt the flow of traffic. Tack on mines too (buoyant, rising, CAPTOR (torpedo launching)), all deployed from fishing trawlers, or dhows (junk trading vessels). There’s thousands of those, so deconflicting the area will be difficult.

Plus, it only takes one hit to ratchet up the economic costs. One drone getting through, or one mine causing damage means the whole market gets repriced. Even a minor disruption can be material. If 150 vessels a day transited the SoH, what happens when only 130 do? Isn’t 20 still a material disruption?

From purely an oil perspective, let’s do some math on what’s actually happening. 20M bpd of oil flows through the straight. A few hundred thousand to about a million barrels are still flowing as Iranian exports to China continue. The Saudis have also reversed a pipeline that runs East/West and can potentially redirect 5-7M bpd there, so the disruption is around 14-16M bpd.

The oil isn’t entirely lost though because if the artery is plugged, producers can shunt it to storage for a limited time before they have to shut-in their fields. Unfortunately, the IEA reports that ~10M bpd of production is currently shut-in as storage tanks are getting closer to full capacity. Note that this is the most important figure because it’s the real production that’s lost. So take that 10M bpd and multiply it by the number of days, and you’ll start to see some large numbers. 100M barrels in 10 days alone, 200M in 20 days, and that’s not even factoring in the delays if/when the US and its allies can reopen the strait and how long it takes the ships to get refueled, repositioned, and sailing again. Ripple that through to inventory balances, and assuming 1/3 of that impact shows up in IEAs inventory figures, and you suddenly get a base-line of $90/bbl (i.e., the price oil should fall back to once all is said and done).

It’s the difference between a hiccup in your supply chain vs. a real supply shock. Stock-outs are what we’re worried about, and life is coming at us fast.

Prolonging the stock-out though is effectively Iran’s strategy. It’s two-fold right now,

1. Deterrence - make this endeavor so costly that strategically, the US, Israel and any other ally will be deterred from attacking Iran again;

2. Resilience - no matter what you do, this regime will survive. More importantly it can survive longer than the stock market and global economy can hold-out on such a large supply disruption.

Unfortunately for Trump and investors betting on a TACO (i.e., Trump Always Chickens Out), the timeline this time isn’t entirely in his control. For the most part, the clock is ticking, but that clock isn’t controlled by the West. The longer this lasts, the higher the economic pain, and it behooves Iran to keep testing that pain threshold. Closing the SoH, or even threatening to close it, gives them the ultimate leverage in any negotiation. Attacking oil infrastructure through the Middle East also encourages the Saudis, Kuwait, Qatar and the UAE to call on the US to bring about a ceasefire/truce on terms favorable to Iran.

Oh wait, they know that.

So for Iran, each missile launched, each drone sent, is an invitation to their hurt locker. Spread the pain and really test everyone’s resolve. The desire to exact revenge and retribution will also drive Iran’s thinking. While it has been weakened, and not immaterially, it knows that this battle is existential, and if they’re playing the trump card of closing the SoH, it better be for a larger pot.

Kinetic Affects

As the US and its allies are still marshaling naval and ground forces in the region, it will take another few weeks before a proper military escort can begin to break the blockade. In fact, likely month-end.

Tack on the repositioning of combat troops and we’re looking at least another few weeks.

Our rule of thumb is that oil prices will rise $1/bbl, conservatively, every day this excursion continues if we assume 10M bpd of shut-ins (i.e., real production lost). What we mean by that is every day the SoH is closed, equates to about $1/bbl of premium when we “return to normal.” If everything gets sorted by month end, we think this is what inventories and oil prices will look like.

Any longer than that, and we’re rebasing higher. Two caveats: first, there’s bound to be some demand destruction as oil prices climb, airfares getting expensive and road trips not taken, but the world can likely keep calm and carry on for a few weeks (so we’ve disregarded that for purposes of this exercise). Second, you’ll notice that in the chart oil prices have previously dislocated from inventories since mid-2024. That’s largely because of the calls for “inventory gluts,” etc., so tack on whatever discount to the $90/bbl fair value you think is appropriate (i.e., the discount that you think will “survive” even after this debacle). Suffice it to say if oil stuck around in the $80s after kumbaya breaks out, oil companies will print money (they need to if the world wants producers to increase production).

We don’t know when this will all end, it could end suddenly and oil can plummet, but what we do know is that the US is beginning to manipulate oil prices . . .

. . . and trying desperately to find a palatable political narrative . . .

All of these shifting statements and market manipulations will prevent real price discovery. It’ll deter producers from drilling and pumping more because of the potential volatility. Furthermore, it prevents the market from responding to the real shortage, and shifting enough capital to address the issue, which will inevitably exacerbate the issue.

Ultimately, selling financial paper and lowering prices via press statements can suppress oil prices for a bit, but the physical always disciplines, and the Iranians know that.

Again, this is a race against the clock, but the Iranian’s are holding the watch. The longer this lasts, the higher oil climbs.

Welcome to the hurt locker.

Iran’s one of those topics where we have a lot of opinions about, but very few convictions in with the uncertainty so high.

As the US engages in “offensive operations” against the country, we’ve just started Day 6 of this conflict. Iran’s now effectively blocked the Strait of Hormuz, a small maritime chokepoint in which 20% of the world’s crude oil flows. It’s not only narrow, but fairly shallow in certain areas, so even in the best of times, it requires careful coordination when moving VLCC behemoths in/out of the Persian Gulf.

Lob a few drones at anything that transits there and you effectively plug it. Lest you’re a daring owner cut from the same cloth as Jack Sparrow and you run your tankers at night with your AIS turned off to break the blockade, most will stay away. Still that’s a lot of risk to take, and for most multinational shipping companies, one they’re unwilling to take even if you give them adequate insurance coverage. Sure the US can backstop shipping insurance all it wants, but will they also cover the lost income if an Iranian drone sinks a ship? Unlikely. Will it cover the replacement value or the ship, or the fair market value of the ship? Who knows.

So thus the strait likely stays closed unless international pressure forces Iran to reopen it, well really the IRGC. For now though, that pressure won't come from Iran’s largest customer, China, because guess who’s still allowed to transit the passageway? That’s right, good ‘ole Xi Jinping, and everyday this “operation” continues, Xi gains increasing clout. Besides China, no one else is willing to transact with Iran today, and later when the country needs to start rebuilding, guess who’s at the front of the line for those contracts. So yeah, the strait’s closed . . . but not to China.

Shutting-in Supplies

Oil prices have vaulted though due to all these shenanigans. Climbing from $73/barrel on Friday to today’s $84/barrel.

That’s 15%, give or take, and it’s just the beginning if the situation persists. How high really depends on how long this goes. The longer the strait is closed, the more storage facilities in Saudi Arabia, Iraq, Kuwait, and the UAE fill-up. Once those tanks are filled, then production shut-ins start to happen.

Iraq has already announced a cut to oil production of nearly 1.5m bpd. If that doesn’t sound like much, Iraq produces 4M bpd, so yeah, that’s plenty. It’s inevitable though because spare storage is finite at ~300M barrels in the region. So by 2-3 weeks time, we’ll fill those puppies to the brim, and then force the fields to idle.

In turn, that shut-in translates to an increase to oil prices by $10 to $15/barrel for the month, so think $85-90/barrel for Brent. In the short-run, it’ll almost certainly exceed that if we cross longer than 10 days . . . and we’re nearly halfway there.

The market though (as represented by the S&P 500) has been fairly nonchalant.

It’s barely down in the past 5 days, and it’s almost certainly looking at a TACO scenario whereby Trump Always Chickens Out. It’s willing to overlook the near-term rise in oil prices (we are after all “glutted with oil”), and the temporary bump will not only prove fleeting, but even more encouraging is that once the Iranian populace revolts against the IRGC, we could see oil prices decline even more as the vast production potential of that country is unleashed.

Never mind the political uncertainty a toppled IRGC will lead to, or the sectarian issues that’s deeply embedded in that region. No doubt 100K former radicalized IRGC members will blend quietly back into a new cosmopolitan Tehranian life, and all will be well.

Call us doubtful.

Still, this is the path we’re on. Despite the rhetoric of the administration, this endeavor doesn’t appear to be fully thought through. The administration is likely counting on a quick capitulation. Flush off the success of Venezuela, the surprise surgical strikes in Iran should bring about a regime change as protesters reappear. Our good deed in Venezuela worked, so no doubt it’ll work in Iran. Moreover, oil prices shouldn’t rise too much right? We have nearly 4M bpd of spare capacity AND a super-glut of inventories, so the oil market will stay calm. We firmly believe that’s what they believe, and as you know, we firmly believe that it’s wrong.

So based on these faulty assumptions, and limited past success, we’re off to the races in wiping out the IRGC leadership. It’s regime change we’re after, so it’s existential for the IRGC. So surely, they’ll go quietly into the night.

Yeah right. There’s no way. Iran will continue to lash out at its neighbors and ratchet the pressure on the global economy. It certainly knows that the longer it can last, the better it will survive. The US can only continue its operational tempo for so long. Given the sheer distance and the vast size of Iran (i.e., larger than Alaska, and more than twice the size of Texas), the ability to project air power is finite as men and machines invariably wear down. There’s also a plethora of hiding places in the mountains for Iran’s weapons, and they’ve no doubt become adept at shooting and scooting.

So bear down and survive. Iran knows there’s two things that can end this conflict . . . the market and munitions.

Munitions & Markets

The market’s patience, and dare we say complacency, is limited. Continue to block the strait and eventually oil prices will leap so high that demand destruction (i.e., a recession) must follow. It also isn’t just the Strait of Hormuz that’s the issue, Iran’s attacks on lightly defended refinery complexes in the region also shuts in production. Saudi’s Ras Tuna’s refinery (550K bpd of processing), Kuwait’s Ahmadi refinery, Qatar’s Ras Laffan LNG complex, and Bahrain Petroleum Company’s Ma’ameer refinery (400K bpd) have all been targeted. Attacks and repairs halt production, which increases the need to reroute or store the incoming crude. Damage enough infrastructure and you’ll force producers to shut-in production. Translation - everything and anything is up for grabs, my pain is your pain.

The cumulative impact is real. The longer the conflict goes, the more the pressure grows. If energy prices vault as a % of GDP (as it did in 2022), it will cascade the market.

Trump ties his personal and presidential success to the stock market, and if the real time report card starts to slide, then the odds of a TACO Tuesday ramps higher. What isn’t clear though is what happens after. Can he TACO if the IRGC remains intact. Can he even TACO at all?

He can certainly declare “Mission Accomplished,” but like the ill-fated Bush declaration, the knock-on effects of an even more dangerous and now betrayed Iran grows. Good luck negotiating with that, and we all better tighten our borders.

Munitions is the second issue. Eventually, the US will run low on stocks (both offensive and defensive weapons). In fact it already is.

It’s started shifting missiles from Asia to the Middle East, which tells you what inventories are really like for the US and its allies. Missile stocks are quickly dwindling given the sheer number of threats. Just today Bahrain intercepted 75 missiles and 123 drones in a refinery attack, but can it do the same the next time? Even after downing so many weapon systems, the refinery was still struck. What of its other neighbors, or even more lightly defended targets? As inventories fall, drones and ballistic missiles will start getting through with increasing frequency despite Iran’s lower launch rates. So it’s a race between finding and destroying the launchers vs. the rate at which defensive missiles deplete.

Tick Tock

Regardless of what happens, there’s a ticking clock here. The longer this goes on, the more pressure the US will face to cease hostilities and look for an offramp. Product prices (i.e., diesel, gas, jet fuel, etc.) are already roofing as refineries are taken offline (either because of lack of crude supplies or refinery attacks), and as prices climb at the pump, political support will degrade further. Inflation was already one of the largest issues in the upcoming midterm elections, and that was before energy prices climbed higher.

For Iran? The calculus is much simpler. Just-in-time refinery operations worldwide provide little to no resilience for our global energy market. As their attacks persist, as they continue their oil blockade in the strait, even for a short while, the market shock will force the US’s hand. Sure OECD countries and non-OECD countries will likely release supplies from their Strategic Petroleum Reserves (“SPR”) in short order, but if Iran is disrupting even half of the flows in the Strait of Hormuz, the 10M bpd loss will still be quickly felt worldwide.

We’re on Day 6, and thus far this is an energy shock, and one the world is unprepared for if it crystallizes and far too complacent about. So said another way? We think this has to go higher for the economic pain to be real. We have to go risk off before we can dial the risk back. Markets are like people in that they only really change when the cost of something becomes far too great to bear.

$84/barrel today just isn’t there yet, so the beatings will continue . . . until morale and oil prices improve . . . and they likely will.

That’s the rough figure we use for Occidental Petroleum (“OXY”), a company we’ve been holding for a bit. This one’s been in the dog house for awhile after recently closing the CrownRock acquisition and selling its OXY Chem division to Berkshire Hathaway. The stock’s languished as oil prices trended lower in 2025. Having shed $10/barrel from $70 to high $50s, OXY similarly sympathized and fell by $10/share, give or take.

So $10 x $10. The’s ur rule of thumb. It essentially means that for every $10/barrel oil price moves, we’d expect (all else being equal), OXY’s stock price to move $10/share. 10x10.

10x10 . . . well that is, until this quarter.

Because finally, we’re getting some traction.

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It’s something I have saved on the desktop. Nothing obnoxious, it’s unobtrusive, but it’s there.

I’ve had it for awhile now.

I’ve seen it repeated, many, many times, and in many places.

Sometimes on the things I own, sometimes not. Fortunately, not so many.

The chart doesn’t always repeat, but in Mark Twain’s parlance, history sure does rhyme.

That’s not surprising though because human nature isn’t surprising. We get bulled-up, we get excited, and we get greedy. Then the euphoria rips, and the grifters grift. The institutions legitimize it and the investors harp it. The media focuses on it and retail gets swept up in it.

Then . . . and only then, is when it tips, and when it tips, is when we all get nervous. Michael Burry it seems, senses some nervousness (his chart below for Palantir).

For some, nervousness lends itself to bravado. “I want IT to crash, so I can buy more!”

. . . no you won’t.

Nervousness lends to seek answers “What do you see in the charts? Where’s it headed?”

. . . I don’t know, but maybe down?

Nervousness leads to questions “Why isn’t the management team defending the price?”

. . . they were busy selling.

. . . and buying things that surely speaks to the revolutionary nature of what they’re doing . . .

It doesn’t matter though.

We don’t understand it. All the US government contracts, all the software platforms, Gotham, Foundry, AIP, and Apollo. Awesome game-changing, face ripping, sweet-mother-of-GOD dashboards and tools that allow companies to manage their supply chains, detect financial fraud, and hunt terrorists . . . simultaneously.

Such an endeavor cannot possibly be valued because we simply can’t comprehend the types of services their consultant (nay . . . “Forward Deployed Engineers” (“FDE”)) provide. Got it?

No sir, these FDEs are embedded with clients and mission driven to engineer solutions to tailor Palantir’s proprietary platform to the client’s unique data-set.

Isn’t that what most consultants do?

Fine. Maybe we don’t get it. Maybe FDEs and their crack sales teams are AI ninjas that provide so much value that they can simply turn over random rocks to find billions of additional revenue each year.

Heck, let’s growth them at an even faster rate than today. How’s 70% to your liking? More than the 60+ they’ve been doing. Let’s be more aggressive because we simply don’t know. 70% every year for the next 5 years. How’s that look?

By the end of 2029, we’re looking at $37B in revenue! Quite honestly, amazing . . . but even if the stock doesn’t increase from the $135/share today, it’s still nearly 10x revenue. Again we go back to Scott McNealy’s quote reminiscing about the 10x revenue multiple investors were willing to pay for SunMicrosystem’s stock at the height of the internet bubble in 2000.

People today? Hold my beer.

. . . 72 TIMES REVENUE. Oh wait but that’s trailing 12 months. What of 2026?

Fine, 43 TIMES REVENUE.

Feel better?

Or do you feel nervous? Because again, take a look at this chart.

THIS. DOESN’T. INSPIRE. CONFIDENCE.

There’s an air pocket there. An air pocket in which the oxygen’s dwindling, and the fear is increasing. In all likelihood, fear will become extreme, and in time fear will turn to capitulation.

“It’s already fallen so much . . . I might as well keep it.”

When momentum shifts, then the cascade really begins as traders press it lower. Longer-term investors will hold though. They always do because of anchoring bias. Well actually every psychological bias kicks in, creating a toxic stew of stupor. So most won’t sell, most will hold. HODL they say.

Eventually this may all turn into despair and dismay. There’s few natural buyers in the wasteland. Very few who’d step-in to catch a falling knife. Perhaps a bit lower, some compounder bros will deem it worthy enough to take a look, but that chart will make any position small. A starter position if any. If their buying fails to arrest the landing, then lower we go. All the way to the floor, where the carrions of the investing world dwell. The grave dancers, the roaches . . . the value investor. Still, that time has yet to come. That’s further down the road and much further to the right of these charts.

Maybe this’ll come to pass, maybe it won’t. We own puts on the stock and are short common shares, so we’re certainly talking our book. We’re probably wrong, but just look at that chart. How’s the bravado feeling? It’s certainly a bargain today than it was yesterday . . . at 43x Revenue.

Yeah we’re nervous too.

“I want IT to crash, so I can buy more!”

You just might get your wish.

Please hit the “like” button and subscribe below if you enjoyed reading the article, thank you. (Disclosure: Note we own June ‘27 Puts with a strike price of $95 and other instruments short PLTR shares).

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What it was instead was “blah,” and “blah” doesn’t cut it when your subscriber base is shrinking and there’s fears around the durability of your business.

That’s the market right now though, and you play the hand you’re dealt. Anything short of glorious results will get scorched, and the market certainly torched the stock sending it promptly careening 30% lower on this one. Understandable, but as we look at the underlying results, we’re wondering . . . overreact much?

Small misses can lead to disaster though. Everyone knows that, heck there’s a proverb.

For want of a nail . . . the kingdom was lost.

What’s the nail you ask? It’s basically this . . . $30M of revenue, for a company with $2.5B in total revenue. So written another way $0.03B.

Yeah, slightly more than 1%. The reason is because this is about optics and expectations. The issue is PTON has declining subscriber enrollment, and though it is profitable, the Street wants to see top-line growth. If you can’t get subscriber growth right now, at least get revenue growth since you just increased prices in October.

Here’s what the annual guidance has looked like in the past few quarters. Though we ended FY 2025 with $2.49B, PTON’s guidance for FY 2026 in Q1 was $2.45B, so down about $40M. 1% year-over-year, not great, but maybe they’ll beat it.

Relaunched product line and increased subscription prices, awesome. Revenue growth right?

Nope.

For Q2, however, PTON really clipped out and fell out. The company had guided to $675M during the busier holiday season, and unfortunately for shareholders, ended up landing at $657M, missing by $18M. That miss, and likely whatever insight the company already knows from its busier January season (think NY resolutions to get healthy) resulted in the full year guidance falling by $30M ($18M from Q2 and likely $12M in Q3), thus leading to the further reduction in full year guidance from $2.45B to $2.42B.

Again . . . for want of a nail . . . the kingdom was lost.

The $30M and heightened questions around growth led to a near wipeout of the company as shares lost 30% of their value. PTON’s market capitalization fell by nearly $700M.

Said another way the $30M miss was valued at near 25x revenue. More accurately, the value’s really attributable to the market’s lost confidence in the company (i.e., the diminished faith in the investment community that a turnaround is afoot). If you can’t grow top-line, eventually the melting subscriber counts will catch-up to you. A company simply can’t cut expenses infinitum, and profits will eventually follow where topline goes.

Yet, there’s still time. The company is free cash flow (“FCF”) positive, and the existing users still love the product. This is still a very sticky business, and even with the price increase, subscriber churn rates didn’t blow out.

In contrast to the disappointing top-line, the bottom-line metrics continue to march higher as operating margins, Adjusted EBITDA and FCF have all been guided upwards as expenses have been brought down (both in totality and as a % of revenue):

The cost reduction efforts have resulted in an increase to the bottom-line guidance.

1. Gross Profit Margin increased year-over-year from 49.1% to 53% and for the full year PTON forecasts an increase from 49.6% to 53%.

2. Adjusted EBITDA has also been increased. At the beginning of the year PTON guided to $425M, and as of today, it’s guiding to $475M at the midpoint. We anticipate the company reaches $500M as we hit Q3.

3. Lastly, FCF has similarly been trending higher, guidance moving up from $200M at the beginning of the fiscal year to $275M as of today. Similarly, we think this will eventually land around $300M by fiscal year end.

As FCF lands, debt should be somewhere in the ~$200M net debt range, and ready for refinancing in about three months (May).

So where did we go wrong?

Subscribers

Well it appears that our internet scrape data pointed at too high of a subscriber count addition. Though interest/search for the new products was high, that didn’t necessarily translate to more sales. There could be a lag effect as the consideration cycle for exercise equipment is longer, but that would be too optimistic a view to take given the aggressive promotions PTON ran during the holiday season. If performance marketing didn’t move the needle then, what happens to sales afterwards once marketing budgets soften?

So while we had forecasted only about a 40K subscriber count lost, the company delivered a 71K reduction, and that’s a significant number of equipment not sold and subscription revenue not earned. Some of this could also be a one-off impact from the higher subscriber cancellations than we modeled (we used prior price increases as an estimate). Though that could be a factor, we think the 1.9% churn this quarter was still lower than anticipated, which means that as we lose subscribers, those that are left are the “hard core” users, and thus tend to be stickier . . . which is a long-winded way of saying . . . they likely didn’t sell as much equipment.

So where does the data point to today for Q3?

Ironically very near where PTON’s guidance is for the quarter. Still that Q2 miss sure does casts aspersions on the accuracy of that tracker (though you can see it has historically been very accurate).

We think it’ll creep back on trend though because the price increase last quarter did throw a monkey wrench into the entire exercise. Moreover, if PTON is guiding to the range our tracker is seeing (with the most important New Year / January sales already under its belt), that gives us comfort it’ll meet it.

Product Sales

What’s slightly more accurate was tracking PTON’s Cost of Goods Sold (as a proxy for Connected Fitness Products Revenue assuming a 15% margin).

You can see we can land fairly close to where PTON’s end up, but since it PTON missed earnings by $20M, it doesn’t take much for a small blip to swing our forecasted numbers. We assumed too high of a COGS, which led us to assume miss on the Connected Fitness Revenue. We’ll temper that forecast next quarter.

Keys to the Kingdom

So overall where does that leave us? Well it leaves us where we started.

FY 2026, which ends on June 30th, is a reset year. We just thought the inflection would start this quarter with the introduction of the products as a catalyst. This hasn’t panned out, which means we’ll need to reassess PTON’s other plans.

The company has slashed expenses, continues to repair its balance sheet, will refinance debt shortly, and re-introduced a new line of products. H2 2026 likely sees an introduction of a cheaper PTON Tread, which will help with attracting new subscribers. Again the treadmill market is nearly twice the size of the bike market and PTON recognizes that its treadmills are twice the average price of its competitors and uncompetitive in the marketplace. Lowering the price means tapping into a larger addressable market and potential subscriber base. This likely happens in the September/October time frame, which would be just in time for the holiday season.

More importantly, investors are still waiting to see what the other new vectors for growth will be. This won’t really start until PTON refinances its existing debt in May. Once done, it’ll lift the overly restrictive debt covenants that prevents the company from pursuing M&A to flesh out the product portfolio as Peter Stern pivots the company from fitness to wellness.

Investors are currently demanding that the company slash operating expenses to pay down debt. Fair enough, but once that process has run its course, what becomes of the enhanced FCF? That should be answered in May.

Remember, it’s about a return of capital and return on capital. We need to see both as investors, and Stern’s plan needs to begin snowballing as we get into the latter half of the fiscal year. We anticipate seeing more M&A, content licensing deals, and joint ventures as PTON moves the brand into other categories.

Ultimately, experiencing this sell-off was largely our self-inflicted. While the trackers are directionally important, we placed too great of an emphasis on their precision. Sales of new equipment did indeed turn out sluggish, and PTON has now been forced to reset expectations after a banner FY 2025 where they handedly beat and exceeded expectations. It can no longer only keep cutting expenses and enhancing the bottom-line to garner a higher share price. What matters is growing the top line, and while that’s difficult, it’s exponentially harder when debt covenants tie your hands. Those knots will loosen soon, and thereafter, we’ll get a better picture of how PTON reacts after getting knocked.

Though our confidence in the path forward is tempered, we can say with confidence that the sell-off is overdone. This is now a $1.8B market cap company generating $300M in FCF, with a very slowly declining subscriber base, and optionalities to the upside.

At 3.5x market cap to Adjusted EBITDA ($500M), or 6x market cap to FCF, we’re certainly in discounted territory. Again it comes down to the perception of growth (or lack thereof) of the user base. This investment hinges on it, and the market undoubtedly thinks the company won’t or can’t deliver. Therein lies the asymmetry. If PTON and its management team can nail that, then the shares will rerate considerably higher.

For now though the market wants a nail . . . before the kingdom is lost.

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The economy’s growing, but mostly because of AI. Inflation is low, but prices are high. The consumers’ strong, but it’s largely the upper class. Contradictory notions whirl through our analysis as we wait patiently and some painfully. Have we erred, or is it oxygen deprivation? Could be both. This year we did in thinking OPEC+ would continue managing the markets instead of materially raising production to take market share. Geopolitical pressure or abandoning a failed strategy, whatever the reason, they chose a price war. So let’s all run this capital intensive and depleting sector below its cost of capital and find out what happens shall we? The resulting higher inventories, lower prices, and shale’s treadmill effects will certainly blunt supply growth, while global demand keeps rising. This’ll be fine.

It’s frustrating when reality falls short of expectations . . . for now. That’s what the younglings call “cope.” Perhaps, but it’s also the young ones that are the most ardent advocates in a bubble. This one appears to be a trap, a slow springing one. A confluence of compelling narratives buttressed by easy money. Add in a dash of real innovation, and the ingredients are there to lure a new generation of investors to believe that these are easy paths to riches, and the journey’s worth any price paid today. Never mind that the sector is replete with related party transactions and recursive investments made under the guise of developing the ecosystem. Never mind that the ecosystem becomes increasingly fragile when a customer’s ability to buy your products depends on your ability to finance them.

Capital is oxygen, and you can only recirculate it so much before the market needs a fresh tank. When valuations vault to extremes, who’s left to provide that? Investors will need more from their companies to attract the next group that’ll provide their exit liquidity. Grow revenues 50% year-over-year? The market will demand 60%. Grow 60, it will want 70. The mountain is unforgiving. So long as the weather stays fair and your narrative intact, the greater fool will come along to deliver fresh oxygen so you can climb higher. Hypoxia’s still a threat though. Each step will become increasingly perilous, and each movement uncertain. At dizzying altitudes, some climbers may begin to untether from the mountain as even their bravado fails to impress the quarterly judges. That’s when your oxygen’s cut-off.

No, we’re probably wrong. Everything will be fine.

No . . . this is a trap.

Oil Demand & Oil Supplies

As we’d written last quarter, oil inventories began building materially in Q4 as OPEC+ lifted its quotas, removing some of the last vestiges of artificial constraint on their members. What started this summer has continued into the fall, and oil inventories have moved upwards counter seasonally. No longer “managing the market,” OPEC+ members have abandoned restraint and pressed forward with production increases. So far, the inventory increases and higher oil-on-water largely mirror the increased exports from the OPEC+ members.

With their shackles thrown clear, producers gunned exports. Oil-on-water increased as sanctioned barrels met with higher exports. First oil-on-water and later oil-on-land.

The producers, save Saudi Arabia, the UAE and Kuwait, are effectively maxed out today. What spare capacity is left remains in the hands of these three producers in the Middle East, and we surmise that totals ~1.5M bpd. Still the deluge from the OPEC+ members is real, and much of it is transiting to land storage. Once they arrive, land figures will show the increase. It’s why oil prices have declined 18% this year. This is a price war, and it’s everyone for themselves.

Interestingly the increase has been less than forecasted by analysts. It’s not much of a consolation when the build is “only” 2M bpd vs. the expected 4M bpd, but it does suggests that the bearishness is vastly overdone. Current builds (QTD with January)? 0.7M bpd. What is clear is that low prices have killed US shale growth, which has provided nearly all of the non-OPEC supply growth in the past decade.

This also explains why despite the price war, oil prices have stayed in backwardation, which is indicative of higher near-term demand. So despite initially building at a pace second only to COVID, prices have not collapsed. The velocity of the build is now slowing. So is the glut real? Yes. Though much smaller than expected. What happens next? What happens after low prices induce higher demand and lower supply in the near future? Again say the phrase . . . run a capital intensive and depleting sector below its cost of capital, and let’s find out.

Portfolio Update

Occidental Petroleum (“OXY”)

Oil’s malaise in the past quarter took the wind out of OXY’s sails. As oil prices sank, OXY’s stock retreated 13% in Q4. Given we own the warrants, those declined more at 20%. At low-$60/barrel, most oil companies in the US are generating around 8-12% free cash flow (“FCF”), not particularly compelling as investments, but not financially dire for the sector. Into the $50s, that’s when FCF starts to disappear. OXY is no different, so at today’s prices, the company treads water. This doesn’t mean that the company hasn’t been furiously churning beneath the surface. After selling a steady business in OXYChem, OXY has decided to go “all-in” on oil production in the Permian. The transaction closed on January 2nd, so after the quarter ended. Following the Q3 conference call last year (and after announcing the transaction), the company provided scant details about its plans for capital returns following the sale. The market didn’t love the obscurity, and OXY will likely provide clarity in the next call now that the transaction has closed. Still the stock was left adrift with no supportive narrative as oil prices weakened in the quarter.

Despite oil’s decline, we’re expecting OXY to still generate ~$0.5B in free cash flow (“FCF”) for the quarter, and slightly over $3.5B for the year, for a company with a $42B market cap. We’ve come a long way from the days where a sub-$60/barrel oil price would’ve proven disastrous. De-levered and re-stocked, this company’s in a different place today with a much healthier balance sheet. Having said that the equity needs to move higher and soon. Either the company will self-cannibalize, and buy back a material portion of its 1B shares outstanding, or a suitor will come along and decide that the synergies involved are too compelling. By becoming a pure play producer and shedding OXYChem, OXY’s remaining businesses are easier to integrate, which makes the company a more attractive target. It’s not dissimilar to what happened with MEG Energy. Eventually MEG Energy sold above $30/share, a price last seen when oil prices reached $90-100/barrel in 2022 because the synergy savings realized from the transaction accreted to the buyer.

We think the share price today makes little sense. Someone eventually will decide to bid if OXY’s shares keep languishing. With synergy savings likely over $1B for a company of this size (i.e., slashing G&A, rationalizing redundant functions, and leveraging scale), the higher FCF is more than sufficient to cover the interest burden on the debt needed to fund the deal.

Energy companies are so discounted in the market today that consolidation is a much more affordable and less risky way to grow production than exploration and drilling. An acquisition not only increases the acquirer’s FCF, but also reduces risks. It’s cheaper and safer to buy than to build it yourself. Inevitably, a buyer will simply look at the expected cash uplift and extensive reserves, and back into the most accretive financing to accomplish the task. The path forward here isn’t just oil prices, it’s further consolidation in the patch. Either oil prices move higher, or we’ll see another round of M&A as shale producers become larger and larger.

Peloton (“PTON”) Update

The coming 6 months are critical for this company. That’s the gist of this investment. After introducing a set of new cross training equipment (i.e., bikes, treads, and row), the company’s embarked on a strategy shift from a pure fitness equipment/subscription platform to a “health span” platform, one designed to give its customers a healthier and longer life. PTON’s new strategy tackles cardio, strength, mindfulness, yoga, mental health, nutrition, etc., and is an attempt to leverage its popular instructors and platform to broaden the reach of its audience. One example is the emphasis on weight training to offset muscle loss for those who are using GLP-1s and for women who are in menopause. From a high-level perspective, the shift is important. The wellness space is a $7 trillion market, whereas the home exercise bike and treadmill market clocks in at a combined $6 billion. Yes, trillion vs. billion. Here’s an excerpt from Peter Stern’s annual letter . . .

These are all noteworthy shifts, but investors will wait until the company can demonstrate that it can steady its core business before getting excited about the new ventures. So for the time being, the company remains largely dependent on equipment sales and subscriber counts. It’s still the razor blade/razor strategy of yesteryear, and where subscriber counts go, so too will the financial and stock performance of the company until the new initiatives hit.

Since the October launch of new AI powered products, the financial press has published stories like this:

The holiday season through the first weeks of January (New Year’s resolutions) is when a majority of equipment are sold, and based on our tracking the demand was robust last quarter.

As background, holiday sales (Black Friday / Xmas) fall into PTON’s fiscal Q2 period. New Year sales will fall into the Q3 period. While Q2 sales may be good, the subscriber counts will be slightly off this time because PTON recently increased its subscription price. Prior price increases led to a subscriber loss of ~60K, but even if we factor that in, the overall results should still beat guidance.

PTON ended Q1 with around 2.73M subscribers, and we think it’ll end Q2 with ~ 2.69M, which would mean sales of new bikes did fairly well. As evidenced by aggressive New Year’s pricing, the company’s heavily pushing its Peloton Bike+ Cross Training bikes.

The above may seem like aggressive discounting, but recall that PTON raised equipment prices ~13% across the board in October. That was only a few months ago, and if we look at the subsequent pricing of the company’s products during Black Friday, Holiday Sales and the New Year, we can see the discounts are roughly the same, if not slightly less on some products vs. the “old” prices.

For the 2026 New Year Sales, it’s certainly upped the ante as the company aggressively priced the Bike+. The promotion likely encouraged customers who’d otherwise buy a regular Bike to upgrade to the feature-laden Bike+ (with a movement tracking camera, fan and larger screen) for a few hundred dollars more. By our estimates consumers were trending in that direction as the mix shift has seen a higher proportion of Bike+ purchases after the latest updates (from a 75/25 split previously to a 65/35 split today between Bike/Bike+ sales). The extra cost to produce a Cross Training Bike+ vs. a Bike is negligible, so like Apple’s ability to incentivize customers to pay a few hundred dollars more for memory, on balance this should have induced shoppers to upgrade from the base version. Bike+ subscribers should also be “stickier” because cancellation rates for subscribers who take two or more modalities are materially lower, and the Bike+ features are geared towards non-bike floor exercises.

Financially, the picture’s also improving. Last quarter we wrote:

“In totality, what we have today is a $3B market cap company with ~$460M in net debt. That’s fairly cheap for a company that boasts 2.8M subscribers and dominates the connected fitness space. PTON has recently guided FY2026 to be $2.5B in revenue, $425M in Adjusted EBITDA, and $200M in FCF. We think that’s light, as 2025 revenue came in higher at $2.5B, Adjusted EBITDA at $403M, and FCF at $328M. If you’re increasing prices by nearly 15-20% across the board (pro-rated for FY2026 as it takes effect in Q2), how’s it possible that all your metrics will be lower? We sense there’s “conservatism” in the numbers.

Since then, PTON has raised 2026 guidance. The company kept revenue unchanged at $2.45B, but bumped Adjusted EBITDA from $425M to $450M and FCF from $200M to $250M. We still think that’s light. For 2026, we have Adjusted EBITDA of $500M and FCF around $350M, for a company with a $2.4B market cap today. We think the stock should move higher once PTON demonstrates its equipment is selling well again, and the shares would need to double to match the multiples of its closest competitor.

As the company begins to refinance its debt and buyback shares, Wall Street’s hype machine can help change the narrative. Based on recent reports, the company plans to refinance its existing debt in May. By then, the company will have ~$300M of net debt (i.e., $1.3B in total debt less ~$1.0B of cash). The company’s de-levered balance sheet should garner a B to BB credit rating, which translates to a 6-7% interest rate on new corporate bonds, a far cry from today’s 10-11%. The resulting 4% lower rate equates to ~$40M of annual interest expense savings on $1B of debt. Apply a 10x multiple and that’s $400M of market cap value . . . on a $2.4B company.

Refinancing the debt also allows the company to lift restrictions on capital allocation. The current debt covenants severely restrict the company’s ability to conduct M&A, or implement share buybacks. Thus, removing these terms will give it greater freedom in generating shareholder value. Overall, the company’s executing and the new products are selling. The enormous subscriber base serves as a solid foundation for Peter Stern’s strategy to tackle wellness, health span, and mental health. We plan on increasing our position ahead of the quarter’s announcement, and believe there’s a long runway here.

Parting Thoughts

We have a barbell portfolio as we write this. We’re invested in companies that are in deeply unfavored industries, or ones with terrible sentiment, but also short companies that we think are priced not for perfection . . . but nirvana. The market loves these stocks. They’re “sexy” and can’t help but be loved on and doted over because they’re growing so fast. AI, predictions markets, gambling. Every chart is up and to the right in terms of growth metrics. The narrative is simple, limitless potential, unlimited growth. In contrast our investments pale in comparison, they’re stodgy and forsaken. We get it. No one talks to old people when babies show up at parties.

Yeah, to heck with the babies. We’re short an AI one that’s currently trading at over 65x 2026 projected revenue. 65x REVENUE. At the height of the Internet Bubble in 2000, Sun Microsystems traded at over 10x revenue. Years later in an interview, the CEO of Sun Microsystems, Scott McNally said this . . .

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

As you’d expect, we get this question often. How can we not participate in one of the greatest advances in human history? What are we thinking? Our response isn’t that we’re not participating, we just wonder whether that needs to be today. Like the internet, AI will eventually be ubiquitous. What passes for AI today though is far below that. While the infrastructure for the AI revolution is being developed today, the technology isn’t there yet, which means there’s likely a bust following the capex boom when reality falls short. Google, Amazon, Meta, they all rose following the Internet Crash, and we’ll wait to participate in that. The market knows this, but it doesn’t care. What it cares about is growth, hype, and the velocity of capital today. It doesn’t matter if it really works . . . it works well enough. Amidst this euphoria, we look at the opportunity costs, but really wonder about the costs of the opportunity.

65x REVENUE though, ponder it for a second. The company is projected to grow revenue by nearly 40% this year. Great, 50x revenue then by year end. Tack another 40% for the following year, and we’re still talking about 35x. To get to 10x revenue, the company needs to maintain this growth trajectory for 6 years straight, selling billions of dollars of services until 2032, and only then would the multiple fall to 10x revenue (assuming the stock doesn’t push higher), the level of absurdity McNally spoke of during the height of the Internet Bubble. We’re the ones paying now as AI and easy money sucks the oxygen from the market, but what if the bill eventually comes due for those who own these things? What are we thinking indeed. Maybe we are wrong, but we don’t think so. Maybe it’s just an another opportunity to learn.

Me: That’s sure a lot of As on your report card there.

Mason: uh . . . yeah? (wisely sensing nonsense is about to start)

Me: You know there are other grades right?

Mason: Like the ones you got?

Me: Well if mistakes are opportunities to learn, doesn’t that mean I learned a lot more than you?

Mason: What IS you talking about???

Me: hahaha, you should listen to me more because I was so much better educated.

Mason: This explains a lot . . .

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A few odds and ends that we’re looking at this week as we wrap up our quarterly letter in the coming days, which we’ll publish once we send it out.

First payroll figures. Well really withholding taxes on employment income. It’s been an interesting tracker that we’ve used to see what the momentum of the economy is like. Here’s the latest update of the chart.

The logic on this one is fairly simple. Withholding taxes on employment income = employment. Sure there’s some flux b/c of pay raises, etc., and seasonality, but for the most part, it makes sense. If you have employees, employers have to withhold, and if you’ve fired your employees, then well, daily withholding should decline.

What we’re seeing is that employment appears to be weakening. These are year-over-year comparisons, so it can get choppy, but the trend seems to be clear. Certainly the government shut-down in Q4 had a large impact on private wages. The layoffs rippled from federal employees to contractors as well, so there could be some lingering effect. Government withholding is about 4-5% of the total pie, so it’s a blip in the grand scheme of things. Perhaps the ripple effects is 2-3x that in the non-federal employment sector, which could explain the recent dip.

As a corollary, job postings on Indeed.com have increased slightly, but that’s likely seasonal. Temporary labor hirings also appears to be falling, which isn’t a great sign. In total, we’ll have to see how the January and February data comes out, but as we enter the new year, employment does hint at some weakness.

To combat the economic malaise, the Trump administration will attempt to juice the economy ahead of crucial midterm elections, so that may offset. As the forces push and pull though, this second chart has us handwringing a bit.

The market? It’s expensive . . . and historically so.

Now we know, there are various reasons why the CAPE Shiller Index isn’t the be-all-end-all for indicating when a market is overvalued, but Apollo isn’t necessarily wrong here. The index supposedly doesn’t capture the value shift of stodgy old companies to the new fangled tech, and tech (e.g., MAG 7 like Apple, Amazon, etc.) should arguably garner a higher multiple given the sustainability and profitability of their businesses. Since tech dominates the indices these days, naturally the CAPE Shiller Index should be higher. Fair enough, but at 40, it can still easily fall (and has before back below 30, and even that haircut of 25% would be exceedingly painful (think 2022).

As we look at some high fliers, after crossing into the new year, we begin to think . . . what propels something that has already mooned further past the moon? When we’re already valuing companies on multiples of REVENUE, how high, and more importantly, who could, power this market higher? We don’t know, but on balance, doesn’t these things look to be at best flattening?

Perhaps the liquidity is just finding new places as memory and storage chip makers get their turn at the punchbowl.

How outlandish is this really? Let’s zoom out.

Yeah . . . insane.

If we’re mooning the stocks of companies in the very definition of heavy capex and commoditized industries, we are certainly in the very late innings of market mayhem.

Again, it’s important to remember that the stock market is not the economy, but it sure will impact the economy if: 1) we’re in a “K” shaped one where the rich are powering the economy while the less affluent are getting hammered by inflation. Guess who’ll feel the “negative wealth effect” if the market dislocates, and 2) what will happen if we hit a funding crisis if the public market gets hit? The exorbitant AI capex spend that’s currently powering the economy will slam into reverse if funding dries up in the public markets, venture capital sector, and private equity. Public markets have a significant impact in the private ones. Heck, the market has run so far ahead that it doesn’t even need to dry up, if funding simply doesn’t grow as fast, then watch out, this thing can tip over.

So two charts and a few more to mull over on this long weekend. We’re feeling cautious here as we start the year. Happy New Year, and Happy MLK Day to you all.

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Peloton Update

Peloton continues to chug-along and we’ll have more data to parse on how the quarter is going in the coming weeks. Fingers crossed in the final innings of the important holiday season. While Black Friday and Christmas are important, New Years is equally key since many people make resolutions to get fitter, healthier, and happier in the new year. Thus, purchases of exercise equipment extends into mid-January, so there’s still about a month to go in the selling season.

Current tracking still paints a positive picture, though take the graph above with a grain of salt because Peloton raised its subscription prices this quarter, and that likely induces a one-time 50-60K subscriber decline (our assumptions). Even factoring that in, we’re still ahead of guidance, and we think there’s a high chance it could come in even better than our figures. Another chunk of data should land in early January as people make New Years resolutions and commit to them by buying a bike or a treadmill (though much of those figures/economics of such will fall in Peloton’s Q3 report).

We’re at least happy to note that the treadmills seem to be selling decently at this time, and again, the treadmill market is 2x the size of the bike market, so any momentum in this space will help as newer sales pushes older used Treads into the second hand market, broadening the user base. Peloton’s treads are selling for nearly double the average treadmill price, so “seeding” and broadening this category is important. We doubt Peloton will introduce a cheaper treadmill at this stage given the price premium commanded by its products, so it’s really the second hand market that will need to do the lifting. The updated Cross Training Treads can supplant older Peloton Treads, and the latter can start trickling into the used marketplace. Currently, used Treads are selling around $1,400 - $1,800 on Peloton Repowered. Given that the average treadmill runs around $1,000, and new Peloton Cross Training Treadmills are $2,800, the “half off” category should help.

Overall the stock has had an atrocious year as it fell by ~30% YTD despite generating nearly $350M in excess cash and halving net debt.

The company will be able to refinance its remaining debt by mid-year and free itself to return capital, and invest in further growth. We don’t think the company will stay at these levels and should move higher as net debt falls to zero, growth initiatives hit and management delivers on its promises and initiates capital return.

Lululemon Update

Another company that had some interesting news was Lululemon. Recall our summer intern Matt Nakagawa took a look at the company after its share price deflated post-earnings.

Well turns out Elliott Investment Management also sees something they like. Two weeks ago, Lululemon announced the sacking of its now former CEO Calvin McDonald, after performance “nose dived.” The Wall Street Journal reported that Elliott, took a $1B stake in the company, or about 5% when the shares traded down to $160-180/share and the company was worth ~$20B.

On the topside, the company is currently valued at 2x sales ($11B/$24B), which is comparable to Nike ($46B/87B). It’s also still growing, albeit at an anemic 1% on a local currency basis and 2% on a constant dollars basis. Free cash flow (“FCF”), however, is positive. Though Nike’s reported Q2 sales figures show a similar flat trajectory, the FCF is decidedly different. Nike continues to bleed red. Holiday sales are of the utmost importance for both companies, but on a comparable basis Lululemon can still play offense, whereas Nike appears to be retrenching.

Still 1% growth means the company is stuck in the mud. Elliott’s agitating for change, having engaged former Ralph Lauren CEO Jane Nielsen to consult and potentially(?) step-in as the new CEO. She’s been working with Elliott for months and likely has a deep grasp of the problems afflicting Lululemon. So this certainly kicks the turnaround story into high gear. The brand remains solid despite the heightened competition from Vuori and Alo, and after seven years with Calvin McDonald, it’s a good time to pivot. A change of leadership and strategy could be what this company needs. It has the resources and isn’t by any means on its heels yet. Even an incremental change will supercharge its stock, so take a look and maybe pocket a few shares as a stocking stuffer. You can find it in the discount bin.

United Parks

As you enjoy your holiday season, don’t forget the fishies. About a year ago we took a look at United Parks, the owner of Sea World in San Diego and Orlando, and a few other amusement parks.

It was an intriguing story, but we actually never pulled the trigger at buying the stock as we were invested in other companies (Peloton above). After a successful MEG Energy acquisition, we exited with a dollop of cash and this one appears to be interesting again. After what can only be described as an “ugly” summer season, investors have been swimming with the fishes of late.

You’d think with the stock caving 40% YTD, there’s something existentially wrong with the business, but other than a softer summer season, we’re not entirely sure this isn’t just a market temper tantrum. The issue here is park attendance, which obviously translates to admission revenue and in-park spending. It’s been pretty flat of late, and we saw a hit to the all-important summer season as quarterly attendance fell because of 2 reasons 1) the opening of Epic Universe at Universal Studios and 2) weaker consumer spend. Given its lower price point, SeaWorld tends to attract a lower demographic of consumers, and in the current “K” shaped economy, the lower K are the one’s harder hit. It’s not so severe that we’re seeing a major downdraft in SeaWorld’s park attendance, but enough to result in a negative year-over-year comp.

So that bottom-chart above tells the difference. The “shark’s fin” just wasn’t as prominent in this year as in the past. The good news is that when the park-goers are there, they are spending more.

Yet, the company’s having to discount tickets to get them in the park, so lower ticket prices are mitigating the positive uplift of higher in-park spend. Since park costs are relatively fixed, we’re left with earnings that must suffer. Negative 10.2% for the trailing 12 months (~$700M to $630M).

Mind you, this is adjusted EBITDA (i.e., the metric management likes to use because they get to “adjust” and exclude a whole host of pesky expenses). FCF though is still hovering around $400M on a TTM basis, so management has dialed back capital expenditures to preserve cash flows.

Assuming that the holiday season is flat to last year, PRKS will still generate ~$400M in FCF, for a $2B market cap company. If you assume a similar “bad” summer season for Christmas, then we’re looking at $350M, again, not terrible for a $2B company. Undoubtedly, the company will continue to cannibalize shares at an accelerated pace especially at these levels. Shares haven’t been this cheap since the beginning of COVID, and arguably the business is much better. The next catalyst will be what PRKS does with its land.

Here’s what Marc Swenson said on the prior Q3 call:

“On real estate, we continue to discuss alternatives with potential partners and have recently received specific proposals that we are actively evaluating. As we have discussed, we own over 2,000 acres of valuable real estate in desirable locations, including approximately 400 acres of undeveloped land adjacent to our parks, including significant developable land in Orlando. We do not believe that the public markets have or are appropriately giving credit to these attractive and valuable 100% owned real estate assets.”

This is almost assuredly true, but PRKS has been slow in developing this asset and shareholders have been patiently waiting for further developments for nearly years.We think they’ll continue to slow play this front though while Hill Path compels PRKS to gobble-up additional shares, thereby increasing Hill Path’s ownership percentage.

As of Q3, Hill Path owns about 27M shares out of the 55.5M outstanding, so 49%. For all intents and purposes it owns the company, and spiking the price while it’s trading at today’s discount makes little sense. We think if the price stays here, Hill Path will likely take out the company in total, and then turn around and develop the land privately, capturing the upside itself. For minority shareholders, taking a position here would be a bet that there’s value here, and you’ll likely be able to extract some of it before Hill Path takes their ball and goes home.

The Consumer

You can see with the companies above, we’re a glutton for punishment. Most of these consumer stocks are down significantly for the year, and have been pummeled as the “K shaped” economy takes hold, despite being operationally healthy and generating decent FCF. We think they will recover, and at the current levels they’re being priced for distress when the businesses are anything but. So take a peek while you wait for Santa, they might just make great stocking stuffers.

Happy Holidays.

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Once the sector or the company falls out of favor, the media piles on. Negative articles tend to attract twice the eyeballs, so negativism sells, and it sells well. We get it, but holding the positions requires some understanding (or faith/hope?) that things will turn if you’re right.

So a few weeks back we came across this article from Bloomberg.

Now that’s a nasty headline. Peloton, one of the positions we own, recently launched a new collection of cross training bikes and treadmills on October 1, something we covered here.

The introduction of the physical products coincided with the launch of Peloton IQ, an AI powered “personalized coach” that would recommend specific workouts across the different modalities (e.g., cardio, strength, yoga, pilates, etc.) to achieve your fitness goals. So the success of Peloton’s refreshed product line is critical to its long-term success, and if it completely shanked it in a “K” shaped economy (i.e., the rich getting richer and spending, while the poor getting poorer because of inflation), then we’re looking at a slow melting ice cube.

So how’re we doing?

We think you’ll be surprised. Let’s deep dive this like a hedge fund would . . . oh wait that’s us . . . here goes:

Read more

Just take a look at this situation, NuScale power.

NuScale, if you don’t know is a US company that designs and markets small modular reactors (“SMRs” for short). The company’s stock also trades under the NYSE as SMR, and has agreements to build SMRs throughout the US.

NuScale, along with most other nuclear energy companies, have been the darlings of Wall Street, with nuclear energy as the perceived clean energy source to power the bevy of data centers to be built for the coming AI revolution. Again, like many things with AI, the hype precedes the reality. As of the most recent Q3 filing, NuScale has about $680M of cash and little debt. Aside from $400M of accounts payable, it has no real liabilities. Okay so it’s not what we consider “asset heavy.”

What about the business? Well that my friends is great! $30M of revenue in the past 9 months YTD), which of course leads to ginormous losses, and really we’re talking ($256M) of red ink in cash. Yeah, it’s a nuclear meltdown, but fret not because it has the kissed the hand of the administration, and all licenses will be granted and projects will be completed. It’s not a cash burn that requires a capital infusion . . . this is investing. So what’s this cash bleeding business that will need to raise capital (i.e., read “money” via dilutive stock sales to get its projects off the ground) worth?

$7B

That’s right, it loses money, will need to issue more shares, and hasn’t broken ground on anything quite yet.

$7B

What’s even more nutty about this is just 6 weeks ago, this thing was worth north of $16B! That’s fun.

What’s not so fun? That “correction” since October 15th. A lot of that is the euphoria leaking out of the AI nuclear trade. Sure it’s bouncing a tiny bit here, but that drop-off was steep. It’s what happens when mo-mo turns into a car crash and momentum investors jump off. Euphoria turns to despair . . . or dystopia.

Still though, don’t get twisted yo. It’s still worth . . . $7B.

Know what else is worth $7B? This guy . . . well not the author, but this one . . .

Fluor Corp.

Fluor Corp, if you don’t know is an engineering services company. Full disclosure, I used to work there, many many eons ago. It’s a stodgy company run by engineers tackling big engineering projects. Oil and gas, power, infrastructure. Think refineries, embassies, power plants, people movers, etc. One of the largest engineering, procurement and construction (“EPC”) firms and there’s not many left. Mind you there were quite a few of them years back, but the chase for big projects led to some costly misjudgments.

Like building a house, building refineries and other large projects in far flung places around the globe often come with unexpected costs. Change orders, commodity prices moving against you, political turmoil, economic uncertainty, war, etc. Thus, you’d often bid on a cost + basis. $1B project? Tack on 15%. $10B? Tack on 12%. Whatever the case is, make sure you cover your costs, and get a little something extra. Unfortunately, as with all things, people begin to race to the bottom on price. Yet instead of reducing what they charge, EPC firms began to shoulder more risks to win the projects. In comes the fixed price contract.

Imagine building a refinery for $1B on a fixed price contract, hoping nothing goes wrong. Good luck with that. As you’d expect, many things go wrong and profitability inevitably plunges when you shoulder those costs because you inadvisedly bid “fixed price.” Risk is always two-sided in a contract. You either have it, or you don’t, and when you have it and it goes wrong, you eat it. EPC firms cratered and so did FLR’s stock. In comes the new CEO and today, the company’s on more solid footing, with less competition.

Here’s where it gets interesting. About 15 years ago, FLR actually bailed out a tiny company called NuScale as funding froze post-financial crisis. It was this pet rock of an investment, really an equity infusion into a company that maybe one day could develop its nuclear power plants, and then FLR would have first dibs at the engineering work. So in addition to providing a cash life line, FLR received not only equity, but an Exclusivity Agreement on any project NuScale would embark on would be serviced by FLR.

Fast forward 11 years later, and NuScale has gone public, with FLR holding about 126M shares. It’s since sold down about 15M of those Class B shares, but still owns 111M shares. Leap another few years later and boom . . . AI. NuScale pounces on that wave and investors pounce on the stock. SMR shares go nuclear despite having no revenue or any profits imaginable, shares reach $44/share and the market cap jumps past $16B.

A month ago, before the recent spate of AI volatility, the stake was worth nearly $4B, which means you were buying FLR’s EPC business itself for $3B. Its stake in a small previously “immaterial” company had ballooned to be worth more than FLR’s entire organic business itself. Since October though, market volatility has halved the value of SMR, but at $22/share, or $2.4B of value ($2B post-tax) against, it still accounts for ~30% of FLR’s entire $7B of market cap or a third of its $6B enterprise value.

That type of dislocation doesn’t last long. So in comes Starboard Value, an activist investor that took a position in Q3 and began prodding FLR’s management team to aggressively divest its NuScale stock and turbocharge a share buyback. It appears to have succeeded:

FLR currently has about 160M shares outstanding, with a $7B market value ($6B in Enterprise Value as it has excess cash). The NuScale holding represents nearly 30% of that value at $2B (assuming post-tax cash). If FLR can sell down its 111M shares at today’s $22/share level, the company can repurchase nearly 45M FLR shares in exchange. In addition, FLR has increased its share repurchase plan (independent of the NuScale sell down) by $800M, which should retire an additional 10% of FLR’s outstanding shares. So altogether, we’re looking at nearly 35-40% of FLR’s shares retired.

Now when Starboard ran its figures, NuScale’s stock was trading at $44/share and FLR stock was trading slightly lower, so instead of 2.8x CY27E EBITDA, we’re really at 5.6x CY27 estimates today.

Still the general reasoning holds, and relative to its remaining peers in the EPC space, it’s still fairly cheap.

What’s important isn’t necessarily the 2.8x EBITDA that Starboard is using, but the fact that even at 5.6x today’s figure, it “ain’t” 13x FLR’s peers.

So it’s a foot race. It’s a foot race between how long this AI bubble can go on before FLR can sell down its holdings and repurchase its stock. FLR’s agreement with NuScale is an orderly divestiture from November until the end of Q2 2026, so give or take 7 more months with November already in the books and soon December, and each month of divesting 15M NuScale shares.

It’s a reasonable bet though that this gets done, after which we’d expect FLR’s shares to bounce higher into the $65-70/share range from today’s $44/share price (all else being equal). Quirky times indeed, but hey, when it’s freaky in your favor, you might as well watch.

We sure like seeing a good race.

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It’s something we wrote last year after witnessing the explosive growth of AI and semiconductors stocks. GPUs computing at nearly the speed of light, or whatever speed transistors compute at. Even the quickest of them pale in comparison to Wall Street’s hype machine as the investment banks all jump in unison to tout the latest investment theme.

The bevy of themes lately seem particularly bountiful. AI, Ozempic (GLP-1s), battery technologies, uranium, quantum computing, this and that . . . take your pick. Choose wisely though. When picking holy grails, everyone knows that melting portfolios become testaments to poor choices.

As the excess liquidity sloshes around the world, the sheer number of themes have increased to match. Someone has to get the money, and there’s sure a lot of it. “A lot” being the operative word as we run federal deficits near pandemic highs . . . after the pandemic is over. Which is why the excess liquidity has to flow somewhere. Without truly productive avenues, the liquidity simply stays embedded, churning and moving from one financial pocket to another, bounded by the craps table and Wall Street. Excess liquidity acts like fertilizer to thematic weeds, every bad idea is funded, and every nonsensical venture launched. Why not? There’s money or SPACs to be had. Couple that with the gamification of gambling (i.e., Draft Kings, sports betting, Robinhood, 0DTE options, etc.), this generation is primed to speculate constantly and ever so casually.

The rising liquidity and leverage inevitably means higher asset prices, which translates to higher net worths. In turn, that net worth starts to affect the psyche. The excess liquidity also begins to find its way, seep its way to main street, unbounded by the croupiers in the casino. We are flush and this is EASY. Everyone’s brokerage accounts have added an extra zero at the end.

Well, not all of us. This is the “K” shaped economy after all. The haves are the upper arm of that “K,” pitying the lower arm. Well we did thrown them a bone didn’t we? Nobless oblige. No taxes on your overtime, but please clock-in. Still, feeling flush is where we’re at. Sure it’s limited to the upper crust, but no worries, it’ll trickle down eventually. Flush times though never last, but don’t tell that to the kids.

“Things are cyclical” you’ll say, but those words land cynical. As my son says, this isn’t the 19’s (i.e., the 20th century, the ‘99s), as if that was a whole century ago. This time it’s different.

Is it?

Every generation needs its bubble.

Every generation needs to experience their own de-generation as they ride the wave up . . . and down. In 2025, the stories being told around the campfire are different, but the hero’s journey is a well worn construct. AI and the riches that sector will bring. Fanciful words like hyperscalers, datacenter and tokenization are the passwords to enter this speakeasy of riches. Once in, we all nod knowingly about Palantir’s proprietary “ontology,” and the secrets of how Nvidia forever transformed its business to enjoy permanently high margins. Never mind that their higher margins come at the cost of someone else’s capex. If you think their customers (“MAG 6”), which comprises >60% of their sales)) won’t try to claw that back, or produce some of the chips in-house, then you don’t understand business.

Now this isn’t true if these hyperscalers can charge their customers more, but AI is in its infancy so we’re not there yet. Nonetheless, tales will be told and fortunes will be transferred. Every generation gets its bubble because every generation needs its bubble.

Younglings have never experienced it. They just don’t know. Sure the ones that’ve read any market history may know that valuations are extended, but “they don’t really know,” do they? Experiential learning is vastly different than book learning. Youth conveys profound benefits of vitality, vigor, energy, and creativity, but also a dose of irrational overconfidence and unwarranted bravery. Great if you’re training marines, but dangerous when you’re floating in bubbles. If they're in the industry, it’s actually even worse as they couple bravado with career risk. Lagging performance = flagging careers, so they hold their nose and hit the bid.

The Bubble

We are in an AI bubble. We know it. Wall Street knows it. Heck, even the founders of the companies that are building out the sector know it. First comes displacement, AI will transform everything. The narrative crystallizes. Then the boom as institutional investors dive in and buy-in. Initially it’s the intrepid, then those fearful, fear of missing out. As AI touches everything, everything becomes euphoric. A vortex of glorious euphoria that sucks oxygen out of the room leaving investors lightheaded and eager to fund anything and everything directly or tangentially related. So long as they put a “.com” behind it, it’ll go up. Oh sorry, wrong bubble, we meant “AI.”

A seemingly endless supply of capital deluges the sector. What was niche becomes the next, and everyone wants in. In business, the 80/20 rule applies, and when the hyperscalers declare AI is a must have, the 80% dutifully follow. AI comes to dominate every conference, every discussion, every analyst call. Promises get bigger, commitments get larger, and investments get grander. The financial web entangles all as equity investments and special purpose vehicles proliferate. OpenAI signs deals with CoreWeave, who signs deals with Nvidia, who signs deals with OpenAI. My spend supports your revenue, and vice versa. Around the money goes.

Brilliant right? Seed each other, support each other . . . leverage each other. Perniciously, a small equity investment coupled with a promise to buy/rent your services later allows fly-by-night companies to lever up (i.e., borrow bigly). Have collateral, can borrow. Off balance sheet debt isn’t real debt right? Well it is for somebody.

“You don’t get it.” Maybe. Nah we do . . . as if this generation invented creative accounting . . . who do you think wrote the books? You’ll eventually get to learn terms like VIEs and such. Don’t worry, before long you too will get your own Sarbanes Oxley. Every generation needs internal controls.

It’s all fine today because investors love hype and momentum, at least initially. We’re funding business models that will produce profits, just not today. Spend it now . . . and customers will come. Whether it’s a field of dreams, or a rapidly depreciating data center, the immense capital commitments are justifiable in the early stages. What happens though when obsolescence creeps in? Today, GPUs that power AI’s evolution become obsolete in 2-3 years. Doesn’t that mean your capex is really just opex? This is especially true if you’re energy constrained. The higher energy efficiency of new chips means the old chips devalue faster, and many business models revolve on running the latest GPUs to generate more tokens to survive. So while the promise of AI dwarfs that of the internet, the economic risks are likely even worse.

Unlike the internet bubble in 1999/2000, you only had to lay the fiber optic cable once, and there was lasting value. The overcapacity was eventually absorbed after the bubble bursted. So imagine having to recommit hundreds of billions every year (and more) to sustain and grow AI’s momentum. You can’t build it once hoping customers will come, you need to keep rebuilding it every few years even if they do. The pressure to show productivity and profits increases exponentially. The timeframe compresses dramatically.

According to JP Morgan, “AI related stocks have accounted for 75% of the S&P 500 returns, 80% of earnings growth and 90% of capital spending growth since ChatGPT launched in November 2022.” Capital spending is soaking up nearly half of MAG 7’s profits, fine for now, but sustainable if the revenue side isn’t growing quickly? Per McKinsey, nearly 80% of companies are now using AI in at least one business function, but >80% of companies still report no material contribution to earnings from their AI initiatives. If there’s so little tangible return, how will that stack up against the real spend? The spend crashes against the reality of insufficient revenues, large losses, and little productivity gains. That’s when shiny things start to tarnish. People begin to question their subscriptions when there’re few benefits.

Enjoy Your Bubble

AI will change the world and this vortex of euphoria will end in tears. Those two things can be true. We simply have too many mismatches today, uncertain revenue vs. exorbitant spend, rising energy costs of data centers subsidized by local utilities, or related party investments that double count and inflate values. Each one’s a domino adding to the collective fragility. We cringe to think what happens when the first one falls. Eventually we may just look back and question everyone’s intelligence, artificial or otherwise.

Given the historic quantum of excess liquidity, this time will be different. Mind you, we’re talking about the size of the bubble, not the eventual outcome. Lest you think we’re chicken littles, we’re not. The sky isn’t falling, heavens no. We’re saying that we’ll reach the heavens . . . then fall from it.

It is inevitable.

Still, if you’re a youngling . . . this is your bubble.

You can bet on it.

(Note: We are short Palantir (PLTR) at 100x revenue (or 80x or 50x, frankly it matters little at any of those numbers), and RobinHood (Hood) on the idea that every generation’s bubble is traded on their very own platforms, and once the bubble pops, their platforms tend to fall).

As we walk through OXY’s Q3 results, it appears on first glance to be another “great quarter guys,” operationally that is, but it leaves us wondering . . . why do all your efforts rarely translate to shareholder returns?

Let’s walk through it.

The Dust Begins to Settle Post-OXYChem Sale

Okay obviously the big news last quarter was the OXYChem sale for $9.7B, $8B net of cash. $1.5B of that cash will go straight to the balance sheet, call it a downpayment for the 2029 payoff of the $8.5B of preferred shares ($9B if you include the 5% premium). That leaves you with $6.5B, which will be used to retire $4B in near term maturities (likely what’s highlighted in blue).

This will cost a few hundred million extra because of the make-whole provisions within the bonds, but at least $1.3B can be retired at par (as it’ll be used to payoff the 2026 Term Loan).

Thereafter, there’s little to no debt left between now and 2029.

Once complete, the $6.5B in total debt repayment will yield ~$350M in interest expense savings. The remaining $1.5B of cash on hand likely generates ~$50M in interest income, so add the two together, you’re around $400M of interest savings/income.

That’s less than what OXYChem brings in on a FCF basis, historically, or even on projected basis. In contrast though, Vicki Hollub has stated that it’s a push, and in turn de-leveraging the balance sheet will allow the company to enhance its capital allocation.

Okay that doesn’t quite make sense to us when we look at the figures. Even using historical numbers, adding back depreciation and amortization and subtracting capex, we get to a slightly different numbers. Perhaps if we use after-tax numbers then. That would make sense, and sure enough it does.

It’s a bit of a fib though since 2025 has increased capital spend because of the Battleground expansion, and if you’re assuming post-tax income, you probably should also assume that the interest savings you’re getting with the debt pay down is post-tax (i.e., it’s lower because you no longer get a tax deduction for the interest expense).

Overall, we think there’s a spread here in lost FCF from the OXYChem sale, and 3-5% feels about right, and the fact that the stock fell 7% after the deal was announced makes sense as the market likely adjusted for the greater market volatility once you remove the ballast of OXYChem from FCF generation.

2026 Capex

Okay, that’s largely water under the bridge. So let’s level set. You sell your major subsidiary, capex should correspondingly decrease next year right? Right. Initial guidance for 2026 capex guidance pencils out to the following ($6.3B to $6.7B).

Here’s the company’s commentary in the Q3 call:

So at the high-end we’re looking at $500M in capex reduction ($7.2B this year to $6.7B in 2026), which makes sense, but again this is largely stemming from OXYChem’s sale (and eliminating the OXYChem maintenance and growth capex spend of $700M and $900M, respectively).

Said another way, the $200M - $400M of additional capex spend is . . . well extra. This amount is being reinvested in the Permian, which will help increase OXY’s production by ~2% next year. It’s not too egregious. To be honest, we’re a bit agnostic on that as it’s not a game changer, and helps with the development of the asset base.

Capital Allocation Policy

For OXY, what needs to be a game changer though is their capital allocation policy. The company’s shares have trailed the broader sector for the past two years thanks in large part to the CrownRock transaction. Post-Anadarko and now post-CrownRock, long-term shareholders have been patient with the company as the ill-timed acquisitions have created a company with great rock/great assets, but a terrible return.

For all the reasons we’ve said in prior articles, some of this was outside of OXY’s control. Whether it’s COVID (post-Anadarko sale), or the timing (when CrownRock wanted to sell), sometimes you don’t have full control over the circumstances of when you’ll pull the trigger, and what happens after a deal. Having said that, if Vicki and company are really done with acquisitions (as she’s shared):

. . . then the rest is up to them.

At the very least, why is OXY not buying back the 29.56M shares it issued to CrownRock at $59.38/share on August 1, 2024? With the stock at $42/share, it would effectively save $514M on the transaction. Moreover, $1.2B in stock repurchase would only equate to the FCF of 1 quarter, and an easy lift for OXY. The company’s shares are languishing at current levels, and with a 10% FCF to market cap and a newly delevered balance sheet, OXY should be aggressively buying back shares.

Sure, “Opportunistic Multi-year Share Repurchase Program” is listed as the next batter up at #3 in OXY’s latest slides, but we failed to hear anything definitive in the most recent quarterly call. #2, Immediate Debt Repayment, will come in Q4/Q1 2026 once OXY closes its transaction with OXYChem, so given the muted explanation in the Q3 call, we anticipate a board approved share repurchase announcement in the next conference call.

Mind you, Step #3 is between #2 (debt-pay down) and #4 (Berkshire preferred equity redemption. Timing wise, we have about 3.5 years to see what can be done (2026 to August 29 = ~14 quarters). If we assume today’s oil prices across that timeline, OXY should generate about $14B in FCF over 14 quarters (i.e., $4-$4.5B in FCF per year = $1B a quarter * 14 quarters).

Retiring the preferred equity will cost ~$9B (including a 5% premium), which leaves $5B in buybacks, or $1.42B a year. We think it’ll be slightly more, likely about $2B of buybacks a year, or half of the FCF at today’s oil prices. That’s likely the baseline, which shrinks share count by 15-20% over that period.

Bump WTI by $10 from $60/barrel to $70/barrel, and you’re looking at an extra $2.7B in FCF annually * 3.5 years, and we’ll have another $9-10B in FCF during that time. $15B basically retires 40% of OXY shares in the next 3.5 years, which should be enough to double the stock during that time.

Frankly that may not be enough. Mind you it’s Vicki Hollub who has said that’s the company’s goal, but 5 years is simply too long, and if oil prices cooperate, we’d expect OXY’s share price to rerate higher as projected FCF vaults, wasting an opportunity to enhance per share value by shrinking the share count today.

There’s a scenario where if OXY is correct, and its enhanced oil recovery (“EOR”) efforts do yield a 100% uplift in its onshore unconventional resources, nearly doubling proved reserves in the Permian, then OXY’s stock is even more woefully undervalued.

We can envision a scenario where if OXY does continuously enhance its reserves, an integrated producer looking to bolster its reserves would explore taking OXY out given its depressed stock price. Sure, Berkshire’s 1/3 interest may be a hurdle to overcome, but deals can be made.

Lastly, the company was fairly quiet about the Low Carbon Ventures (“LCV”) business, and in particular, the Stratos start-up. The first Direct Air Capture facility was supposed to come online in Q4 and begin capturing carbon for storage, but that appears to be delayed by one quarter. We also think the market’s weakened for green energy projects as the Trump administration pivots away from climate change, and prior efforts of the Biden administration. Nonetheless, the Stratos facility will help prove out the concept, and that should go a long way to developing the market for the next DAC facility.

Overall, another good quarter from OXY, but the lack of clarity on capital allocation coupled with the low-share price means they have their work cut out for them.

This management team needs to start delivering not just operationally, but capital-wise. What should have been a conference call where OXY came out to state that they will unequivocally self-cannibalize given their extraordinary value turned into a mealy-mouthed discussion about conducting “value calculations,” and weighing buybacks against debt repayments, and reinvesting in the business.

Sensible, but that makes no sense. The overall quantum of debt has been wrangled down below their target of $15B, and oil prices are touching the $60/barrel range, so what’re we actually talking about here? It’s time for the company to clearly and aggressively repurchase its shares, and return capital to shareholders, otherwise all that was done . . . was done for naught.

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That’s what I’m thinking as I see these results. This management team, reconstituted since the beginning of the year, actually knows what it’s doing. A revamped product line, a refocused 4 point strategy that’s communicated effectively, a renewed emphasis on super serving existing customers, all performed with a keen eye on financial discipline.

Yeah, this has the potential to breakout . . . after lying in wait these few quarters.

Let’s go Peloton.

The company reported Q1 2026 results yesterday, and if it isn’t clear, it should be. This retooled business has the wherewithal to really generate significant cash flows. Since the termination of Barry McCarthy as the CEO, the interim-CEOs and now Peter Stern, have habitually set low guidance bars. The conservatism’s justified given the historical execution. Under McCarthy, the strategy to deliver fitness via an “app strategy” alone drove the company to near bankruptcy. What matters in the end wasn’t the way the content was delivered, what matters is how connected the community feels, and how much value the company delivers its patrons.

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Okay we were wrong about this quarter and what’s been transpiring. As we left off Q2, inventories were building in H1 2025, as higher US production coupled with OPEC+ tapering their prior production cuts means supplies were coming. We had anticipated that OPEC+ would bring on supplies at a fraction of the cuts they’ve unwound, keeping prices in check, but what they brought back was much higher than anticipated and closer to the unwound quotas.

The barrels? They be flowing.

Despite this, as OPEC+ unwinds its second tranche of production cuts into year-end, we still think “real” production will lag. In the past few months, we can see that OPEC+’s production is leveling off even as the quota increases (chart above on the right). This is likely due in large part to OPEC+ production capacity, as we’re bumping up against the max for many of these “voluntary cutters,” and the only ones left to push actual production higher are the big 3 (Saudis, UAE and Kuwait). As we’ve now learned, they’ll likely do that as they regain market share, but for the rest (i.e., Iraq, Russia, etc.) it’ll be much harder as the physical constraints become tighter.

Still though, even if OPEC+’s ability to ramp materially higher is reaching a peak, the current pace of supply increases exceed global demand. So unless China increases its reserves (i.e., buys more), and/or the US throttles its production, oil inventories will build. For the time being, China is doing its part, but not the US as production here keeps chugging higher.

Although rig counts declined post-Liberation Day, the Israel/Iran ruckus in Q3 (and the short-term oil spike) allowed producers to hedge and we’re seeing that trickle through to capex budgets. Greater efficiency in drilling have also helped firms to maintain their production profiles, even with rig counts and frac spreads falling. As the kids say though . . . don’t get it twisted, yo.

We don’t think this is permanent as the number of rigs and frac spreads coupled with the lower Tier 1 inventory levels means US oil production will slow as the headwinds build. This has always been a capital treadmill, and if few producers are making money at today’s level, then production profiles will decline like free cash flow. Price will constrain all.

Still with OPEC+ unwinding, US production maintaining (and even increasing a bit), and Brazil/Guyana coming online, we are well supplied. Though global demand is higher than forecasted by nearly all of the energy agencies, it’s not high enough to accommodate the trifecta. In the end, global inventories ramped.

After trending with seasonality, inventories decoupled this past quarter, and began to build as oil-on-water increased substantially. It appears that previously sanctioned suppliers have also been given the green light to export fully.

In turn, OECD inventories (i.e., where about 1/3rd of the barrels reside, but where oil prices are determined) have also increased. Typically 1/3rd of global inventory changes eventually find their way to OECD inventories, and as such, prices reacted as OECD have built by ~100M barrels YTD (again note that global stocks in total increased by 311M barrels YTD).

Prices today though imply that OECD inventories will build by ANOTHER 100M barrels, but we’ve yet to see that so far. So call it a “pre-loading,” and one that’s depressing prices today, though the actual barrels have yet to show up. As of Q3, oil prices were down ~15% YTD.

In the past few weeks in October, they’re range bound, but in a low $57-61/barrel range.

Suffice it to say, conditions today are extremely bearish as nearly every analyst anticipates more OPEC+ unwinding, more US production, and more oil from sanctioned countries. More, more, and more. The question is simply by how much. IEA has bandied about COVID like builds (+4M bpd), but last we checked the world wasn’t going through a pandemic shut-down. Just taking a step back and using satellites, inventories in the nascent Q4 time period have been building in the recent weeks, but not anywhere near expectations.

Oil-on-water has vaulted higher, which makes total balances look bearish, but it’s being offset by lower onshore inventories. Our guess? Sanctioned barrels (think Russia) is finding its way to water as their refineries get hit by the Ukrainians. So it’s a hiccup in the system. Since the crude can’t be refined, it’s steaming towards another port/refinery of call.

What about inventories in the OECD countries where oil is priced you ask? Well our proxy real-time tracker doesn’t show significant builds yet, but it is October, so let’s wait until we see November and December. So far, so good though, and 2025 Q4 QTD for OECD territories? Kinda like every other year.

Still you can’t argue with prices, and we’ll just have to let the market stifle supplies with low oil prices. Still if we’re right and builds are much less (say 0.5M bpd), or 15% of what the market “expects.” What happens when we turn then calendar? If our oversupply in a weak slow demand season is small, but we head into a spring/summer 2026 season with higher demand, what then?

By then, OPEC+ spare capacity will be near zero (absent significant investment and/or ramp-up), US production will likely have declined a tad, and overall demand will be higher as growth continues unabated?

That’s the scary part of all this. The analysts would have you believe that the spookiness lies in this Q4/Q1. The builds are coming, and may already be in the room with you. Nah, the real scare? It’s likely in 9 months when we realize . . . we’ve been worried about the wrong thing all along. Still for Q4, just hunker down . . . something wicked is supposed to come . . . we’ll believe it when we see it.

Happy Halloween.

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As we head into FY 2026, PTON announced for the first time in its history a revamp of its product line. The company’s new connected fitness devices now come with AI assisted workouts, enhanced audio, a swiveling screen, upgraded processors, improved WiFi and Bluetooth for connectivity and a built-in movement tracking camera that can provide form feedback and rep tracking. Best part of all? They’re pretty in silver.

The new product lines are collectively called the Peloton Cross Training Series, and encourages users to incorporate different workout activities into their fitness routines (e.g., combining cardio with strength training, yoga, meditation, or pilates). The company is also leveraging AI to personalize the workouts. The newly branded AI assistance “Peloton IQ” can offer recommendations using the data you provide to create a personal health plan.

We’re not entirely sure how useful this offering will be, but it does show progressive thinking, and if anything it’s a good marketing tactic. More importantly, AI can help the company translate/dub workouts into different languages, reducing the cost to expand PTON’s content to new markets.

The company has also revamped its go-to market strategy. PTON has partnered with more third-party retailers, started its own used equipment website (Peloton Repowered), and redesigned its retail footprint. Gone are the costly and large format retail stores. Instead, PTON’s experimenting with mall kiosks one tenth the size.

The kiosks should generate the same amount of foot traffic and revenue, but have significantly more flexible lease commitments. The company plans to have 10 micro-stores open by the end of 2025, and fully shuttered all retail stores by 2026. Additionally, the company’s refocusing its Precor brand to target commercial businesses and third party gyms, and has introduced Peloton Pro Series, a line of products that cater to gyms, hospitality, multi-family residential, corporate, education and hotel in-room fitness.

From a marketing/corporate messaging standpoint, Stern has shifted the company’s strategy from focusing on fitness to the broader category of health and wellness (i.e., focus on “health-span” and not just life-span). It’s an effort to reach a greater audience and access a larger addressable market. Here’s Stern’s comments in a recent quarterly call:

Health, recovery, menopause, mental health, injury prevention, yoga, pilates, meditation, come one, come all. This should further enhance how “sticky” the PTON ecosystem is as cancellation rates are still LOWER THAN Netflix . . . and nobody cancels Netflix.

In the recent quarters, we’ve seen little deterioration of these membership metrics, and would expect subscribers to maintain their loyalty. More pointedly, the already anemic cancellation rates fall by half if subscribers take two or more modalities (e.g., bike + strength, or jog + yoga). It’s partly why the company’s emphasizing cross training with its new product line. PTON’s new Strength+ app should also reinforce this aspect of the business. So despite the company’s slow bleed of subscribers in the past few years, we’d expect the new offerings will help stem the tide, slow subscriber cancellations, and bring in new customers.

Price Increases

In conjunction with introducing new products, the company also raised all of its prices by ~15-20%.

After the increase, hardware prices better reflect the true costs of manufacturing, and the subscription prices better captures the value enhancements PTON’s rolled out in the past few years. Even at the highest tier of subscription, All-Access Membership, the classes are a relative bargain to in-person instructor led classes. The new $49.99/month All-Access Membership should result in $160M of additional EBITDA over an entire year (even factoring in modest subscriber cancellations). Cancellations will almost certainly increase, but previous price increases in 2022 tell us that the impacts normalize after a few quarters. The price increases coincide with new product launches for the holidays, so cancellations this time around may be lower.

In totality, what we have today is a $3B market cap company with ~$460M in net debt. That’s fairly cheap for a company that boasts 2.8M subscribers and dominates the connected fitness space. PTON has recently guided FY2026 to be $2.5B in revenue, $425M in Adjusted EBITDA, and $200M in FCF. We think that’s light, as 2025 revenue came in higher at $2.5B, Adjusted EBITDA at $403M, and FCF at $328M. If you’re increasing prices by nearly 15-20% across the board (pro-rated for FY2026 as it takes effect in Q2), how’s it possible that all your metrics will be lower? We sense there’s “conservatism” in the numbers.

In addition, PTON announced that it will slash operating expenses by another $100M (after having concluded a $200M restructuring in FY’25), which should provide even more of a cushion to “beat and raise.” FCF also seems light at $200M as we surmise it should be closer to 2025 even with inventory and tariff headwinds. If so, this means, the company’s net debt will largely be extinguished by fiscal year end. It’s likely PTON will continue to operate with some leverage, but the interest expense should fall from the usurious 11% to something more manageable. If PTON ran with half its leverage today, interest savings alone will boost FCF by $60M, nearly 20%. Slap a 10x multiple on it, and it’ll boost the stock price by 20% alone.

There’s definitely headwinds though. We get that. A weakening economy, high price point, depressed consumer sentiment, tariffs, and the need for inventory restocking. FCF will be impacted by a few of these factors (namely the last two), but the reduction in operating expenses means the two should push. PTON’s stock based compensation is also egregious, and the company recently revamped its stock compensation plan to tame it, so we’ll see if that brings it closer in line with peers.

As PTON shifts from a fitness focus to health and wellness, the interest for PTON’s products should grow. Couple that change with international expansion and renewed focus on corporate accounts, we think there’s opportunities to reignite growth. To replicate this business would take billions, and the stickiness of its clientele puts this company in rarified air. If Peter Stern and team can demonstrate a modicum of growth, watch out, the value of this company can soar.

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