Possible Deflation and New Positions
This has been a tough year for metals and miners, which means a tough year for you the client. Unfortunately a lot of the macro research I am reading also points to lower metal prices going forward. So we will have to be patient during this time, since this is our largest position in our active portfolio. We did sell out of our Freeport position earlier in the year when Copper prices hit an all time high of five dollars a pound. We didn’t sell because we thought this was a temporary high in the copper price, but sold because Freeport looked overvalued when considering the historical cash flows. Selling at the high was just a lucky coincidence and this type of opportunity is not normal for us. But it was our third largest position and has helped with stabilizing performance during a down year in commodities. After the sell of Freeport we had a large cash position for most of the year until a couple of months ago when we got excited about Allstate and allocated our cash position towards this company. We have made a nice return here in the last couple of months and this will help in our performance for the year, but we are still trailing the performance on the SP 500. We also added Carrefour to our active portfolio, but on a smaller size, so this has only added minimally towards our performance.
With metal prices going down and our three main positions of RIO, BHP and PICK underperforming this year we want to take advantage of these lower prices. Unfortunately I don’t feel comfortable adding more to these companies since your portfolio is already heavily weighted towards them. So we have started to allocate money towards Anglo American during this down market. Although Anglo doesn’t have as high of returns on capital, they are going through a reorganization and will be spinning off their diamond, platinum, nickel and steel making coal business. This might create some above average value for shareholders going forward.
We are also starting to get excited about the fertilizer market. We have seen a large sell off in the previous two years and valuations are starting to get attractive. We also like the macro economic outlook of this market. We are starting to accumulate a position in Nutrien, which has a 20% market share of the global potash market and a 22% share of the total US fertilizer market. The return on total assets are not great for this company at mid single digits, but they have a very attractive dividend of ~4.5% and produces a lot of cash relative to there stock price. Selling at 12x their ten year average net free cash flow.
The last position we started to accumulate last week is Goodyear Tires. I would consider this a speculative investment since the company doesn’t have positive earnings or a dividend. But on occasion we do toe the line with speculation when the risk/reward ratio looks to be in our favor. This is not an original idea of mine, my mentor and friend Steve introduced me to this. I will not regurgitate his research here, but the speculation is based off a European legislation on deforestation that will take into effect at the end of this year. And on the demand side the heavier EV cars might also speed up the use cycle of tires and the auto depreciation cycle is also near an all time high. The combination of these three variables make this an interesting place to allocate your money. I also like that Goodyear is the third largest player in the tire market. Which gives me confidence that they will be around for a while even if the supply demand outlook doesn’t play out like we think. I am thankful to have Steve as my friend/mentor and have access to his brilliant research. He has a long track record and is one of the best when it comes to commodity and macro economic research.
In conclusion, the market for commodities looks soft right now so short term returns might not be great. But this is giving us an opportunity to find well run companies at good valuations. We don’t know how long this deflation cycle will last but we feel confident that the companies we are investing in will be around many years from now and hopefully selling at a higher valuation. In the mean time we feel comfortable collecting some nice dividends.
Schwab and Carrefour
Today we are seeing a nice sell off in Schwab. It is down fifteen percent over the past five days because of a quarterly report. This is one of my favorite times to purchase a great company at an attractive valuation. I really like the idea of Schwab getting into lending. They have a competitive advantage in the Financial Advisor space, and being able to offer quality lending to that platform should be accretive to shareholders.
Other thoughts from yesterdays conference call:
They are very focused on customer satisfaction
They are focused on growth. Has good historical growth
Very focused on operational excellence/efficiency
They have high return on equity
Has a competitive advantage
Big believers in investing in technology and innovation
Risks: Blockchain Technology. Keep an eye out for ways a new technology can undermine Schwab’s competitive advantage.
Here are the historical NFCF numbers:
18.5b 2023
1b 2022
1.2 2021
6.3 2020
8.6 2019
35.6b total nfcf. 7.12 five year average
11.9b 2018
-1.2b 2017
3.3b 2016
1 2015
1.9 2014
16.9b total. 3.38 five year average 5.25 ten year average
1.4 2013
1.1 2012
2.3 2011
-1 2010
1.3 2009
5.1 b total. 1b five year average 3.84 fifteen year average
I like to look at the five year averages with this company. It will smooth out the cash flow inconsistency. Management has a good track record of growth.
Even if the five year average NFCF doesn’t grow, we are still buying this company at an attractive valuation. 17x the current five year average NFCF seems attractive in this interest rate environment. Seems like decent value, considering the quality of the company.
Carrefour:
My friend introduced me to Carrefour last year. I usually don’t take recommendations but this had some good attributes. And the stock is down 19% in the last year. They are very focused on the customer and operations. Very data focused. Care about environment and community and employees. Largest food retailer in France, with 1,500 quality own-brand products. They are innovative. Trying to develop new products and tech. Looking for bolt on acquisition. Has competitive advantage in Brazil, France, and Spain. Management made an intelligent move by exiting markets without a competitive edge. Very focused on increasing Net Promoter Score. Large land owner in Brazil with 21 billion m² in its landbank.
Some of the negatives are:
Very low return on assets. Had negative net free cash flow two years out of the last 12 years. Franchise model might not work. Brazil is a higher risk country than investing in Europe or America.
Valuation:
Net Free Cash Flow (NFCF) five year average = $1,346M
NFCF Ten year average = $893M
NFCF Twelve year average = $1,000M
$10.9B Market Capitalization.
.19c dividend paid annually. But very large ADR holding fees for American investors. So after fees only an 13.3c dividend. Current stock price is $3.15. So a 4.1% dividend after fees. And management mentioned they are committed to growing this.
Has a decent valuation when considering the historical cashflows. 7.5x the five year average.
Conclusion:
This investment doesn’t check all the boxes but has enough qualities and a margin of safety. The margin of safety would be bigger if they didn’t not own assets in Brazil. But we still feel the rewards out weight the risk. We could also see a boost to earnings if commodity prices stay high.
Higher Interest Rates and Regulation Change Creating Opportunities in Financial Companies
Over the past year I’ve helped a few clients increase their take home income by showing them how to buy a money market fund or short term treasury bills. From my experience the average American doesn’t understand how to invest short term or liquid (cash) assets. This is understandable since short term treasuries have only recently started to offer an attractive rate. 18 months ago short term rates were <1%. But times have changed and unfortunately the average American usually holds cash in a checking or savings account uninvested. This is great news for the big banks, since they make a spread off the interest they pay you and the interest they can earn on your uninvested cash. That difference is around 4.5% right now. That means a big profit boost for banks at the moment.
I still have some research to do on the banking industry but I do feel comfortable buying Schwab for my active portfolio clients. They have a nice competitive advantage and a great reputation for providing a good service to their clients. Schwab is also fairly valued when looking at historical earnings so I feel we have a margin of safety with this investment, incase interest rates drop again and the profits shrink. Here are some of the fundamentals:
$133b market capitalization
18.47x five year average Net Free Cash Flow (nfcf) or 5.4% earnings yield
25x ten year average nfcf Or 4% earnings yield
5 year average nfcf = 7.2B
10 year average nfcf = 5.29B
15 year average nfcf = 3.9B
12% ten year NFCF average return on equity.
26B ltd
41b shareholders equity
Shares outstanding have historically gone up, but shouldn’t be dilutive.
Schwab has seen a good earnings growth rate and strong return on equity over the decades. The valuation according to historical cash flows is not super exciting at the moment but the valuation is low when looking at the $18.9b cash produced in 2023. I feel like we have a good margin of safety with this investment and also some upside potential if government interest rates and current profits stay steady.
Allstate has also been added to the clients active portfolio. In January of this year, California allowed auto insurance companies to increase premiums. I know because I use Allstate and saw my monthly insurance bill increase by 30%. So not only does Allstate benefit from the higher interest rate environment they are also able to increase premiums. This is a double benefit to their earnings power, while the company valuation is already attractive from a historical earnings perspective. Here are some of the fundamentals:
$42b market capitalization
historical nfcf:
4b 2023
4.9b 2022
4.8b 2021
5.2b 2020
4.7b 2019
$23.6b total nfcf for last five years. $4.7b five year average.
4.9b 2018
4b 2017
3.7b 2016
3.3b 2015
2.9b 2014
$18.8b total. $3.76b five year. $4.24b ten year average.
$26b shareholder equity. $6.6b Ltd and consistent. Premiums growing at 4.7% annually over last 4 years. 13% book value per share growth. Dividend was .18 cents in 1993 compared to a >2$ dividend today.
They are very focused on keeping and growing customers. Also very focused on tech and investing in marketing, data. Very long track record of profits.
At less than 10x historical nfcf and the possible boost to earnings from higher interest rates and higher premiums, Allstate has a nice margin of safety with a chance for appreciation if the current environment stays consistent.
2023 Review
On the Olde World Investments (OWI) active portfolio management side, 2023 was a good year for the metals producers. The MSCI ACWI Metals and Mining Producers Ex Gold and Silver Index was up 10.88% in 2023.
The metals and mining stocks were very volatile last year. Having strong corrections in May and October due to political and economic factors. The government had trouble agreeing to increase the debt ceiling and the federal reserve decided to increase interest rates. The fundamentals of the large diversified miners looked attractive during these corrections, so OWI felt good going against the market and being a buyer during 2023. The increased interest rates will eventually decrease demand for the miners products, but so far the profits are healthy.
Our investment positions were little changed from last year, with our core positions being in BHP, RIO Tinto and Freeport-McMoran. But we did initiate a new investment in PICK, which is an ETF focused on the metals and mining producers. I decided to initiated this position because the major diversified miners (BHP and RIO) had already distributed their dividends for the first half of the year and since PICK only pays dividends in June and December every year, we were still able to receive dividends from the major miners that went ex-dividend in the prior months. In hindsight I should have instead, kept buying BHP and RIO, but the ETF format does mitigates the unsystematic risk involved in holding the individual securities. The cost of holding this ETF is high at .39% a year, but the valuation, dividend and risk mitigation looks attractive enough to keep the position for now.
On the passive portfolio front, the SP 500 was up 24% in 2023, compared to a dismal -18% in 2022. Historically the market has gone up inline with economic growth and productivity. And a portfolio indexed to the SP 500 has historically been a good way to participant in this economic progress. I have been suggesting clients purchase a broader diversified ETF like VTI instead of a SP 500 specific ETF. The valuation is a little lower due to having a allocation toward small caps.
VTI
23pe = 4.3% earnings yeild
SP 500
26pe = 3.85% earnings yeild
The earnings yields are not drastically different, but with long term government bonds at 4.5%, the US equity ETFs are already close to being overvalued. I also suggested that clients allocate up to 40% of there equity ETF portfolio towards international stocks. The US based companies have an overall competitive advantage and are the leaders in innovation. But the international valuations are substantially cheaper and you get a hedge against the currently strong dollar. They also have a nice dividend which is north of 3%.
VEA
12.2x trailing PE
VXUS
10.4x trailing PE
In conclusion it was a decent year all around and we were able to be disciplined and stick to our principles. Not every year will be positive, so lets enjoy it while we can.
Disclaimer: It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. Past performance is not necessarily indicative of future results.
Debt Ceiling Creating Opportunity for long Sighted Investors
I watched some of the Berkshire Hathaway annual meeting a couple of weeks ago and here are a few of Warrens comments I really liked:
The debt ceiling will be raised since no one wants to be responsible for putting people out of work and destroying the economy.
There will always be opportunity in the stock market because of short sightedness.
Both of the above happened this week in the metals markets and OWI was able to purchase more great mining companies at great valuations. We are focused on 5-15 years down the road and are confident in our research so we can go against the crowd and buy when the masses are scared.
I read Rio Tintos annual report last week and found an interesting comment:
“We expect the energy transition will add as much as 25% in additional demand above traditional sources across our key products by 2035.”
The outlook for the best miners in the world is good, so we want to be aggressive when the markets let us. 2023 has seen some good market shaking events (SVB and Debt Ceiling) and OWI was able to take advantage of both of them.
A lot of our investing principles have been hit on this metals investment, so OWI believes there is a good chance we can generate a good return over the next 5-10 years. We also believe we have a good margin of safety if the energy transitions doesn’t bring above average returns. Our investments are spread across the largest and best miners in the industry, all very well managed, great balance sheets and strong competitive advantages. So OWI’s capital seems safe but also has a nice kicker if the energy transition really does create above average returns. Also, we get paid handsomely while waiting since these miners pay good dividends.
2022 Review
We made no major investments in our active portfolio for the first 9 months of the year. But in September of last year when the markets started to go down and valuations looked attractive, we bought what we thought were good deals at the time. Our main purchase in September was Freeport-McMoran (FCX), which is one of the largest pure play copper companies in the world. There was a disconnect between copper demand and the copper price in September. The market was afraid that the feds interest rate hikes would choke off copper demand. But this was not the reality, the major copper producers were saying that demand was good and the physical market was tight.
Here is what FCX said in October of 2022:
“We certainly have no problem selling copper,” FCX CEO Richard Adkerson told investors on a conference call. “It’s just striking how negative the financial markets are about this industry and yet the physical market is so tight.”
OWI gets excited when we hear or see a disconnect between price and value. And we usually try to get into the position in a healthy way. We did this in September and October with FCX. The stock ended up rising to 46 dollars a share over the next three months. Which was a 76% rise from the October low of 26 dollars a share. Of course we didn’t catch the entire move, but a few clients that opened their accounts later in the year got a portion of this move.
Another notable mention was the the spinoff of BHPs Oil and Gas company to its shareholders. That was an extra 12% special dividend on top of the 11% regular dividend. Creating a >20% return for shareholders in a year where the S&P 500 was down 18%. Obviously this will not happen every year, but again we will take it.
So a few good events for us, but we do not know or attempt to know what our positions will do in a one year time frame. But we feel our holdings satisfy our investment principles and have a good chance of creating a good return over the next 5 to 10 years. Lets see what happens, but in the mean time OWI will be busy doing more research and hopefully finding more great companies in the years to come.
Disclaimer: It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. Past performance is not necessarily indicative of future results.
Revisiting Commodities - Possible Rough Patch and Interesting Investment Ideas
I was reading some interesting Macro Research yesterday and it was showing a large probability of declining metal prices. OWI is a business investor so on occasion we will see large declines in our holdings due to economic factors. Not sure if this is one of those times, but I wanted look at the bigger picture for a second. This will give us confidence to hold our positions and maybe even add if the market gets pushed lower.
Here are some interesting big picture things to think about:
Population is expected to grow by 20% in the next 27 years. From 8 billion now to 10 billion in 2050.
2 billion people are predicted to drive electric cars by 2050. That is a 100x increase from today.
7 billion people are expected to be living in urban areas, up from 4.5 billion today.
Major Global wide investment is happening in alternative infrastructure.
All the above is very bullish for commodities over the coming decades. We will need more fertilizer to feed more people, more base metals for transportation, more steel for urban infrastructure and copper for the alternative energy transition. Lets keep these bigger picture ideas in mind if we see short term declines in current metal prices.
Other interesting happenings in the metals industry.
We started to buy the PICK etf this last week instead of buying individual commodity producing companies. Why? Because we can effectively get dividends that are already past the ex-dividend date. Since PICK only pays dividends in June and December every year, we can still receive dividends from the major miners that have already gone ex-dividend in the prior months. Also, getting these dividends at lower prices since the market was going down last week. It also might be good risk adjusted move for OWI, since the ETF structure will also provide some risk mitigation by eliminating unsystematic risk.
Another interesting event happing in this field is the possibility for a spin off or IPO of Vales base metal business. These events can unlock value for shareholders. This value unlocking event along with Vales cheap valuation, could make for some buying opportunities going forward.
Southern Copper - Best in class with a good valuation
Looks like copper markets have increased dramatically since my last post. We still want to be diligent with our research and keep digging into this market. The valuations are still attractive and so is the macroeconomic outlook.
Did some reading about Southern Copper today and discovered they are a very well ran company with a very strong competitive position, world-class assets, and great growth options. They have one of the lowest cash cost for copper in the world and is ranked number one in the world for mine life and copper reserves. They are the fifth largest producer of copper, highly geographically diversified, and have a large pipeline of greenfield projects. They also have a proven management team that is laser-focused on cost efficiency and growth.
The market capitalization is currently $48B and they should be able to make $2.5B in Net Free Cash Flow per year. So you are looking at the company selling for 19x cash production. Not fantastic compared to the values we were seeing a couple of months ago, but with long-term government bond rates below 4%, this is an attractive rate of return. Plus, we could see a boost in the copper price if demand starts to pick up.
We do believe demand will pick up and we have discussed the fundamental outlook for the commodity extensively in this blog. I also just finished reading a great piece of research by my friend Steve on the Auto sector depreciation cycle, which has good prospects. So not only do EVs need twice as much copper, the auto industry is in a position where demand should be above average over the next decade. Looks like good tailwinds for a market that has decent valuations. This further strengthens my conviction that copper and base metals could be a good place to find decent returns.
Vale - Cheapest base metal producer And possible TRQ arbitrage
Vale has a strong competitive advantage especially with infrastructure. They also have nickel and copper assets that are on hold currently but the ability to ramp up if prices rise from here. They are also the second largest Nickel miner in the world and has major deals with auto makers for nickel. Management seems to be doing the right thing and focusing on end markets with good economics, cutting cost and increasing net free cash flow (NFCF). The shares outstanding have been consistent, so your investment will not get watered down over the years.
Here is a breakdown of the financials.
Revenue:
80% iron ore
12% nickel
8% copper
$32b ferrous metals
$7b base metal
$5b nickel
$2b copper
Cash flows:
$5.6B fourteen year average NFCF
$4.4B fourteen year average NFCF if you exclude the bumper year of 2020
$5.1B fourteen year average NFCF if you exclude the lowest year (2015) and 2020
Dividend:
$0.87 average per share dividend over the previous 15 years
$0.76 if you remove the largest and smallest dividend over that time period
At the current stock price you are looking at a dividend of ~6%
Conclusion:
With a current market capitalization of $68.6b and a range of possible cash flows between $4.4b and $5.6B, Vale is an attractively priced base metal company. Olde World Investment believes the company has growth opportunities in their base metal portfolio and sustainable cash flows in the ferrous metals.
TRQ ARBITRAGE
Rio Tinto made a cash offer for the shares outstanding of Turquoise Hill (TRQ). The arbitrage is currently offering $1.43 per share (buyout at $31.29 minus current price of stock $29.89). That is 4.8% gain in less than 2 mounts. Its always hard to tell who will vote for the buyout, but finding the valuation of TRQ will give us some confidence, since we will be holding the stock if shareholders do not vote for the proposal. I will look into the TRQ valuation in later post and hopefully some other interesting topics.
Possible Low in Mining Stocks and Further Valuation
The fed rate hikes are starting to work with some major economic indicators beginning to drop. Also, the stock market volatility increased substantially during this last rate hike, these could be signs that the Fed has reached (or is close) its limit on rate hikes. We could see a nice pop in stock prices if the fed starts to pause. Its hard to predict, but these are some interesting observations non the less.
The rate hikes have brought lower prices in the mining stocks and we have taken advantage by being a net purchaser. We base our investment decisions on valuation, competitive position and end market outlook. Lets review.
BHP:
BHP is best in class when it comes to ROTA and operational excellence. Its the best operationally, which is seen by comparing return on total assets (ROTA) to RIO and Freeport-McMoRan.
$14.8B 5 year Average NFCF. Total assets is $95.2B. 15.5% ROTA. $10.5B 10 year average NFCF. 11% ROTA. And this is done with only $12B in long term debt (LTD), which is basically no debt with a company this size. Current Market cap is $129B. So we are looking at 8.7 PE (11.5% yield) for the 5 year average and 12.3 PE (8.1% yield) for the 10 year average.
RIO:
Valuation for Rio is also cheap and they have great to good quality assets. But the ROTA is below BHP.
$10.8B 5 year average NFCF. Total assets of $103B. 10.5% ROTA. $6.5B 10 year average NFCF. 6.3% ROTA. And again this is done with only $12.7B in LTD, which is almost negligible with a company this size. Current Market cap is $91.3B. Giving us a 8.5 PE (11.8% yield) for the 5 years average and 14 PE (7.1% yield) for the 10 year average.
FCX:
Freeport-McMoRan is the largest publicly traded Copper Producer in the world with some of the biggest and best copper assets. The Free Cash Flows and ROTA are not as attractive but we still like them for the pure play exposure to our energy transition thesis.
$2.5B 5 years average NFCF. Total assets of $48B. 5.2% ROTA. $1B 10 year average NFCF. 2% ROTA. $9B total LTD is a little high compared to historical cash flows, but the company is focused on keeping debt levels low, which is showed by the steady decrease since 2015 ($19.7B LTD). Current Market Cap is $40.5B. 16.2 PE (6.2% yield) for the 5 years average and 40.5 PE (2.5% yield) for the 10 year average.
Conclusion
Valuation - Comparing the above yields to the long term US government bond yields of below 4%, these companies are extremely attractive.
Durable Competitive Advantage - All the above companies have large advantages when it comes to cost, sustainably, diversification, reserves and technology.
Outlook - We have discussed the outlook for base metal producers in length during past blog post. The thesis is still in place and looking even better than thought. Almost every car company is investing in battery manufacturing in a big way. There is just not enough base metals to satisfy this demand. Especially copper, since large high quality reserves are very hard to find and even harder to develop. The Resolution Mine in Arizona is a good example. Resolution has the largest copper reserves in America and would satisfy 25% of Americas annual copper needs, but its on hold because of Native American traditions that are held in the area.
RIO and BHP are not pure play base metal companies but we have looked into and discussed on our blog the outlook for Iron Ore and we still like these companies based on good valuations and best in class copper assets. There is a possibility that Rio and BHP get revalued higher if they can sustain cash flows.
Although FCX is the most expensive valuation wise, OWI has decided to take a position since this gives us a pureplay way to invest in our energy transition thesis. We believe the amount of copper needed in the next decade will not meet demand. And we are predicting that a NFCF north of $5B will be the norm for this company. So although this is more speculative than our BHP and RIO trades, we believe its an intelligent speculation.
Good Opportunity This Week In Base Metal Companies
This week started with capitulation in the mining stocks. This was great news for OWI since we were able to get further invested during the early week sell off. The decision to buy more on the way down was not an easy one. Losing money in your portfolio and still being aggressive is very difficult to do. But its also usually where the best buying opportunities present themselves.
A couple years ago my girl friend and I were walking through San Francisco and stopped at a little free library. Tony Robbins book Unshakable was part of the collection and I suggested she take it. She never got around to reading it, but I picked it up one day when I was at her house and had nothing to read. 99% of the book was basic personal finance stuff, but there were two pages in that book which made it invaluable. In those two pages Tony went into detail about Paul Tudor Jones trading principles. And one of them was “is the trade hard to do”. On Tuesday this week the base metal trade was indeed hard to do. My stomach and body hurt from losing money in the markets. But instead of standing still and do nothing, I’ve made it a habit to act when I start feeling sick and highly uncomfortable.
Having this principle and about a dozen others should serves us well when making investment decisions. But also makes finding investments difficult to do. The last time we got fully invested was when Bitcoin had an unexpected leg down in 2019. We were almost fully invested at that time and we lost a lot of money on that correction but instead of sitting on my hands I got to buying, cause its one of my principles. But the point is, this was three years ago, which is a long time frame for finding a good investment.
Here is my complete list of principles. Some of these I’ve taken from the great investors of our time and of the past and others have been from trial and error over the past 20 years:
Understand (understand what the economics of the business are likely to look like 10 years from now. What they do and the competitive landscape)
Durable Competitive advantage
Honest and capable Management
At the right Price
Consistent High Returns on total assets or ROE for financial companies over a long period of time
End markets with positive long term macro Economic fundamentals
Low Leverage
Innovative
Focus on Operational excellence
Delight Customer
Human Resource (employee) focused
Opportunities to reinvest (Growth) retained earnings at high rates of return
Do it with size
What’s the risk/reward ratio is it 5 to 1?
Psychology (is the trade Tough To Do)
Is it in line with current Money Flows
Is there opportunity for hysteria
Like I said, its hard to find an investment that meets all the above principles, but I believe we have found a candidate with base metal companies. And this last week was a good buying opportunity.
There are still risk to this trade but we are definitely happy with the valuations and competitive positions of the companies we are invested in.
Disclaimer: It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. Past performance is not necessarily indicative of future results.
Outlook for BHP End Markets
I got into reading BHPs most recent economic and commodity outlook today and a few things stood out.
As we have discussed in previous post, the amount of nonferrous metals produced will probably need to increase substantially over the coming decades if decarbonization continues. So BHPs copper and nickel assets could be more valuable in the coming years. But what about the iron ore assets? Its the largest cash generator creating $20B in revenues while the next largest asset class, copper produces $10B.
They do have a competitive advantage with the iron ore assets, being high grade and close in proximity to the largest consumer. The risk in the short term for this asset is higher interest rates, but we want to look at larger structural risk. The large risk here is if Simandou starts producing. Which could happen in a couple years time. Simandou is located in the forest region of Guinea and is considered one of the best iron ore deposits in the world. But the project has been delayed several times due to political instability. With the country under new leadership will this project get underway? Looks like it, with a recent agreement to start building the 400 mile railway needed to transport the ore to port. The new government has only been in control for a short while so we really don’t know. But something to keep an eye out for. Even if this project does come online, it is possible iron ore prices could be supported by the demand needs of China.
Below is another exert from BHPs recent post that caught my eye:
“Turning to the long term, we firmly believe that, by mid–century, China will almost double its accumulated stock of steel in use, which is currently 7–8 tonnes per capita, on its way to an urbanisation rate of around 80% and living standards around two–thirds of those in the United States. China’s current stock is well below the current US level of around 12 tonnes per capita. Germany, South Korea, and Japan, which all share important points of commonality with China in terms of development strategy, industry structure, economic geography, and demography, have even higher stocks than the US.”
So the demand for steel and iron ore does look good. It just wont be as bullish for BHP when Simandou comes online.
BHP has a very attractive dividend with some of the largest and low cost mines in the world. So although its not a pureplay base metal company like Freeport, BHP’s high ROTA, cash flows, efficient and best in class operations makes it an attractive investment.
Deeper Dive into Freeport McMoRan
They are largest pure play base metal miner and could be a great way to take advantage of the possible increased need for base metals. The other companies with competitive advantages in the mining industry have good valuations also, but are more diversified into energy and ferrous metals. So OWI believes freeport could be a good way to participate if there is an increased demand for base metals.
A couple slides from Freeports most resent earnings release caught my eye.
There is a divergence of price and inventory levels. Inventory levels have actually dropped this year while prices have also. And according to Freeport the incentive level to produce is almost a dollar more per lb then current levels. If that is true, than inventories will drop further or prices will need to increase. This price drop is due to concerns about slowing global growth. Which could or couldn’t be the case, but if we take a longer view the demand landscape for copper and other base metals look attractive.
Not sure how accurate the above forecast will be, but the perception of the energy transition alone could drive up prices. If copper prices get back above $5, Freeport would generate $6B in free cash flow. Which is 8x the current market cap. If higher copper prices can sustain, we could see a decent return here.
Be Observant and Patient - Take Opportunities When They Come
There are, most of the time, good companies selling at fair prices and we do purchase these stocks in small amounts throughout the year. But seldom does something come along that checks most boxes on my investment criteria checklist. After two years of consistent research and being patient, commodities started to look undervalued last year and are meeting a high percentage of principles on my check list.
Rio Tinto just came out with their six month dividend amount. It will be paid at the end of September and it is almost 5% of its current stock price. That is only the semiannual dividend and this is at a time when long term US government bonds are offering 3%. Something will have to give, commodity stock prices will have to rise or the economy will have to slow and profits will have to decrease. I am not in the business of predicting the economy, so I just need to buy value when I see it and have a big enough margin of safety to outlast down economic times. The large publicly traded commodity companies (Rio, BHP, Free-port) have this margin of safety. They all boast a competitive advantage in different ways and should outlast a down turn. But if the economy doesn’t fall out of bed, we might see these companies get revalued higher. Lets see what happens but either way I feel like after two years of waiting I have founds something the is hitting a majority of my investment checklist.
Markel (MKL) - Great Company For Your Retirement Account
Markel Corp, Ticker MKL, had a nice correction today down over 5% as I am writing this. The company is fairly valued selling at 14x the five year average net free cash flow (NFCF). The management here is top notch and has a great track record of creating value for shareholders. With a 10% compound annual growth rate in shareholder equity per share. And premiums have increased 17% in the last two years. With $14.7B in shareholder equity the company has a return on equity of 8.4% using the five year average NFCF.
I don’t know the competitive advantage of their insurance company. I would have to dig deeper to understand it, but I understand the managements philosophy and historical track record. And this gives me enough understanding to take a small position in this company and would be a nice addition to anyone’s retirement portfolio.
This company hits almost all of OWI principles for a great investment. They are very focus on employees, customers, high return on asset businesses, being market leader and operational excellence.
The data below was taken from Markel’s annual letter and is pretty interesting since I look at 5, 10 or 15 year averages when analyzing companies. Looks like Markel does the same.
A big portion of Markel’s income comes from their equity portfolio. They have very similar principles when looking for investments. Here is their 4 tier approach:
invest in businesses with good returns on capital that don’t use too much debt
management teams that possess equal measures of talent and integrity
that can reinvest their earnings at good rates of return or redistribute it
at fair prices.
These principles have worked out well for them. Their current invesment portfolio is $9B with a cost of $2.9B.
Management has a 20 year track record of outstanding business returns and shareholder returns. This is an easy asset to buy and hold at this valuation.
Freeport-McMoRan - Industry Leader with a Good Outlook
Most forecast show the need for copper will almost double in the next decade. Freeport-McMoRan is a good pureplay copper company and could benefit if this demand forecast turns out to be accurate.
They have a long track record of developing projects in complex jurisdictions. Strong reputation and infrastructure in the four countries they mine in: Peru, Chile, USA, Indonesia. Decades of block caving experience, with Grasburg in Indonesia being the largest block cave in the world. Freeport also has talented leaders with a lot of experience and a focus on ESG, innovation and operational excellence.
The fifteen year average net free cash flow (NFCF) is $1.4B and the fifteen year average dividend is 1.9% at the current $47B market capitalization.
Some negatives and risks: Shares outstanding have tripled in last 15 years, but have stayed consistent over the previous five years. The main risks to this analysis is a commodity price decline, economic decline or the company’s inability to find growth opportunities. OWI believes these are all short term risk and they would create good buying opportunities. They have long life assets with 30+ years of reserves, one of the most experienced leadership teams in the industry with an end market that has a strong demand forecast.
BHP and RIO - Deeper Dive into Economics of End Markets
BHP and RIO are considered best in class for the mining industry. So we should have a position in these two, but they are not pure play base metal companies. And we want exposure to base metals for our energy transition thesis. So are the non-base metal end markets attractive? The largest market for both companies is Iron Ore and second is Copper for BHP and Aluminum for RIO. The demand profile for copper and other base metals is well documented and demand is expected to double in the coming decades. So we will focus on the economics of Iron Ore and Aluminum in this article.
Rio and BHP have a competitive advantage with their Iron Ore Reserves. They are the highest grade producers of Iron ore. This is important because the world is focused on decreasing emissions and High Grade iron ore is the best way to produce steel with less carbon output. 86% of the worlds high-grade iron ore is located in Australia, where the above companies are the biggest players. And Australia has current reserves of 60+ years. So BHP and RIO are high grade, low cost iron ore producers in a country with a skilled mining workforce and strategic location next to China, the largest Iron Ore consumer in the world.
The above sounds fantastic, but there are risk. China is committed to decreasing their reliance on Australian Iron ore. They have set a target of 45% iron ore self-sufficiency by 2025. The plan is to increase domestic production, foreign direct investment in Iron Ore mines and utilize more electric arc furnaces. Its very possible we could see an erosion of demand in Australian Iron Ore. This is a risk, but doesn’t mean Iron Ore demand will drop off a cliff. The companies will most likely be making great returns on these assets for years to come. They are still the lowest cost, highest quality iron ore in the market and Chinas Iron Ore output has actually dropped 20% over the last decade. So lets see what happens, but something to keep an eye on.
There are other risk such as ports getting blocked and interest rates rising. But these are a short term risk and are hard to predict. So we just want to do a macro look today since OWI would actually take advantage these short term risk when the long term economics look good.
A quick look at Aluminum shows us a little better demand outlook. Most reports are showing a 40% demand increase by 2030. Although not the lowest cost producer, RIO is a strong integrated player and could possibly have an advantage as the lowest emissions producer. They are investing heavily on energy efficiency technology and has a large hydro plant that produces relatively clean aluminum. With large companies like Apple looking for zero emission aluminum, RIO could become a leader in this.
Although BHP and RIO are not pure play base metal companies, they are cheaper on a valuation bases than Glencore or Freeport and the dividends are bigger. As discussed in previous articles these companies look attractive as investments, but we might focus on accumulating Freeport shares going forward if the markets gives us another buying opportunity. Since they are more of a pure play on base metals.
VNQI - Nice dividend with a dollar hedge
Looking at a way to take a contrarian view of the strong dollar., VNQI etf might be an interesting route. The dividend is higher than your standard international equity index fund at a five year average of $2.60 dollars per share. Representing a 5.9% interest rate at todays prices. The ten year average dividend is $2.45, representing a 5.5% rate at todays stock price. These are well above your income yield opportunities in other assets at this risk level. So we are collecting a nice dividend while possibly getting a boost in stock price if foreign currencies start to look attractive again.
It definitely has some heads winds with the strong dollar and rising interest rates, but the low valuation and beat down stock price should start attracting some attention.
VNQI has positions in some of the best real estate assets in the world from German residential, Australian logistics, Hong Kong and Japanese hotels. And being able to get this in ETF form which helps mitigate the individual stock risk is a nice bonus.
Mining Stocks - Looking at Anglo American and Rio Tinto
Here are a couple stocks I have been following. Will these stocks ever get revalued or was the inflation cycle super short this time? These are questions that are very hard to answer if not impossible. What is possible is looking at the fundamentals of a business and analyzing the current competitive landscape. Grasping the above areas will give us the ability to determine if Anglo American and Rio Tinto are high quality companies and should be added to a diversified portfolio.
Anglo American:
They have a strong competitive advantage in the diamond world, with De Beers. If you have ever been ring shopping they are the biggest player. But unfortunately its only 4% of their revenues.
Iron ore 47%
Copper 19%
Platinum 26%
Nickel 5%
Diamonds 4%
They have a mind for innovation and technology. Using innovation to differentiate themselves, create operational efficiency and above average returns.
Highly focused on global trends with good management that won’t chase price. They also have a culture of servant leadership and actively manages asset portfolio to improve overall competitive position. They had two fatalities last year but they have a task force focused on eliminating all casualties and injuries.
There mission statement:
“Secure, develop and operate a portfolio of high quality, long life resource assets. We then apply innovative practices and technologies in the hands of our world class people to deliver sustainable value for all our stakeholders.”
The valuation also looks good with a $3b net free cash flow (NFCF) nine year average and a $42.7b market cap. The earnings are stable except 2014 and 2015 with a flat or small loss.
Rio Tinto:
High quality employees and assets, low leverage. Safe efficient and well run business. Delivering High quality products to customers. They Invest in sustaining, innovating and growing. The company is a leader in technology to find mines. Providing products necessary for human progress. They produce 30% of the worlds borax and also has a competitive advantage in aluminum.
They are getting a lot of flack for the Serbian lithium mine though. Would probably be a good idea to let this project go. The CEO is a finance guy so you will get good returning projects but probably not as much on the social front.
Disciplined on price they pay for mines. Focused on developing current mines. Intelligent and excited when they see great returns. Have lots of projects in the pipeline: lit, copper, iron ore.
Aluminum is a replacement for copper in the electrical world, which should be a great place to be if cars go electric.
Revenue by segment US$:
Iron ore $15b
Aluminum $10b
Energy and minerals $7b
Copper and diamonds $5.5b
Average dividend over last 22 years is $2 a share. That’s a 2.7% dividend at current prices. Better than current US index fund dividend return. The fifteen year average dividend is $2.60 or 3.6% at current prices. The ten year average is $3.30 or 4.5%. Excluding special dividends, the ten year average is $2.4 or 3.5%.
Shares outstanding have been consistent at 1.9b in 2009 1.6b in 2021.
Dividend payout ratio is usually over 50%.
$20b long term debt and $97b total assets.
$6.7b NFCF fifteen year average with a $94b market capitalization.
I also have been following Freeport-McMoran and Vale but I will save that for next weeks post.
BHP - Healthy Dividend and Capital Appreciation Potential
According to Circle Economy, the world consumes 100.6 billion tonnes of materials annually. Of this total, 3.2 billion tonnes of metals produced in 2019 would account for just 3% of our overall material consumption. The world’s appetite for materials is growing with its population. As resource-intensive megatrends such as urbanization and electrification pick up the pace, our material pie will only get larger.
BHP is the largest and best run material companies in the world. They make large returns on tangible assets at 12.5% ROTA, based on a five year average net free cash flow of $13.54B (NFCF).
They are very focused on forward facing commodities (mostly copper and potash), operational excellence, high quality assets and competitive position. They have a competitive advantage when considering technology and infrastructure and is the lowest cost producer of high grade iron ore.
Revenue by segment:
Iron ore 20b
Copper 10b
Coal 6b
Petroleum 4b (oil and gas division divested 6/22)
Other 1b
They also have a long history of dividend growth. Not perfectly steady but over a ten year period it looks good. Excluding this years bumper dividend the average over the last 15 years is 3.8% ($2.06), for 10 years is 4.2% ($2.32) and for 5 years is 5.9% ($3.43).
They expect to spend 9B on capx in 2022 and they have very little debt and consistent shares outstanding. With shares outstanding of 2.7b in 2009 and 2.5b in 2021.
With a five year average of $13.4b NFCF the stock is trading at 11.79x the current market capitalization. Considering the company fundamentals and competitive position the valuation is attractive.