Sunday, 25 June 2017

Tesla (NASDAQ:TSLA) - Read Between The Lines

Tesla has become every short sellers nightmare. Mine included. It is the stock that just won't die despite its hideous 'cash burn rate' evocative of the Dot Com bubble. Much has been written by minds much smarter than mine (See Mark Spiegel's analysis) on the subject of Tesla's financials, the upcoming competition in the market, the build quality issues and the dangers of the autopilot.

I wanted to look at something a little different and that is the motivations and truth revealed by actions as opposed to words. As investors we always look for insider buying and selling as a yardstick for what management do with their own cash - this tells us much more than words. 

A guy like Elon Musk of course knows this - so he borrows some more against his stock to buy into his equity raises - giving the idea of firm commitment. Insider buying is a great yardstick unless the business in question is a 'confidence' business which means either a bank or another business that requires constant Tesla.

But I digress....
"As I grow older, I pay less attention to what men say. I just watch what they do."
           -Andrew Carnegie 
"And so when Cora Tull would tell me I was not a true mother, I would think how words go straight up in a thin, line, quick and harmless, and how terribly doing goes along the earth, clinging to it, so that after a while the two lines are too far apart for the same person to straddle from one to the other and that sin and love and fear are-just sounds that people who never sinned nor loved nor feared have for what they never had and cannot have until they forget the words. Like Cora, who could never even cook."
          -William Faulkner As I Lay Dying

So in that spirit let us make a few simple observations in relation to Elon Musk and Tesla. I have my own theory that 'everyobody tells you everything you need to know' if you read between the lines - it is like a form of dupers delight. Here is an example:

I read these Tweets as admissions of failure. He is saying that starting Tesla has nothing to do with making money. Think about this for a minute. The guy has a company with a $60bn market cap with which he never intended to make money.

Now the second tweet. I think he knows Tesla is failing - why would you be mulling over the origins of your business on Twitter, the great gamble of it all...if it weren't for the fact that you think it is failing? Maybe he is preparing the runway...

Or just chilling to get away from the stress....

This excellent article from the Buffalo News tells you a lot - they report that the $750m former Solarcity (now Tesla) factory still remains effectively mothballed with a skeleton staff. Here are the things they are saying in this article:

Tesla has promised to hire 500 people to work in the factory within two years of its completion and create a total of 1,460 jobs in Buffalo within five years. But the clock does not start ticking on those deadlines until all of the manufacturing equipment has been acquired and delivered to the factory – a condition that has not yet been met.

Action undertaken: Funnily enough they have not been racing to complete the factory. The state government still think its on:

"It has all of the ingredients for great success," Zemsky said. "When that cake comes out of the oven – whether it's in the second quarter or the fourth quarter or mid-2018, I don't know – all of the ingredients are there for tremendous success. That's what I believe."

Hope is not an investment strategy. And the State government is hardly going admit its financing a huge white elephant...a white elephant with very little realisable value:

"By shifting more of the state funding toward the building, the contract amendments have reduced the amount of state money being used to purchase equipment and increased Tesla's obligation to purchase machinery. Tesla – not the state – will own any of the equipment purchased with the electric vehicle maker's funds."

If you never plan to actually open the factory, and your having to ramp it up is conditional on having all the equipment delivered why not just deliver some equipment (that you retain the rights of ownership on) and then sit on it. Do not install it - do not given tours of the factory.... 

Think about what a bad deal the state is giving themselves. Tesla can sell the equipment and leave the state with a huge white elephant of a an empty factory. 

What is the realisable value of an empty purpose built factory in Buffalo? 

Oh and if I were Tesla I would probably look to find a buyer pretty sharpish for that equipment...

Tesla now says the panels produced at the Buffalo plant will be a hybrid product that combines elements of the high-efficiency technology from both Silevo and Panasonic. As part of that deal, Panasonic is investing $256 million in the Buffalo factory, further easing Tesla's financing demands as it gears up for production to begin.

Hybrid product means the Silevo technology is technically rubbish and Panasonic have a better one. The Panasonic deal means another sucker (following the state government) is invested in this project and getting it built. Panasonic has workable technology evidently. What Tesla is doing here is setting up a deal where Panasonic has to buy them out because they will waste enough of Panasonic's money that the sunk costs become unbearable.

Oh and then you can be super clever and paint the deal as a factor slowing the progress on the project.

Smith said he believes SolarCity’s purchase by Tesla and the Panasonic manufacturing arrangement has contributed to delays in opening the factory.

The bottom line is Tesla are not remotely rushing to finish the factory. Otherwise they would be finishing it! 

The reason is making solar panels and selling them is no longer profitable. Tesla know that opening the factory will increase their cash flow drain more than keeping it closed. In the meantime they are hoping to suck Panasonic in to take it off their hands....

You could say this is all conjecture. You would be right. But it is obvious.

Read between the lines. You cannot trust any investment with Tesla written on it. 

Disclaimer: I have a modest short position in(NASDAQ:TLSA) Tesla. These are opinions only, not investment advice. If in doubt read my disclaimer. 

Saturday, 24 June 2017

Grains & Canes; Adecoagro (NYSE:AGRO): Investment Case: Part II

After my qualitative discussion in Part I it is time to explore some risks and the valuation of Adecoagro:



Although the Brazilian Real and the Argentine peso have suffered huge devaluations in recent years the local inflation rates play a part. This means that in real terms with 40% inflation in Argentina for instance costs have been rising in USD as the currency depreciates below that rate.

Adecoagro earns most of its revenues in dollars through commodity exports or in items linked to commodities and dollar prices such as Ethanol. This means the company does better when local currencies depreciate against the USD as it reduces their local costs.

The worst case macro scenario for the company would be a strong dollar driving down commodity prices in combination with also stronger BRL and AR$ rates driving up costs. This is an unlikely scenario and would require particular macro conditions in Brazil or Argentina to prevail that made their currencies appreciate with the dollar.

The debt of the company is split around 3/4 USD and 1/4 BRL:

Company Presentation

Lending in AR$ is essentially only short term due to very negative real interest rates. The debt seems fairly well matched in terms of currency given the domestic exposure to Brazil and predominantly USD derived revenue. Note also Net debt has been declining as the company pay down debt following a major expansion in sugar capacity (some of which is still ongoing.) 

Generally the debt levels are unconcerning to my mind at sub 2x EBITDA. Given that the appraised market value of the companies land holdings alone is $870m and they carry net debt of $600m it is effectively collateralized (but note the debt is mostly for the Brazil plants rather than Argentina farmland). It would be imprudent for a commodity company to carry high financial leverage due to the existing operating leverage and instability of the business. Still they do pay interest in excess of 6% on these debts (in part due to high rates in BRL) although interest coverage was around 3.5x last year which is reasonable especially given that net debt has expanded recently in part to finance the expansion of capacity which is now coming on stream.

Foreign Ownership Rules

Country and ownership rules mean it can be difficult to acquire land or hold onto it. Both Brazil and Argentina have foreign ownership rules and restrictions on land. 

Argentina has foreign ownership rules which restricts individual foreign owners from owning more than 1,000 hectares of land in the core area of the country. These were implemented in 2011. Presently Adecoagro have more than 200,000 hectares of land in Argentina but the restrictions are not retroactive however they do limit the ability of the company to acquire additional land in Argentina. This is however also a significant barrier to entry for competitors (or at least foreign ones) to build scale in the country.

Brazil has similar restrictions for similar reasons although the operations of the company are different there as they lease most of the sugarcane land and are instead more focused on industrial production of sugar and ethanol than actual land acquisition.

Obviously environmental disasters/problems can cause significant problems for production. Floods, droughts etc can mean entire crops are lost. One advantage is the diversity of crops that Adecoagro produce but still their geographical concentration is high. Environmental problems elsewhere can however be a boost due to raised global price conditions for a given commodity.

Is it cheap? How can we value it?

This has been a major headache. The reason being the predictability of earnings is hard as the company is something of a black box - by which I mean beyond say 1 - 2 years who can say what they will be planting - Soy or Corn? and what they will be producing? Ethanol or Sugar? As these decisions are all market condition dependent. This makes it very difficult to make a relevant and accurate DCF model.

This is further complicated by the accounting. Farmland is recorded at book value, crops to be harvested are carried as biological assets and there is a complex cash flow hedge accounting arrangement between the debt and expected revenues. Therefore the earnings look awful at +200x trailing PE! But the best thing is to focus on cash flow in my opinion.

What I can say is I think the stock is cheap for the following reasons:

Free cash flow:

Company Presentation

The company made positive free cash flow last year of $133m ($85m inc expansion capex) following several years of heavy investment and this gives gross and net FCF yields of 10.6% and 6.8% respectively. Note also 6 years of continued strong growth in operating cash flow, with the heavy investment of 2011-2015 in sugar capacity growth which is now operating. 

Remember this positive cash flow growth is during a generally depressed period in agricultural commodity pricing.


As I mentioned in Part I production capacity has expanded greatly in the past 5 years even while commodity prices have tumbled and the stock price has been broadly flat that whole time. So cyclically there should be great latent earnings capacity during a cyclical upturn.

Book value adjustment:

The company has a lot of land recorded at book value especially in Argentina which was acquired cheaply following the 2001 crisis. The book value is $122m -If we take the company's independent land value appraisal of $870m this means the accounts understate the value of the business by ~$750m. Currently the stock has a market cap of $1.2bn and book value of $671m meaning Price/Book is 1.8x but adjusting for this market value would increase book value to $1.42bn making the Price/Book 0.85x. 


Now yes stocks can trade below book value and not be cheap - it depends on the return on assets and the value of the assets underlying the business. But most of the other assets other than the revalued farmland are also tangible ~$500m+ of plant, machinery and buildings (recently built) from the sugar operation and ~$600m current in cash, inventories, unharvested crops and receivables offset by debt and current liabilities. No significant intangibles ($17m), deferred tax balances ($38m assets and $15m liabilities) or other difficult to realise assets.

Now those sugar / ethanol assets are very productive. In the segmental analysis the company notes the following assets in that business; 

2016 Annual Financial Statements

The Sugar/Ethanol segment generated EBIT of $142m last year on assets of $831m ~ 17% EBIT / Asset return. Even subtracting a proportional $40m in interest and taxing that at 34% gives net $67m and would give an ROA of 8%. Now lever that with the $298m of equity in this segment and you get an ROE of 22.5%. 

Note also the ROA +20% in farming but this is really much lower if we adjust the farmland to market value - because farming has low productivity of assets. If we take the farming EBIT of $49m less $10m in interest and taxing at 34% this gives $25m. Divide this by the assets of $245m + $750m MV = $995m and we have an ROA of just 2.5%. Now lever that with the $893m of equity in this segment and you get an ROE of just 2.7%. 

What does this tell us? Well farming has a poor ROE compared to the sugar and Ethanol business. But there are a few important reasons for this:

  • The farming assets are owned outright with very low leverage (adj for market value) hence the low ROE. This is a good defensive strategy for selling commodities as your operating leverage is already high.
  • The Brazilian lands for sugar cane are mostly leased so are off balance sheet driving up the ROA - also industrial assets should be inherently more productive due to greater capital efficiency
  • The Brazilian assets have higher leverage and hence a better ROE (but they are now paying down debt)
  • Remember the farming assets were acquired at very low prices meaning their ROA and ROE base level is extremely high. If we back out the market value adjustment ROA and ROE are 10.2% and 17.5%. This is an unrepeatable feat and is a 'mini moat' shall we say...
Now also remember that sugar pricing has been better in the past few years while grains have remained depressed - so there is cyclical upside in the farming business.

The Bottom Line:

So what is it worth? I will be conservative and say 1x adjusted book value or ~$12 a share (+20% from current levels). This is however not factoring in cyclical improvements in commodity prices and other improvements in efficiency and scale. 

Why 1x Book? Well that seems a fair and conservative price to put on the business assuming one wanted to start from scratch to make a similar business. Given the tangible nature of the assets a low multiple seems warranted but it does also provide some bearing on the realisable value of the assets of the company. 

As a quick excercise combining the two segments of the business we get our pro forma earnings post tax of $67m + $25m = $69m. Now subtract $20m in overhead at 34% tax means ~$56m in earnings. The equity value of the business is $440m + $750 MV adj =  $1.19bn which is a 4.7% ROE. 

I would not pay a lot more than 1x book for a business with a 4.7% ROE - but I feel this could be improved in future by better profitability from improved pricing. Also remember this is the adjusted ROE - if the business actually could revalue the land and release some of that adjusted equity the equity base would be lower meaning a more capitally efficient business.

I can't help but wonder how much the founders have made from this business before the IPO in 2011 - buying up farmland which with improvement is now worth 8x more! However I still see value here for a patient investor such as myself betting on a longer run improvement in commodity prices and happy to take a cash cow option on that for the future which trades below its book value.

Disclaimer: I am long NYSE:AGRO at present. These are opinions only, not investment advice. If in doubt read my disclaimer.

Wednesday, 21 June 2017

Grains & Canes; Adecoagro (NYSE:AGRO): Investment Case: Part I

If you want to find an unloved sector look no further than soft commodities. Agricultural products in particular grains look cheap having been in a cyclical bear market for several years now. With most stocks and financial assets looking decidedly pricey I wanted to set out my investment case for my recent purchase of Adecoagro. 

Adecoagro is a Latin American agribusiness venture centred in Brazil and Argentina. 
The company is a scarce pure play on agricultural commodities as most stocks in this sector gain exposure through fertilizers, equipment or single commodity businesses like Indonesian Palm Oil stocks.

Adecoagro Presentation

Initially Adecoagro was focused in acquiring farmland in Argentina following the 2001 crisis and growing grains. In the past few years the company has expanded strongly into sugarcane and ethanol production in Brazil. 

Why Soft Commodities?

Well as I noted in my thesis on CMP they currently look cheap - soft commodities in particular are in a multi year bear market; Bloomberg Grains Index

Somehow we need to feed the world with a growing population of people. Now obviously over the past century crop yields have achieved fantastic improvements - but structurally more farmland and higher outputs will be required to keep pace with the growth of mouths to feed. Only Africa and Latin America have substantial untapped and underdeveloped land.

Adecoagro has the scale, diversity and capital to be able to change crops to suit market conditions and also to grow the business in the direction of demand. At present they produce Rice, Soy, Wheat and Corn. Aside from grains they also produce dairy. 

However the main business is sugar. They have grown scale in sugar substantially in recent years and much of the cane is crushed by Adecoagro and used for producing ethanol. In Brazil ethanol is a common additive to fuels and is used extensively.

Company Presentation: Ethanol & Sugar production
Now sugar too has been in a cyclical bear market although prices rose substantially last year; Bloomberg Sugar Index

So with generally depressed pricing for their major products how has the share price done?

Well it has been stable, rising about 6% over the past 5 years:

Google Finance
I think the reason for this is that underneath the lower prices for their products Adecoagro has expanded production massively. The underlying volumes and capacity of the company have increased greatly meaning a cyclical turn in pricing could lead to an explosive financial performance:

Company Presentation

Note how production has increased in the past 5 years. Farming area +15%, farming production +41%. Then see sugar planted +109% and sugar crushed up 165%. But sales in farming have been flat and sugar sales up only 58% due to weak pricing. Despite all this the company has improved the EBITDA margin by 710-bps in the meantime. Corporate expenses are down every year for the past  5 years. This to me has the hallmarks of a very good operation.

What is Adecoagro's sustainable competitive advantage?

Agriculture does not lend itself to 'moats' generally due to commodity pricing and high competition. However the company does have a few good resources;

Land is scarce and irreplaceable. 

Good farmland more so. They acquired a lot of land in Argentina after the 2001 crisis when it was cheap. They own most of their farmland in Argentina. Today due to foreign ownership rules enacted in 2011 this would not be possible. 

More recently they have expanded into Brazil where they lease most of their land. The book value of land is presently $122m whilst an independent appraisal now values that at $871m. Adecoagro develop and enhance land that they acquire for agriculture. They tend to sell small portions of the developed land bank each year and acquire new areas.

Farmland in Brazil and Argentina is incredibly productive. For instance the humid pampas in Argentina allow farmers to plant two crops a year due to the excellent growing conditions. This means Adecoagro are a low cost producer - wages are low and productivity is high in these areas. Transport logistics are a headache but in Argentina at least access to the Rio de la plata mean shipping is relatively economical.

Note also that the company itself is a scarce asset. It is highly unusual to find a listed agricultural producer. Most methods to gain exposure to agriculture require investing in fertilizer companies (Potashcorp/Mosaic), seed/GMO stocks (Monsanto) or farming equipment stocks (John Deere.) Most farms are disparate and privately owned - therefore Adecoagro is somewhat unique and unusual as a pure play on Agricultural commodity prices.

Other things of note

Adecoagro also are building scale in sugar and a ready home market for bio ethanol in Brazil. Much of their sugar cane is crushed to produce bio ethanol fuel. Since 1976 the government has mandated that all vehicles must run on a minimum amount of ethanol. Between 20 and 25% of fuels are ethanol based. The ethanol in Brazil is grown from sugar rather than Corn which is used in the US. Sugar is a much more efficient crop for producing ethanol due to the extremely high photosynthetic energy efficiency of the crop.

This means the economics of bio ethanol production are good in Brazil - the ethanol is already in the country reducing transport costs and a ready and substantial home market exists. This is of course government policy and could change but it has been in place for over 40 years.

Ethanol prices generally trade at a discount to gasoline due to the lower energetic content of the fuel - therefore with low oil prices we would expect weaker returns from Adecoagro's ethanol division. 

The company has an all star management team; The venture was originally driven by George Soros and the company was managed by Alan Boyce. Alan Boyce remains on the board today and is an amazing authority on all things agricultural despite having a background originally as a fixed income trader. You can watch his videos on Realvision if you are a subscriber. The company has extensive local directors and a good track record of managing crisis.

The Qualitatively important points

There is so much to say about this stock - the 20F filing alone is a nearly 200 page treasure trove of data. But to my mind the key drivers for the stock will be:

  • Sugar prices
  • Brazilian ethanol prices, demand and oil price
  • Soft commodity prices/ USD strength
  • Localised weather events and yields
  • Argentine & Brazilian macro events

So having established this, is the stock cheap?

Valuation & Risks

Please see part II for my discussion on valuation and risks - coming shortly.

Disclaimer: I am long NYSE:AGRO at present. These are opinions only, not investment advice. If in doubt read my disclaimer.

Monday, 19 June 2017

A quick note on Bed, Bath & Beyond (NYSE:BBBY): How Women Shop...

This weekend I was enjoying The Investors Podcast episode 143 which featured a round table discussion on four stock picks. One of these was a stock I own namely BBBY. As I noted before this is a very cheap retail stock and I like the valuation despite the rise of peak Amazon.

During the podcast it was interesting to hear their discussion on BBBY and the ways in which the margin had declined and whilst it was cheap it was potentially a value trap. Preston Pysh was saying how he would just buy all the things BBBY had on Amazon. At this point I paused the podcast and had a chat with my lady about this - and it is something i mentioned in my original note on BBBY:

 'I think retailers with things like clothes, home-wares, furniture etc have a greater chance of survival against total 'e-commercialization' due to the tactile nature of their products.'

The way women shop is different from men. These men think like me - I want a specific thing - I go on Amazon and order it - it saves hassle and is usually cheaper than driving to a store. This fails to capture how women shop. Women want to go and browse things, smell them, sense them etc - my partner declared she would never buy a towel or bath accouterments online as she wants to feel them first and check the colour in person.

Funnily enough on resuming the podcast it turns out that everyone's wives do shop there too! If you do not already follow this podcast I highly recommend it to any would-be value investor - it is a great moment in the this episode....

So I retain the view that whilst BBBY is ultimately a 'no moat' business the fact that most of their customer base are women means it is more likely to survive in physical format than an
electronics retailer. I still see this as a cyclical downturn in the US economy as much as it is a structural change in retailing.

Disclaimer: I am long NASDAQ:BBBY at present. These are opinions only, not investment advice. If in doubt read my disclaimer.

Monday, 12 June 2017

Compass Minerals International (NYSE:CMP): An alternative play of Agriculture: Part II

So I have covered my qualitative thesis on CMP in Part I - now I want to talk a little about valuation.



Debt is high in CMP - it looks very high against current comps at 65% of capital and 4x EBITDA but this only captures one partial first year of Produquimica in the equation and the full balance sheet year end debt.

However debt levels are still high. CMP were downgraded one notch by Moodys to Ba2 following the acquisition due to the elevated debt levels of the company. They have bonds totalling $500m issued in the market but funded most of the acquisition by expanding their revolving credit facility. Some $130m is due for repayment/refinancing this year but most of the credit is not repayable before 2021 so there is decent headroom to pay down debt and drive up profitability in the meantime.

CMP Annual Report 2016
The total debt load means interest payments should be north of $50m this year alone. The company has a reasonable ability to generate free cash flow but a lot hinges on the success of Brazil and firmer salt prices. You can carry this kind of leverage in a utility (i.e a stable business like salt) but it is dangerous in a cyclical commodity stock which CMP is becoming.

Amiable Minotaur CMP Model - Net Debt & ROE projection

With reduced Capex expected in 2017 down 25% at ~$130m there should be decent free cash flow generation to pay down some debt whilst still maintaining the dividend.


The dividend from CMP is high for a US company. They do not buy back stock instead they pay a dividend which was $2.76 a share last year with a yield of 4.2% that is quite high. The total cash payout was $94m in 2016. The risk is FCF generation is too low this year and that dividend gets cut. It is generous anyway but a cut in the dividend could seriously harm sentiment toward the stock despite not changing its real intrinsic value. On the other hand should it be maintained the chance to own an option on higher fertilizer and salt prices from cyclical lows, that pays 4.2% a year, seems quite attractive.

Amiable Minotaur CMP Model - EPS/DPS history and estimates

Honestly I think they should halve the dividend and pay down some debt for three years even as an equity investor. I don't think they will though due to the signalling.


Not a big risk. They have a legacy defined benefit scheme in the UK but it is fully funded (albeit with a slightly high discount rate around ~3.8% - high for the UK anyway) -  the total liability is relatively small at $60m or so. Therefore pension blow up risk is muted.


The current picture for margins is slightly problematic. The company discloses an EBITDA margin in Salt of  25% last year and it has been steadily improving despite cyclical weakness. In North American ferts the margins are disclosed as 28% for 2016. The South American margins are much lower at 18.8% last year diluting the combined ferts margin proforma to 22%. So from a margin perspective the Brazil acquisition is not immediately accretive. There may however be significant improvement in future from synergies and best practices. 

Generally I should note the history of CMP is one of excellent capital allocation with 10 year median ROIC at 13.9% so I feel they have a good track record of growing by acquisition and organically.

The Valuation:

I see a tough year in 2017 for CMP trading at around 21x PE due to weak salt pricing and low margins in Brazil following the acquisition. So near term it looks a little expensive but looking further out on my DCF and DDM models I see good upside with price targets of $114 and $75 respectively. Ultimately I think CMP is worth around $80 a share without cyclical improvements in fertilizer prices and with a slight recovery in the salt segment pricing in the high debt risk to that DCF valuation.

[My assumptions are a Ke of 6.7% (RF 2.5%, RP 6%, Beta 0.7) and a Kd of 5.5% pre tax giving a WACC of just 5.17% - which accounts for the lower target price on the DDM despite the relatively high payout ratio. DDM growth rate was 3%]


Therefore I think CMP offers reasonable upside of 20% to fair value with a 4% yield and potential as a leveraged option to higher fertilizer prices and better than expected synergies with Brazil. I like the macro positioning, annual share price depreciation to date, decent moats in Salt and SOP and a stable dividend.

From a Porfolio perspective this adds exposure to a new sector; Basic Materials, it has diversified economic risk across North and South America and it has exposure to the agricultural cycle which none of my other investments presently do.

Disclaimer: I am long NYSE:CMP at present. These are opinions only, not investment advice. If in doubt read my disclaimer.

Sunday, 11 June 2017

Compass Minerals International (NYSE:CMP): An alternative play of Agriculture: Part I

Compass Minerals International is a basic materials company whose principal products are rock salt, sulfate of potash and associated fertilizers. The company has been historically focused in salt mining particularly for winter roads both across the US, Canada and the UK. They also produce sulfate of potash which is an essential fertilizer for various fresh fruit and vegetable growers as bulk potash is too acidic. Most recently CMP acquired ProduquĂ­mica in Brazil adding a wider array of fertilizer products to their portfolio.

In essence:

My view is that CMP is undervalued even at present product prices due to a weak cycle in salt sales in the past few years due to warm winters in North America. I consider the agricultural commodities space to be at the bottom of a lengthy downturn. Therefore upward revisions to my current relatively flat pricing for CMP's commodities would indicate substantial upside to fair value for the stock.

Why do I like CMP?

What I like about CMP is that it has a simple business. Dig stuff out the ground and sell it to people. Now what is sells are commodities. Commodities are by their nature things which are usually fungible and undifferentiated. Therefore if you want to sell a commodity the best position to be in is the low cost producer. If you can sell said commodity for less than everybody else then when the price of that commodity fluctuates and moves down the cost curve you can still make a profit selling it. Some examples of low cost producers; Australian Iron Ore ops (Rio & BHP), Canadian Potash (Potashcorp), Middle east onshore oil (Saudi Aramco) or Chilean Lithium (SQM).

[Now I should add that sometimes if you have a strong view on a commodity it is best to own marginal producers as they can have an equity value of zero at lower prices but being further up the cost curve they act like call options due to the much greater leverage to higher prices of the commodity in question. However in uncertain times looking through the cycle it is better on average to own the low cost producer]

CMP appears to have two key areas where it is a major low cost producer (a) Salt (b) Sulphate of Potash.

The Goderich salt mine owned by CMP in Ontario is the world's largest rock salt mine. The mine has therefore the advantage of great scale, a deepwater port on the Great Lakes and geographical proximity to the principal areas on the US and Canada requiring salt for deicing roads in areas like Ontario, Quebec, Michigan, Illinois, New York etc. 

CMP Annual Report 2016

What this means is CMP enjoys access to a unique asset despite selling a commodity. Therefore they have significant barriers to entry - salt is heavy so costly to import and CMP have vast scale within easy geographical access of their major markets. It would take a foolhardy competitor to try to disrupt that business as the necessary scale to compete would be hard to achieve. There is little pricing power for CMP in salt sales but they have an advantage in scale to undercut competitors. Therefore in road salt in North American I think CMP have a sustainable competitive advantage. 

The salt business is relatively low margin but is stable generating good cash flow - this is the 'cash cow' business of CMP although recent developments make it less significant than it has been historically. 

CMP Annual Report 2016

Whilst demand for salt varies due to the preceding winter as municipalities stock up their supplies before the coming winter. For as long as North America has cold winters and cars need to traverse the roads there will be demand for rock salt. CMP has other Salt mines in Louisiana and the UK but these are less significant in the overall picture although the UK Salt mine at Winsford in Cheshire is also the largest salt mine in the UK.

Cyclically in North America rock salt is not doing well at the moment. Several years of warmer winters mean that customers already have large stocks of salt and Q1 sales figures were not strong for the segment. However everything is cyclical - one or two colder winters could easily see an moderate upturn in prices and volumes. The weak Q1 sales seem baked into the current valuation to my eyes.

CMP is also the largest producer of Sulphate of Potash (SOP) in the western hemishere. 

SOP sells at a premium to Muriate of Potash (MOP) because it is more expensive to produce being less of a bulk commodity (only around 10% of Potash used globally is SOP). MOP is used for bulk crops like Corn whereas SOP is used for higher value fresh produce such as nuts and fruit due to the fact that it doesn't contain Chloride which damages crops like Tobacco and Tomatoes.

CMP has a salt facility in Ogden, Utah which produces SOP from salt flats. CMP lease the land from the State of Utah and use solar evaporation to extract SOP and Magnesium Chloride from pools of natural brine. As you can imagine this is a low cost operation as the sun does most of the work. 

[As a side note I am familiar with a similar operation in Chile being the salars of Sociedad Quimica y Minera de Chile (NYSE:SQM). SQM's salars also contain Lithium which may explain why that stock trades at such a premium to CMP - Lithium is a 'hot' idea at the moment due to its use in batteries. However people need to be aware that Julio Ponce, the controller of SQM, has serious longstanding problems with the regulators due to allegations of securities fraud and the company has a not inconsequential risk of losing its licenses to operate the salars in the Atacama. Unfortunately I think ETF based strategies do not really price this in.]

But I digress, the point is CMP has access to a unique resource in Utah because most SOP is expensive to produce requiring chemical facilities to add sulphuric acid to MOP. Therefore again CMP has a sustainable competitive advantage in its cost of production furthermore 92% of their SOP is sold within the US meaning lower distribution costs keep them competitive against imports. They are the only producer of SOP in North America. At present the strong dollar may be making imports more attractive but this is a cyclical factor - when the dollar weakens commodity prices tend to rise driving up the agricultural cycle. Most global SOP capacity is in China but much of that is not exported - CMP face import pressure from Chile, Germany and Belgium.

The market for SOP is less exciting than say Lithium and with a decent track record of harmony I see no reason why CMP would lose their leases on the salars in the near future. However it is noteworthy that this lease is renewed annually and all CMPs other assets have long leases or are owned outright.

The recent major development for CMP was the acquisition of the Brazilian agricultural supplier Produquimica. 

This company produces a variety of fertilizer products for the agriculture industry in Brazil. To my mind the timing of acquisition is positive for CMP by purchasing during depressed conditions in both the Agricultural industry and Brazil itself where the Real is very weak against the dollar at the moment. 

CMP Annual Report 2016

Produquimica offers CMP a wider product portfolio of specialized fertilizer products and alongside chemical mining facilities. There is therefore ample opportunity for cross pollination of products and extraction processes between the two businesses although the geographical / production synergies are limited. The acquisition seems like an attempt at vertical integration and a bit like horizontal integration as there are similarities in production but differences in sales channels between Produquimica and CMP. The acquisition is kind of bolt on which I quite like as it is easier to digest than a full on merger type job where the apparent synergies later evaporate. This may be a good acquisition for CMP if they can keep the associated debt under control (see Part II).

Why do I think the Agricultural sector could offer cyclical upside?

Well this chart has been doing the rounds;

Incrementum AG

What this tells you is that commodities are cheap relative to financial assets. Therefore the theory is that a reversion toward commodities being revalued upward would favour or at least be hedged by a financial asset (stock) which produces said commodities. As we saw in the Agriculture space in the 2007-2013 period of significant turmoil and monetary expansion.

Now I could be wrong but generally commodities follow cycles - prices are high, people plant more crops, there is a surplus of crops, crop prices fall, people plant fewer crops etc. And when they plant they use fertilizer.

CMP Annual Report 2016

Now Wheat prices are down since 2013 from $800+ a bushel to ~$440 today, Corn prices down from $700+ to $380 today, Soybeans down from $1600 to ~ $940 today. Go and look at the some point the prices of these commodities will pick up... we have a growing population the world over but presently a strong dollar is preventing commodity price rises. This may change as with any cycle and when it does CMP is well placed to ride a cyclical upturn in the industry. My thesis is agriculture is presently in something close to a depression - one of few sectors globally that looks genuinely cheap. 

I tend to focus on cheap sectors/countries to screen for stocks I might want to own. Much like my recent foray into gold miners.

Note: above I said CMP sells SOP not MOP which is not used for bulk commodities like Wheat and Corn but generally SOP sells at a premium spread over MOP as most producers have to add a chemical process to MOP to make SOP - therefore Compass can piggyback on that spread with their production.

So that is my qualitative thoughts on CMP. I think it has some sustainable competitive advantage from low cost operations and geographical positioning (hence a 10 year median ROIC of 14%). I think there is cyclical upside in the fertilizer space from an improvement in commodities and there is also some limited upside longer term from a series of colder winters in North America to firm up salt demand. 

In Part II I will look at why CMP offers an attractive valuation from a bottom up perspective.  

Disclaimer: I am long NYSE:CMP at present. These are opinions only, not investment advice. If in doubt read my disclaimer.

Friday, 2 June 2017

Portfolio Strategy: Gold Miners

Well investment of the portfolio continues slowly due to the generally expensive market conditions and my attempts to add to positions slowly and maintain the optionality of cash.

As noted in my view of Gold I perceive the yellow metal may presently be a decent defensive holding. My most recent shopping has been in the Gold Mining space where I have purchased holdings of four different miners to complement my holding of the GBSS physical gold ETF. 

Why 4? Well generally I want to encourage concentration in stocks as per my manifesto. However in this area the stocks tend to have quite significant specific risks, especially junior miners, due to the political climate, structural issues, ore grades, processing failures, mine failures etc. Hence diversification may have more benefit for this particular class of stock.

I will add a little colour on each investment:

Acacia Mining (LON:ACA): As noted in my research note I feel this company is currently suffering a temporary political setback and is oversold. Acacia has some good quality mines in Tanzania with decent cash costs and some interesting exploration projects. I note that today the company has put out another press release reaffirming annual production guidance and stating they expect resolution of the export issue shortly. If this issue is resolved with a relatively minor financial settlement or impact I expect the stock to rapidly rerate perhaps above the GBP4.00 level it previously traded at prior to March.

Goldcorp (NYSE:GG): I bought Goldcorp shares due to my generally positive outlook for gold. Goldcorp is the 4th largest producer in the world and it has lower AISC than Newmont and Anglogold Ashanti. Furthermore I do not want to own South African producers due to the deteriorating political climate for the economy and the mining industry (yes Acacia is in Tanzania - but it already priced in a large discount). I could own Barrick but i think Goldcorp is better managed having made fewer large acquisitions during the previous up-cycle.

GoldCorp Presentation

Goldcorp benefits from a range of projects spread across generally 'favourable' mining regions from a geopolitical perspective with all production in the Americas. Chile and Canada which are supportive mining environments, Mexico is ok too and Argentina is improving. Essentially this is a large cap play on Gold. There is less upside here than some of the junior miners but also a much stronger balance sheet to support the company through this protracted downturn. The 'Coffee' project in the Yukon could provide a nice sweetener depending upon development results.

The next two are essentially more speculative, but small positions:

Klondex Mines (NYSE:KLDX): This is historically a small operation based in Nevada. In recent years they have expanded buying up projects local to their existing mill and a further development in Canada. Production has been increasing off the back of this and synergies exist amongst the portfolio of mines in Nevada. Whilst AISC is over $1700/oz this is in part due to the high cost 'True North' mine in Manitoba which is being redeveloped. The stock is cheap but has production and generates decent cash flow.

This is something of an option on higher gold prices and I consider it speculative but not so speculative as an explorer with no production or cash inflow. The stock has been a poor performer this year in part due to liquidations from the structural issue at the Junior Gold Miners GDXJ ETF - This presented an opportunity to purchase the stock at an attractive price.

Kirkland Lake (TSE:KL): Somewhat like Klondex this is a Junior miner focused in Canada and Australia - again 'safe' mining areas. AISC guidance is below $900/oz for 2017 and the miner is expanding production. In terms of market cap it is a similar size to Acacia so again a mid-cap miner. The Macassa mine in Ontario is particularly high grade and the company derives around 40% of its total gold from that deposit with total production split 60/40 Canada/Australia. Add to this a good cash position, development projects and decent free cash flow generation.

KL Presentation - Outlook 2017

Some positive signs are the initiation of a tiny dividend in Q1 (C$0.01), a buyback programme - as the board feel the company is undervalued - and a significant recent purchase totaling C$10m by legendary precious metals investor Eric Sprott who is the chairman and owns 10% of the shares:

In a specialized industry like mining I consider insider purchases to be important indicators about the potential of favourable future developments. This is because the board will know of preliminary feasibility results ahead of the market. 

(Incidentally one of the only industries where insider purchases can be a negative sign are banks - this is because they are in the 'confidence' game to assure no bank runs and continued survival - quite a gamble.)

So there you have it - 4 Gold mining positions in a month. I think I will hold my gold positioning there for now as Gold and Gold stocks form 19% of the portfolio. I want to avoid more than 20% in any one stock - as per the manifesto - and I think I would like to avoid more than 20-30% of the portfolio being in one idea - i.e Gold - so will hold off additional purchases for now in the Gold space. 

Note I have broken my manifesto rule of 3 stocks per sector now with these 4 miners in one space but given the small size of each position and need for diversification I am comfortable with this. Depending on outlook/performance I may consolidate down to 3 holdings in the medium term.

The portfolio presently is 38% invested in equities, 11% Gold Physical ETF, 3.5% bonds and the residual GBP cash:

Amiable Minotaur Portfolio

So in chart form we can see how the portfolio is still heavily weighted to cash as each of the new Gold mining positions are all <2.5% of the portfolio:

Amiable Minotaur Portfolio

Interestingly I am quite diversified internationally but weighted towards developed markets in general. I have tried to adjust these measures for country economic exposure rather than necessarily the market where they are listed:

In terms of sectors Gold Miners now form my 2nd largest sector exposure in equities after Retail followed by Energy, Banks, Utilities and Financials:

That is the current positioning of the portfolio. These additional positions give my current equity count of 13 stocks with a total of 15 active positions if we include the Gold ETF and my bond holding in TLT. Both measures are below my 20 suggested stock portfolio limit.

Since inception we are down around 1-2% despite a slightly rising market in principle due to the cash drag, costs of FX fees/dealing and the poor performance of the energy sector. 

Disclaimer: I have an interest in all the securities mentioned in this article at present but i may change these in the future. These are opinions only, not investment advice. Construct your own portfolios with due care and attention.  If in doubt read my disclaimer.