“Capital Returns” is an edited collection of investor letters from UK based Marathon Asset Management. Before reading the book,I actually didn’t know much about Marathon.
On their website, they summarize their strategy as follows:
At the heart of Marathon’s investment philosophy is the capital cycle approach to investment. It is based on the idea that the prospect of high returns will attract excessive capital (and hence competition), and vice versa. In addition, an assessment of how management responds to the forces of the capital cycle and how they are incentivised are critical to the investment outcome.
This capital cycle approach is very interesting. As mentioned above, the book has no direct narrative. The investor letters are however clustered together in chapters with similar main topics:
Capital cycle, sectors (automoblie, commodity, cod fishing, beer, oil)
Growth (Colgate, Geberit, Intertek, Amazon, digital moats, Rightmove, Baidu)
Management (incentives, pro cyclicality, capital allocation, Sampo, Scandinavia, family ownership, Richemont, management meetings, culture)
Crisis (Anglo Irish, securitizations, private equity, Spanish property, German banking, Northern Rock, Handelsbanken)
After the crash (Spanish construction, Bank of Ireland, PIIGS, low interest rates
Funny “Greedspin” Christmas letters
The book is not so easy to read because the letters themselves, despite very well written, are very condensed with a lot of deep insights. I always had to take a kind of a mental break after one or two letters in order to digest everything
Overall, I would characterize their approach as follows:
International with an European focus
generalist approach, all sectors, differenent business models
transformation from “cheap” to “quality” over the years
they also invest into financials
the invest relatively diversified
Essential personal learning experience
The main take away for me was that their supply focused capital cycle model enabled them to see and avoid many of the problems (CDOs, housing, commodities, PIIGS, China) well in advance. Most analysts focus on the demand side only and forget about supply.
This is something to keep in mind for the future. As a bottom up investor, I think their approach can improve decision making without going into useless macro analysis. If you just look at single companies, one might miss some of the overarching issues in the sector (TGS Nopec…..).
Marathon Track record
The question always is: Talk is cheap, how about their returns ? At least from their website, it seems that their funds made 3-5% outperformance p.a. constantly on a 3, 5, 10 and 20 year basis. This is very remarkable for a manager with a couple of billion under management.
For me it was also interesting to see that they not only share many of my personal opinions about investing, but that there is also a nice overlap of companies I find interesting and what they found interesting, for instance Lloyds Banking, Admiral, Handelsbanken and Koc as a well managed family owned company. Clearly there is some “confirmation bias” at work from my side, but still interesting.
Overall, the book is an essential”MUST READ” for any investor. The major drawback is that it is currently only available as hard cover at around 37 EUR.
Following the E.On discussion, I really asked myself if it was such a good idea to invest into Greenlight Re.
My argument was as follows:
the stock looks historically cheap
Einhorn had a few very bad years
based on its track record hw might do much better in the future
After the E.On discussion however, I recognized the follwoing: Whenever I looked at a stock that Einhorn bought (Delta Lloyd, AerCap, SunEdison, Consol, E.on), I never understood why he did it or I thought it was not a good idea. Even if I look at his 20 bigest disclosed positions, I don’t find any stock that I would buy on my own:
APPLE INC AAPL US
GENERAL MOTORS CO GM US
ISS A/S ISS DC
CHICAGO BRIDGE & IRON CO NV CBI US
TIME WARNER INC TWX US
MICHAEL KORS HOLDINGS LTD KORS US
AERCAP HOLDINGS NV AER US
CONSOL ENERGY INC CNX US
ARKEMA AKE FP
AECOM ACM US
ON SEMICONDUCTOR CORP ON US
BANK OF NEW YORK MELLON COR BK US
TAKE-TWO INTERACTIVE SOFTWR TTWO US
GREEN BRICK PARTNERS INC GRBK US
MICRON TECHNOLOGY INC MU US
MARKET VECTORS GOLD MINERS GDX US
VOYA FINANCIAL INC VOYA US
LIBERTY GLOBAL PLC-SERIES C LBTYK US
DILLARDS INC-CL A DDS US
APPLIED MATERIALS INC AMAT US
That in effect lead me to the conclusion that I am most likely the wrong kind of shareholder for Greenlight Re. If things go really bad, I am not sure if I would have enough trust to keep the position or if I would get really nervous because I could not identify with the manager.
Secondly, I honestly don’t have much insight, how Einhorn generated his fantastic past track record.
Together with not liking his long position, I think it was a mistake to invest in Greenlight and I sold my stocks as mentioned in the comments at around 18,45 USD per share with a tiny profit of around +2,5%.
It could well be that Greenlight maybe has a spectacular 2016 but as I have mentioned above, one should not allocate money to someone where you don’t understand what that manager is doing. Conviction is important to withstand all kind of behavioural traps in investing.
Following the market turmoil, I began to establish a first (2%) position in Handelsbanken. Purchase price was on average ~98 SEK per share. Valuation wise they are now at a level where I would expect to earn around 16-17% p.a. long term which looks atractive to me despite potential short term head winds.
I plan to increase this to a full position over the next months. I funded this position by selling some of the HT1 bonds, as I want to keep some cash (~10%) in order to be flexible if some of my watch list shares become really cheap.
funnily enough, he accuses index funds that their only goal is to “attract more funds” at low costs. Why did Ackman then create the public vehicle Pershing Square Holdings ? Well, he also wants to attract more fund but a high costs.
he thinks that there are not enough activists. Understandable from an activist perspective. Subjectively I have the feeling that Carl Icahn alone is activist at every single stock in the US.
at least he admits that “platform” companies like Valeant are not such fantastic cases per se.
On a personal level, I do think there might be already TOO MANY activists. Many of them only care for short term payouts which, in many cases, might not be benefitial for long term share holders.
All in all, if I would have money invested with Ackman, I would really ask myself if I would trust a guy who only blames others for his misfortunes.
As this has turned out to be a very long post, a quick “Executive Summary”:
David Einhorn has published that German utility E.ON is one of his major new long positions. Based on what I have written in the past about E.On, I do think his summary investment rational has some serious flaws, mainly:
buying management’s “spin” that the recent share price decline was only caused by uncertainties about nuclear provisions
assuming a quick and very benefitial (for E.ON) solution for nuclear liabilities
To me it looks like that he tries to come up with some short term, rather risky “bets” in order to make good on his horrible 2015 performance as quickly as possible.
As a new shareholder in Greenlight Re I have to seriously rethink if I want to stay invested, however as a German tax payer I might also be biased in this case.
This is a clearly a first for the blog: A movie review and not a book review.
I had read the book from Michael Lewis a couple of years ago and it was clearly the best of many books trying to explain the sources of the “financial crisis” 2008/2009.
Honestly, I could not imagine how you can make a Hollywood movie out of this book.
The story is mainly about a couple of fund managers who discovered at the same time around 2006/2007 that the US mortgage market was deeply flawed especially in the subprime area and that it was only a matter of time until everything would break down.
Most of those fund managers were “ousiders”, so not mainstream super star hedge fund managers but strange guys like Michael Burry, the now famous medical doctor turned fund manager with the Asperger Syndrom or the 2 guys who founded their fund as students with 100k start capital in a garage.
Another important role was played by a Deutsche Bank investment banker Greg Lippmann (in the movie the guy is called Jared Venett) who tried to sell the instruments to bet against sub prime mortgages.
Overall I found the movie extremely entertaining and very good. Why ?
First of all the actors are really really good. Especially Christian Bale (M. Burry) and Ryan Gossling (DB trader) play extremely well.
Secondly, the movie gets surprisingly almost all the facts right. They do explain the underlying concepts very well and often in surprisingly funny ways. One of my favourite scenes is when Selena Gomaz and Richard Thaler explain the conceptof CDS/CDOs at a Las Vegas Black Jack table.
Of course they made some compromises to turn it into a Hollywood movie. Nevertheless I do think that the movie actually shows a pretty acurate picture of investment banking back in the heydays of 2006/2007.
Best learning experience: negative carry & patience
Of course the characters in the book and the movie were not the only ones who predicted the subprime crisis. Back then a lot of people were sceptical with regard to mortgages banks etc.
But I think what the movie really showed was how difficult it is to actually bet significantly on a “doomsday prediction”. Betting against subprime CDOs required those guys to pay signifcant amounts of “insurance premium”. In Michael Burry’s case, the “negative carry” was something like -20% p.a. for the full portfolio. In all cases the managers were not credit specialists and investors clearly didn’t like what they saw at first and in Burry’s and Iceman’s case tried to force them out of their positions because very few people are willing and able to sacrifice yield in order to make big returns.
And I do think that this is the main lesson form the book and from the movie: It takes a lot of guts and a kind of “outsider” status to actually be succesful when you bet against the overall consensus. Talk is cheap, actions matter.
The second lesson was that patience also plays a big role in actually scoring big. All the portrayed fund managers were early with their trades and the position went against them at first. In Eismann’s case all his partners for instance wanted to sell quickly after they were back in the green, but he insisted on waiting.
Another good example of this rare persistence in adverse situation was Bill Ackman who at the same battled mortgage guarantee company MBIA on their role within suprime mortgage business. Hi fought them over years until he had finally his big pay off. There is a good book about this story as well, “Confidence Game”
So my recommendation for anyone at least partially interested in finance is clear: Go and see the movie !!!!
I actually think the movie should be a mandatory part of any finance course at schools and universities like the original “Wall Street” movie.
Imagine you could invest into a company with the following characteristics:
– Global market leader with 70-90% market share (95% new built)
– Net margins after tax of 50% or more
– business protected by patents
– almost no capital requirement, negative working capital
– a potentially huge growth opportunity
– conservative balance sheet (no debt) and “OK” management
– at a very reasonable price (11x P/E, 7,8% dividend yield)
At a first glance, Gaztransport et Technigaz (GTT) from France seems to be the ideal cheap “moat company”. What do they do ?
Gaztransport is the global leader for “LNG containment systems”. LNG is liquified natural gas and is the predominant method to transport natural gas over long distances. In order to become liquid, natural gas has to be really cold,at least -162 degrees celsius. GTT’s technolgy is required to safely store and transport LNG on ships.
Problem Number 1
Before going into more details, it is pretty clear that GTT is an energy related company. But looking at this chart from their investor presentation we can clearly see what the real problem for GTT is:
Ultracyclical sales. We can see that within 4 years sales dropped -75% only to quadruple again in the next 4 years. Although the overall strength of the business model clearly shows in the fact that even after a -75% drop in sales, they still earned a 30% net margin.
So what do they actually do (The Moat) ?
Gaztransport has been IPOed in 2014 in France (although it was technically more a “carve out” as the company itself did not need any money. They have extremely good English language investor material, for instance the Q3 2015 report.
I try to summarize their businessin my own words:
– if you want to build ship to transport LNG, there are effectively only 2 technologies available to ensure that the LNG is contained safely, one of them is owned and patented by GTT. From inside it looks like this:
– there is a relatively large moat with regard to technology. GTT has developed that technology over the last 50 years or so and it is superior to the only competitor (“Moss”), both in price (for the total ship) as well as in utility (ships are lighter, easier to maneuver, overall cost is cheaper)
– GTT charges royalties, both, for the technology and “consulting” during the building of the ship. After the ship is finished, there are no royalties. Service is currently only a single digit percentage of sales
– Sales therefore directly depend on the number of LNG tankers being build
So the future of GTT clearly depends on the future of LNG. More LNG means more ships and more money for GTT and vice versa.
The Moat vs. new competitors
There are potential new competitors, mostly the handful of Korean companies who actually build the ships. The Koreans for some time now try to develop or copy their own version of the technology. I assume that they clearly know how much money GTT makes with the patent and that they woul love to cut GTT out of the process.
GTT themselves think that the threat is not so big in the near future. The ship certification companies would need to approve first as well as the oil companies who are finally responsible for the LNG tankers and the administrators of any harbour or docking station.
So far in the 50 year history both, Moss and GTT have a 100% safety record with no accidents. The cost for GTT technology within the overall price of a LNG tanker is around 4-5% of the total constructon price. So the question is really why should any energy company take on the risk for a new unproved technology when the potential cost savings are pretty low ? LNG Tankers do carry the equivalent “firepower” of dozens of nuclear bombs, so risk aversion is pretty high especially in developed world harbours.
The LNG market
There is a lot of material on LNG but most of them are very optimistic, some links:
– LNG is considered “clean fuel” compared to oil and coal and should benefit from climate issues
– Natural gas is abundant and in many cases cannot be transported via pipelines
– A lot of the natural gas comes from “stable” countries like Australia and the US and is therefore strategically interesting
But clearly, low energy prices take a toll on LNG as the liquification, transport and regsification are expensive. A year ago I looked at Seth Klarman’s investment Cheniere Energy and I was not convinced. However a lot of money has been now invested into liquification facilities especially in the US and Autralia, so it is not unlikely that the amount of LNG to be transported might rise as projected and the need for transport and storage increases.
So just some rosy LNG projections alone would not be enough to make GTT interesting for me.
As ships get bigger, the pollution is getting worse. The most staggering statistic of all is that just 16 of the world’s largest ships can produce as much lung-clogging sulphur pollution as all the world’s cars.
Because of their colossal engines, each as heavy as a small ship, these super-vessels use as much fuel as small power stations.
But, unlike power stations or cars, they can burn the cheapest, filthiest, high-sulphur fuel: the thick residues left behind in refineries after the lighter liquids have been taken. The stuff nobody on land is allowed to use.
In the meantime however, stricter requirements for ship fuel have been installed. Current caps are mostly effective in Europe and North America, but starting 2020, globally much tighter rules will come into effect.
There are several possible solutions to the problem:
– using cleaner fuel which is however more expensive and limited
– cleaning the exhaust with expensive technology
– use LNG as alternativ fuel
If LNG would become popular in the future, GTT’s technology would suddenly be required everywhwere, from every port and every big ship, which would mean much more steady business than in the past and a strong structural growth over many years.
However, at current prices this is far from a sure thing, so in any case as an investor I would not want to pay for this at the moment.
For an energy stock, GTT has held up quite well since their IPO until late 2015 but then got hammered, howevr as we can see less than TGS for instance:
How to value GTT ?
The problem is the following: GTT is a cyclical company and we are most likely at or near the top of the cycle with regard to the “core” business. One could argue that with an overall size increase of the LNG tanker fleet, the replacement requirement increases but with an expected life of around 40 years, the replacement cycle for the current fleet is a long way off in the future.
So using current profits and saying” Wow the stock is cheap” clearly doesn’t help. Comparing it for instance with a less cyclical stock like G. Perrier and saying: 11x PE is better than G. Perriers 15x PE is nonsense.
As I said before, I would not be willing to pay for the “Option” of LNG powered shipping so I need to come up with a way to value the company based on the cyclicality of earnings.
So what I did is that I tried to “simulate” future earnings with roughly the same kind of cyclicality that we have seen in the past 10 years. This is the resulting “Model” for the next 35 years:
I have “modelled” somehow similar cycles as the current one, with the peaks increassing first and then trailing of somewhat in the future.
We can then discount this cyclical earnings stream by our “required rate of return” to see if GTT is a real bargain or not.
Under those assumptions my results were the following:
10% discount rate: 20,80 EUR per share
15% discount rate: 14,26 EUR per share
So now one could clearly challenge my “model” and tweak it somehow, but in general it looks like that GTT is not a bargain at current prices (34 EUR). To me it rather looks like that the current valuation already implies a certain value for the LNG ship fuel “option”. Therefore GTT at current prices is not interesting to me as an investment.
One important learning experience for me is that I guess one should value all cyclical stocks like this, i.e. really model the cycles and discount those cashflows instead of just looking at current multiples and say “wow that’s cheap”. I think I made that mistake to a certain extent with TGS Nopec.
Overall, GTT is a very interesting, unique company. It combines a “wide moat” with regard to technology and patents with a very cyclical business.
Although the company looks cheap at current multiples, over the cycle there is more downside than upside at current prices in my opinion.
If LNG will become the dominant fuel for ships in general, than the investment case might change significantly to the upside but for me this is not given at current energy prices.
In the future, I will need to analyse and value cyclical companies the same way as I did here: With actually modelling cycles instead of (implicit) constant growth assumptions.