More Gains from the “Gilded Class” — New Frontier Trader

by Travis Johnson, Stock Gumshoe | April 28, 2009 1:01 am

We started looking at this ad for Alexander Green[1]’s New Frontier Trader[2] yesterday, sniffing out that the Latin American telecom poised for huge gains was America Movil[3] … now, to take a gander at the other two.

The big spiel here is essentially an argument for foreign investing, though more specifically the claim is that the “new gilded class” will be pumping $50.7 billion into these companies by April 29.

I won’t argue about the numbers or dates — America Movil is on the verge of reporting their results today, April 28, and we can see then if they’re looking great for the near future … but all three of these companies are huge, multinational firms that probably represent a bit less risk than some of the wild flyers we talk about in this space from time to time.

But what the “gilded class” stuff is about is just … the middle class. The argument is that the new consumer middle class that’s emerging throughout the developing world will be the real engine of growth, pouring money into the companies that provide the goods and services they need. If you’d like the general overview of this “emerging middle class” argument, one of the articles they quote is from the economist, you could do worse than a quick read of that article here[4].

So if this new “gilded class” is going to make us rich, let’s find out how, shall we? We looked at the first teaser for America Movil already, and now we’ll take a look at the second and third.

“Frontier Play #2: Asia[5]’s Electronics Boom

“Expected Gain: 439%

“Consumer demand for new electronics is soaring in frontier economies throughout Asia. Companies like Samsung, Sony, and Panasonic are rapidly opening new factories in places like Vietnam[6] and Malaysia.

“But they have a problem… and it’s costing them a lot of money.

“The electronics they produce require top grade galvanized steel. And the frontier economies they’re expanding into just don’t have it. They’re wasting billions importing quality steel.

“Enter our second Frontier Play. This Asian steel producer, renowned for its high quality steel, just acquired the only company in Malaysia currently producing galvanized steel sheet. They now control 100% of the local supply to the big electronics firms in Malaysia.

“Vietnam is their next target. They’re planning a huge $1 billion steel mill. Once completed, they will be the largest steel producer in the country.

“So how are they keeping the rest of the competition out?

“For one, their operating costs are 20% lower than the rest of the industry. Second, they have $15 billion in cash earmarked for expansion. And finally, they’re turning a huge profit – $4.6 billion in 2008.
With the rest of the competition playing catch up, expect this company to generate even bigger profits in the coming years.”

It doesn’t sound like it from that “electronics boom” header, but this teaser is for …

Posco (PKX)[7], Warren Buffett[8]’s favorite South Korean steel company.

Posco is one of the four or five largest steel companies (by production volume) in the world (Arcelor Mittal is far and away the largest, and a couple of the Japanese firms are a little bit bigger than Posco — this is overwhelmingly an Asian industry, US Steel is the top American producer and it just barely cracks the top ten. This is a long-time value investor favorite, it’s been touted by the Motley Fool[9] several times, Warren Buffett has steadily increased his holdings, and Martin Whitman at Third Avenue has been adding more Posco shares, too.

And Posco did buy the only sheet galvanized steel maker in Malaysia (MEGS — now Posco Malaysia), and that is a high demand market for this fancier sheet steel, there’s a quick article about their initial operations and expansion here[10].

But it’s hard to imagine that this will determine the value of Posco going forward — I really like this company, and I owned shares a few years ago (sold way too early, of course), but they’re probably going to rise and fall on heavy industry demand in South Korea, which may be a bit more uncertain right now even than demand for fingerprint-resistant DVD player consoles in Malaysia. If you think the economy is going to turn around that will be great for Korean heavy industry, shipbuilding, automobiles, etc., which would mean lots more demand in their home market — if you think exports from Korea will shrink for a few years, you’ll probably see a better price on Posco shares in the future (though I don’t know if it will get back down to the panic price of $42 that we saw last Fall — if I had been watching it at the time I might have bought back when I saw it dip under $50).

Credit Suisse upgraded the steel industry a week or two ago based on Chinese demand[11]\, and noted that they favor the “cheap” steel stocks like ArcelorMittal, Nucor, and Posco. On the other hand, there was a good article in the Financial Times this morning about projected steel demand dropping[12] more than at any time since the end of World War Two … and Posco’s first quarter report, issued a couple weeks ago[13], was full of cost cutting, production cuts, and weak sales numbers. Is this the right price for Posco? Your call, let us know what you think.

And one more for our Frontier Trader teaser-a-thon …

“Frontier Play #3: Oil Independence in South America
“Expected Gain: 962%

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“One South American country recently went completely oil[14] independent. Quite an accomplishment considering they were importing 85% of their oil in the 1970s.

“And as usual with frontier economies, one single company dominates the entire market. This energy giant’s 15 refineries control 98% of the country’s total capacity, generating over two million barrels of oil a day.

“But they’re just getting started. This frontier star has big plans for expansion including:

* “The discovery of a huge new oil field with an estimated eight billion barrels in reserves – that’s $400 billion worth at today’s prices.

* “A state-of-the-art facility capable of refining 600,000 barrels of oil a day.

* “An innovative offshore oilrig that can tap into oil reserves previously considered unreachable. It’s pulling out 180,000 barrels a day.

“And the results? This company set an annual profits record in 2008. Even in the fourth quarter, when the price of oil dropped sharply, their profits were up 47%!

“How were they able to pull in record profits in the face of plummeting oil prices?

“Because gasoline prices haven’t dropped in their country.

“Waves of new urban workers are generating huge increases in demand for gasoline – keeping prices high and profits fat.

“With millions more moving to the big cities each year, this company’s profits are expected to continue rising for years.”

This, as you may well have guessed, is the only South American oil stock most people have ever heard of … Petrobras (PBR and PBRA — regular and preferred shares, both ADRs)

Petrobras is the government controlled monopoly oil company in Brazil[15], and they’ve been in the news in recent years both for their huge growth as Brazil became a real oil producing country, and for their huge discovery of the Tupi oil field and other nearby ultra deep water[16] finds that sit under a mile or two of water, under a think crust of salt, a couple hundred miles offshore. This is the world’s great new oil discovery, but it also might be the most expensive big oil field in history, so they need oil to be a bit more expensive if they’re going to make a nice profit from Tupi and the other offshore fields in a few years when they’re actually ready for production.

And that gets into another concern that is worth looking at for Petrobras — is their main priority making money? There are some oil companies that would be shelving the Tupi project until economics improve, or cutting costs like crazy, but Petrobras and the Brazilian government are really going “all in” with these deepwater projects. Good news for the rig owners, certainly (I own one of their contractors, Seadrill), but if oil prices remain in this range for a considerable period of time, or drop further, they might lose a lot of money. I don’t happen to think we’ll see lower oil prices in five years, but I’m no expert on that, and it is a risk.

Petrobras is also one that I owned a long time ago and sold way too early — and I do like the prospects, I just don’t know how they’ll do with their increasing leverage[17] to higher oil prices thanks to these offshore fields, and a governmental mission for energy independence that might possibly conflict with short-term profit motives. I’m not sure that’s a bad thing, to be clear, and it makes sense to me to plan for energy a decade from now rather than worry about current costs, but such is not necessarily a familiar refrain for all public oil companies who have to update investors on their quarterly progress. There’s a good story about Petrobras and Brazil’s oil dreams in Bloomberg[18]’s Magazine this month, well worth a read if you’re interested in Petrobras and Tupi.

And one note on the PBR vs. PBRA stuff … unless you’re planning to use options[19] or do short-term trading, or you prefer not to shop on the sale rack, it seems silly to buy the PBR shares when PBRA is available. They both get the same dividend and have the same basic rights to earnings (though Petrobras, after being “discovered” and seeing earnings suffer with oil falling, is not the income stock it once was), but PBRA is trading at a significant discount to PBR of close to 20%. PBRA does not have options available, so that will rule it out for some folks, and the discount has persisted despite it not having much of a logical rationale (in my opinion), so it may well persist or widen in the future, I don’t know.

So … America Movil, Petrobras, and Posco — not a real secret among them, these are all part of the emerging class of globe-spanning multinationals that happen to be headquartered in emerging economies, and they are among the most popular emerging market stocks for US individual investors, so probably many of you own shares in one of these. If you’ve got an opinion to share on any or all, feel free to jump right in with a comment below.

Full disclosure: I do not own Posco or Petrobras currently, but do own shares in Warren Buffett’s Berkshire Hathaway, and I do have some money in Third Avenue mutual funds[20]. I won’t buy or sell anything mentioned here for at least three days, per my own rules

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