Before you get sucked into reading more of my blather, take a moment and read the Wall Street Journal if you’ve got a copy nearby or an online subscription — not the whole thing, but read Christopher Mims’ column The World Isn’t as Bad as Your Wired Brain Tells You. It’s an unusually brief and clear piece about a few of the biases and irrational thought processes that addle most of us… Availability Bias, Extremety Bias and Confirmation Bias go a long way toward explaining why newsletter pitchmen are so successful at getting us to sign up for their get-rich-quick ideas or scare us into hiding in the basement, why patently absurd conspiracy theories are so rapidly adopted as “real” online, and why everything in media, from Facebook to the great MSNBC/Fox News shouting match, is designed to show us more of what we already have a tendency to agree with. Probably the best thing for our democracy would be if we all agree to stay off of Twitter and Facebook for six months and read only thoughtful and edited journalism and communicate with other people only in person.
Except for Stock Gumshoe, of course, you should keep reading our stuff. Every day. And telling your friends. And clicking on all the dumb ads on our pages so we can finally get that solid gold bathtub I’ve had my eye on.
And the other thing I think you should read this week is a bit more challenging, and older, but I find it illuminating — Ben Hunt’s Epsilon Theory is one of the more thoughtful publications I read, mostly because of his ability to dive deep and explain both the human (and market) need for narratives that drive things, and the way those narratives are formed over time. This older piece wasn’t really about that, though: I recently went back and read his piece on Magical Thinking from 2016… it’s really pointed at the Federal Reserve and the Taylor Rule and the populist movements as a reflection of human irrationality, turning an idea or a formula into a belief system, but I think it’s a good reminder to us all to step back from belief and focus on real life sometimes.
So that’s two new perspectives for you for some long weekend reading — if you’re like me, you’ll get sucked into Ben Hunt’s writing and read Epsilon Theory for a few hours… but whatever it is you do, hopefully we can all open our minds a bit and turn off CNBC and the social media echo chambers and do some thinking for a few days.
What, then, comes to mind as we finish the last week of summer — or at least, the Gumshoe definition of summer? (we usually slow down publication in July and August and ramp back up in September, so I’ll be coming at you just about every day again starting next week… exhausting us both.)
Well, I thought I’d spend a few minutes responding to and opining on marijuana stocks, courtesy of a Banyan Hill ad focused on that market and the deluge of varying questions I’ve gotten about pot stocks in general… then I’ll update you on what happened in the Real Money Portfolio this week.
So… Marijuana first.
The ad that caught my eye was a “presentation” called “Marijuana’s US Tipping Point” by Matt Badiali and Jeff Yastine, pitching Badiali’s Real Wealth Strategist (which, similar to some recent offerings I’ve looked at from other Agora publishers, is a low-cost subscription that both renews at higher prices and includes a “free trial” of a newsletter you didn’t ask for, in this case The Bauman Letter, that they’ll automatically start charging you for after a few months… so if you don’t do anything, your $79 sub to Real Wealth Strategist soon becomes a recurring $176 a year, or whatever they choose to charge in the future).
The ad is all about “how you could turn a $50 starting stake into an early retirement by riding medical marijuana’s wave of legalization,” and that’s a fairly typical promise for all kinds of newsletters, built on this mythical idea that you can somehow ladder your windfall investments — turning $50 into $500 in some hot penny stock, then that $500 into $12,000 by picking another extraordinary winner, then betting that $12,000 to win $40,000, and pretty soon you’ve got a couple million dollars and can retire! Yay!
Assuming, of course, that your children didn’t have you committed for doing something as irresponsible as “doubling down” on every single risky penny stock speculation you make (since, as you probably figured by now, just one 90% drop as you’re building on those imagined profits causes this mythical tower to crumble all the way back down… and there’s always a 90% drop at some point when you’re betting on speculative manias). Conjuring up these kinds of historical “possible” profits from serial penny stock speculations is fun and easy since past stock windfalls are easy to find… in real life, with real money, it would be like playing Jenga after drinking 75 cups of coffee.
Indeed, when these Banyan Hill ads talk about returns they use this same notion of serial victories and “cumulative returns,” imagining that having two gains of 200% each doesn’t just result in a gain of 200% for your two-stock portfolio, which would be the rational person’s way of thinking about a collection of investment ideas, but that you gain 400% because you can somehow stack them magically on top of each other and earn cumulative returns. He talks about winning positions in a portfolio of ten stocks during the last mining bull market (Badiali used to edit a mining-focused newsletter for Stansberry, and before that an oil newsletter), with the best being a 300%+ return, and the total gain for those ideas is not, they claim, the average of the stocks… but the sum of the performance, so somehow a group of stocks, the best of which returned 300% or so, generates 2,672% gains. That’s stupid, and a really unhelpful way to think about your investments, but, well, a lot of people don’t do well in math class and get sucked into those big numbers.
So what are the actual stocks they’re hinting at for this marijuana revolution? Let’s take a bit of a look… here’s the first one:
“It’s a $6 billion company with 700 employees spanning the globe. It has production facilities in Denmark, Spain, Brazil, Chile and Australia.
“It already makes some of the most in-demand marijuana products … from soft gel capsules, to oils, creams and more. And as medical marijuana becomes legalized, it is in position to roll-out its products in all 50 states.
“According to my 10x Blueprint, and all the research my team and I have done … it’s crystal clear that this company is a screaming BUY right now.”
And some more clues on this one:
“This company is ‘positioned’ perfectly. They produce marijuana for both medical and recreational use, with nearly 70,000 patients already relying on its products. It’s predicted the number of patients could swell to 450,000… that’s a potential 543% surge.
“For my ‘people’ filter: There’s a solid management team in charge, too. The founder has held key leadership roles at several different corporations. The president has two law degrees, and has provided legal, political and strategic advice to international corporate clients. And the Senior Vice President started an e-commerce firm at the young age of 13.”
That’s giant Canopy Growth (WEED.TO, CGC), which I mentioned a few times over the past couple years as the company I’d be most willing to dabble in in marijuana because of its leading size and potential brand power (their first brand, Tweed, got a lot of attention in the early days)… though, sadly, I’ve never actually owned the shares. It was a $6 billion company a month or two ago, but surged recently on the back of the news that Constellation Brands (STZ) is taking a much larger stake in the company and looking to develop marijuana-derived beverages for the mass market (Constellation’s an alcohol company, their most valuable asset is Corona beer). And yes, they have had revenue growth approaching 39,000% over the past three years, though that’s because their revenue was close to zero three years ago.
The recent surge has really come on the combination of legalization confirmation and the ongoing “buy-in” by the beverage companies — Constellation really set the stage with their purchase, which could give them more than half the company (at a cost of billions of dollars) if they exercise all their options over the next few years, but then the story immediately turned to “who’s next” as Molson Coors (TAP) bought into a joint venture with Hydropothecary for cannabis-infused beverages, Pepsi and Anheuser Busch are constantly rumored to be looking at one Canadian pot stock or another and, most visibly, international liquor giant Diageo (DEO) has said that they’re negotiating with several major players to possibly invest with as they work on cannabis-infused beverages. Even Heineken, through its Lagunitas subsidiary, has a weed-infused seltzer for sale in California. I have no idea whether THC beverages will end up being big business, or even whether anyone likes them, but it’s possible and none of the big players want to miss out if that market ends up exploding.
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What’s his “Marijuana Investment No. 2?” Here are the clues:
“Shares trade for less than $7…
“Six international operations from Israel to Australia…
“First pure marijuana comapny to trade on the Nasdaq, attracting attention from big investors.”
They also throw the clue that “Constellation Brands paid $190 million for a 10% stake in the company” in there, but that’s probably just an error — that’s a reference to Constellation’s first investment in Canopy Growth, and we already know Canopy was “Marijuana Investment No. 1” in this same ad. So this is clearly Cronos Group (CRON), which is mostly a Canadian investor in grow operations but does also have assets in half a dozen other countries. Shares were less than $7 before the “which beer company will buy a pot stock next” sweepstakes began a little while back, then they doubled recently before coming back down to about $10. That pullback in the past few days was because of Citron Research’s short attack on the stock, which is centered on their report Cronos: The Dark Side of The Cannabis Space that puts a $3.50 target on the shares. That’s not a bearish statement on the marijuana business more broadly, though they do mention the possible oversupply in Canada, it’s more about the lack of disclosure and the very small “real” business that’s actually happening within Cronos’ various subsidiaries.
So that’s number two — how about another?
Marijuana Investment No. 3 is a “picks and shovels” play on marijuana, which they say has “multiple subsidiaries which supply much needed products to the marijuana market,” including hydroponic equipment and services. That’s not a lot of clues.
So this could be a general services company, like General Cannabis (CANN), which provides security and consulting services and facility planning, or a retailer and distributor like GrowGeneration (GRWG), though they’re more focused on the retail experience than on big growers, or even the oft-cited Scotts Miracle-Gro (SMG), which has been pushing into the marijuana business and building a meaningful segment in hydroponics… but none is a perfect fit for that. Given the lack of specifics, you can probably make any services company you like fit that clue… though none of them have jumped out to me as appealing just yet.
“The fourth stock is a company diving head first into the industry. They are providing the capital and expertise for marijuana companies to become successful. In exchange for the funding, this company gets as much as one-third of the revenue from each company it supports. And you can get in for less than $2 a share.”
This must be Auxly Cannabis (XLY.V, CBWTF), which I’ve written about a bunch of times — mostly under the heading, “I love the idea of this business model, but boy, I wish this was a better company at a cheaper price.” That’s a purported “streaming” and “royalty” company in the marijuana space in Canada, but their early deals were essentially heavy bets on both huge demand increases for marijuana, and huge yield increases at their partner companies based on their advice and input, and, perhaps more importantly, on what looked to me like very high per-ounce prices for the finished product. Maybe it will work out, maybe not, but it strikes me that they’re betting heavily on this being a huge market where most of the producers “win.” I covered Auxly in more detail just last month when it was being promoted as the “Royal Gold of Marijuana” if you want more of my chatter on the topic.
“The fifth stock is a biopharmaceutical company. They produce pills from the marijuana plant to help patients deal with the treatment and symptoms of their illnesses. It’s a $4.2 billion company, which could soon go up once the FDA votes on a promising drug they produce… which I think is all but guaranteed.”
That’s very likely to be GW Pharmaceuticals (GWPH), the largest of the real pharmaceutical companies that builds drugs based on compounds in marijuana. That’s very distinct from a “medical marijuana” company, they’re not selling weed to help with nausea from chemotherapy or pain relief or glaucoma, they’re selling real, clinical trial-passing drugs whose active ingredients are derived from specialty hybridized marijuana plants — most recently, they got approval to market Epidiolex for the treatment of seizures in some patients.
So in reality, the marijuana connection is not terribly meaningful — their drugs will rise or fall on their own, and be priced in some way that’s completely disconnected from the raw material, and their fate will depend on the market for their current and future drugs. The only thing that will help, I suppose, is that loosening the regulatory noose for marijuana will make it easier for them to run the business — it would be less onerous to work with marijuana in the lab, for example, if it were downgraded from being a Schedule 1 drug in the US. Then again, if it’s just the active compounds in marijuana that are making the drug work, well, legal recreational pot means that some possible patients might just toke up instead of taking the controlled and monitored dose given by the drug — some folks don’t want the extra “feature” of feeling high, but not everyone avoids that.
I don’t have any particular qualms about GW Pharmaceuticals, I just don’t call it a marijuana stock… and I don’t invest in clinical stage biotechs and drug developers in general, given the imagination you need to have to forecast their profits a few years out, so I haven’t dipped my toes in the GWPH waters, though it has probably been the most-teased stock in the “pot stock” ads over the past five years.
So where am I left after all that? Well, in truth, I think the whole industry is wildly crazy — it’s a relatively high gross margin business so far, mostly on the medical side, though pricing is highly regulated in Canada and we’re not sure what the price of “regular” marijuana will end up being or what the markups will be for edibles and special strains and whatever beverages they may develop… and the existing Canadian medical marijuana sales, at least, are pretty trivial in size in Canada… over the past year Canopy Growth has seen revenue increase by 70%, to just under $70 million for the past twelve months. That’s patently absurd for a $9 billion consumer product/healthcare company unless the growth is going to be truly ludicrous… so it’s obviously all about how recreational pot takes off when the first sales begin to happen in Canada in mid-October (all the laws have been passed, they’re just getting the final systems in place).
What’s the dream? That marijuana becomes the next major legal recreational drug for Canadians (and soon after, for Americans), and that the profits earned from it over the next few years justify the incredible investments that have been made in building up a massive grow capacity over the past year or two.
That recreational market lets you dream about much larger scale production — forecasts I’ve seen are for Canadians buying $5 billion worth of pot per year as it’s legalized, and that seems to be a pretty widely-cited number. By comparison, Canadians spent about $9 billion on beer last year, and about $22.5 billion on alcohol in total. Molson Coors and Anheuser-Busch InBev between them, the two biggest beer businesses in Canada, hit about $4 billion in Canadian sales last year (in US$). So if Canadians start to spend as much on Canopy’s brands of legal marijuana as they do on Molson and Bud Lite put together, a number that averages out to a little less than $500 per person, that could put Canopy’s revenue at $4 billion. If Canopy gets half of at smaller but still insanely huge $5 billion market, that would be, through simple math, $2.5 billion in revenue.
So if you want to imagine that future, which would be incredible growth from the $70 million they pulled in over the past year from the medical marijuana business (as they’ve been expanding production and stockpiling product for eventual recreational legalization), what would that company be worth then? They’d have to dramatically ramp up production, as they’re doing, and I don’t know what that eventual capital cost would total, but if we assume that someday in the future they’re on a sustainable sales level in the billions, and have a similar gross margin to what they have right now, which around 40% happens to be similar to the gross margin for Molson Coors (though lower than the 60%+ of Anheuser Busch), then what would the company be worth? If it’s valued like Molson Coors at that time, investors will be sorely disappointed — TAP has gross margins of 43% and revenue of $11 billion, and trades at 1.3X sales for a market cap of $14.5 billion. Canopy has a $9 billion market cap now, and no one is in these shares hoping for a 50% gain over the next few years — the dreams are much larger than that.
Anheuser Busch is much more profitable, and much larger, with revenue of $43 billion and a price/sales ratio of 4.3 for a $191 billion market cap. And Constellation Brands is stronger still, with revenue of $7.7 billion and a p/s ratio of 5.4 for a market cap of $40 billion, thanks to their big overpriced Mexican beer hits (led by Corona). So that’s the range at which some big alcoholic beverage companies trade, somewhere between 1.3X sales and 5.4X sales. If we slot Canopy Growth in there near the top at, say, 5X sales, and assume that the Canadian marijuana market ends up being as big as the Canadian beer market, with Canopy taking close to half of that market on the strength of their brands and distribution power, then maybe Canopy Growth should be worth $20 billion when that happens.
It’s valued at $9 billion now, with a mere whisper of those sales, so that tells me that investors are already anticipating incredible revenue growth. We’ll leave aside ideas like profit margin and earnings, because no one cares about those if they think they’re getting in early on a multi-year period of massive sales growth, or if big multinationals decide that the regulatory environment is now friendly enough and clear enough that they can start to buy up the pioneers, as Constellation is arguably doing with Canopy.
So you can imagine a world in which the current valuations for some of the leading Canadian pot names are rational, if optimistic… but for me, that world is a lot further away than investors are guessing right now, and I don’t think there’s a high probability that Canopy is going to go from $70 million in sales to $2 billion in sales over the first year or two of recreational legalization, let alone $4 billion… which means I can’t convince myself to buy the stock.
That means I’ve been missing out on a lot of the marijuana fun in the investing world, and of course I regret that, but the numbers just don’t make enough sense to me and I don’t expect the crazy moves of the past few weeks to be sustainable.
That doesn’t mean I’m right, to be clear. I’ve been wrong on the pot stocks in the past, and I could be wrong this time, too. My primary concern is that these companies are being traded by people who assume not only that the market for marijuana will be huge and growing, but also that a growing commodity market will generate higher prices and strong profit margins, which is hard to imagine (particularly because the primary rationale for legalization is to crush the black market, which won’t happen if legal prices are twice as high as black market prices). But I’m also having trouble with the daydreams of massive wealth explosions, because marijuana cultivation and sales doesn’t strike me as a business where margins are going to improve dramatically. Unlike crazy software and other tech stocks, these are mostly farming and consumer products companies that have real input costs for every sale, and that will be spending like crazy on marketing (assuming they’re allowed to).
So that’s my fuddy-duddiness on the marijuana business, which would probably be enough to get me fired by any big newsletter publisher — the newsletters know damn well that they have to sell the people what they want, and what the people wanted was bitcoin a year ago and is marijuana today, with winds that shift all the time, so mining stock analysts are becoming bitcoin gurus and marijuana stock experts and coming up with on-trend recommendations as fast as they can, at the risk of being ignored if they don’t come up with their “top five marijuana stocks to buy.” This is a fashion business, the attempt to find out which pot stock will be most fashionable with investors.
My fear for current speculators in Canopy Growth and Aurora and the other large players is that they might end up owning a fairly boring producer of a legal product whose market size and growth after the first couple years can’t hope to match the investor expectations, given the massive market cap those companies carry today, which could lead to a declining share price. That doesn’t mean I think Canopy will go out of business tomorrow, or that Canadian marijuana will be a bust in general — I expect it will probably be a successful industry, and that Canopy will be one of the relative winners, thanks in no small part to their large backing from Constellation, and maybe the share price will go up another 500% from here… I just don’t see any reason why it should, and I can’t stomach betting on it. The possible range of outcomes is just too wide.
For another point of comparison and perspective, if you’re looking for some skepticism to counter your own “just buy pot stocks!” internal hype machine, think about California — that’s the largest current legal pot market in the world, following legalization of recreational pot last year, and California has almost exactly the same population as Canada (though a much larger GDP, and somewhat higher average household income). So far, the last estimate I saw indicated that California was on pace to have marijuana sales of about $2 billion in this first year, far less than had been anticipated a couple years ago. Part of that’s due to local headaches with getting dispensaries open, which we’re also seeing here in Massachusetts, and maybe those hiccups won’t come for Canada in the same way, but part of it is just because there are lots of enthusiastic folks who want to get into the business, growing and opening dispensaries and developing products, but it’s profoundly difficult to guess what the size of the legal market for marijuana will be, and how much will need to be grown, and what the pricing will be.
Oregon, for example, had a bumper crop this year that caused prices to crash, and that’s putting a lot of farmers and dispensaries out of business — legalization doesn’t mean that every company in the industry automatically gets to make lots of money. Washington and Colorado have also seen per-gram prices drop dramatically in the time since recreational pot was first legalized in those states (Washington, Colorado and Oregon, taken as a whole, would be just under half the size of Canada’s population). Agriculture is a tough business that gravitates to pretty low margins, and consumer products are the same unless you develop a strong brand that users really identify with and are willing to pay for.
So that leaves me thinking that although I’m worried about the valuations of the large players like Canopy and Aurora… I think there’s a good chance that most of the smaller players will be driven out of business entirely, absent a small number of strong consumer brands that could emerge (though limits on marketing could also hobble that brand development). Canopy and Aurora among them are ramped up to supply maybe as much marijuana as Canada will be expected to consume within the next few years, and some of that may be burned off by exports but those are companies also have huge potential market heft and solid balance sheets so they could also just drive down prices for years until any smaller competitors are driven out. The goal is to build the best distribution systems and the best brands, I imagine, and the big guys will be best positioned to do that at the expense of the dozens of smaller growers and dispensaries — though I still think there’s at least a 50/50 chance that the financials of the big players will look pretty awful for several years after legalization, so what the share price is will depend on how much investors are willing to bet on them eventually achieving brand dominance and economies of scale.
Which is a long way to go about saying… I’m happy renting out warehouses to medical marijuana growers as a Innovative Industrial Properties (IIPR) shareholder, despite the crazier valuation those shares have also reached lately, but I’m not buying any actual pot stocks as long as I can’t get my head around the financials. I’ll stick with Starbucks in the “addictive consumer products” category for now.
You might have noticed that shares in Innovative Industrial Properties (IIPR) have gone goofy — they’re well out of “buy” range for me now, thanks to the budding investor mania for pot stocks in general, but it’s also possible that they can grow into this price pretty quickly if they accelerate their dividend growth over the next year or two (which is very much possible, given the extremely appealing economics of the deals they’ve signed, though it’s not guaranteed), so I’m not trying to trade in and out of this as it bumps from overvalued to undervalued and back again… I’m just holding.
That doesn’t mean all these exciting pot stocks won’t work for you, of course, they sure to go up really fast sometimes, and that’s really fun. Sometimes I miss fun stuff.
Speaking of Starbucks, this week I added a little bit to my Starbucks (SBUX) position, increasing that by about 15%. No big news, other than this morning’s update that Coca Cola (KO) is buying the UK coffee chain Costa — that drove shares of Starbucks down a hair in a knee-jerk reaction, perhaps on fears that Coke will pour lots of money into building Costa to compete with Starbucks, though Starbucks is obviously the stronger player in both coffeehouses and, importantly, in the grocery market (Nestle will sell Starbucks branded coffee and similar products globally now, and Pepsi sells Starbucks’ bottled drinks, neither of those firms is going to hide in the corner on fears that Coke is coming). Costa’s a nice chain, but it’s not hugely different from Starbucks in my experience and I doubt they’ll have a competitive advantage anywhere. I think the coffee market is likely to continue to grow, and Starbucks will always have competitors but remains the class of the industry when it comes to margins and customer loyalty… and the financial outlook for Starbucks look better for me each time I’ve looked at it in recent months.
Starbucks has been “dead money” over the past few years, losing the attention of growth investors, which is why I think folks are underestimating its transition to a capital-return company with steady growth. There was a very solid presentation on the stock at ValueXVail, a small conference that I’ve never attended… the rationale they presented is essentially that the return on capital from the Chinese stores should be enormous over time, and that the shift of investment to China should meant that overall returns will be stronger.
In a bit of analysis that I hadn’t previously dug into very deeply, they also point out that Starbucks is on a massive capital return binge — or, at least, that it’s planning such a return. Their goal is to return $25 billion to shareholders from 2018-2020, which, in addition to the higher dividend, might bring a share count reduction of more than 25%. Continuing high margins and strong cash flow might mean they can build on that in future years as well, returning ever more capital, which — as long as the business is a sustainable leader, which I think is the case — could generate substantial returns for those who are patient enough.
So yes, I’ve continued to build my Starbucks position. My base argument that buying a brand this strong at a reasonable PE ratio and a strong and growing dividend (2.7% and growing) is worthwhile… but the capital return, and the gradual increase in leverage that they’re plotting, is what could really speed up the possible returns for shareholders over the next couple years.
The risk is real and is very much connected to China and their ability to grow as quickly there as they’re planning, but I think the risks are also pretty well understood and probably overstated — politics, China, and labor costs are all issues that could work against Starbucks, so a presidential Tweet could bring a 5% move on any given day, but that’s why you can buy the global market leader and a hugely powerful international brand at close to a trough valuation at a time when the economy is growing… and on the positive side, coffee beans are cheaper than they’ve been in more than ten years, and Brazil just had a record harvest and the currencies of many coffee-growing countries are super weak, so that, at least, should help their margins a little bit (though one shouldn’t count on commodities and currencies, since they can turn the other way, too).
Speaking of commodities… In Altius Minerals (ALS.TO, ATUSF) news, some aspects of the Voisey’s Bay royalty disputes are going to be heard in Labrador Supreme court in September — that’s according to Brian Dalton’s comments on the Altius conference call. If this dispute actually ends someday soon, it could mean at least a few million dollars in net new royalty revenue if they win, and more royalty growth in the future. Vale hasn’t been paying the royalty for a couple years, thanks to the most recent claim of theirs that they can deduct the costs of building a new refinery, and even before that Altius and Royal Gold have been in court with Vale alleging underpayment of royalties because Vale sold the concentrate to affiliate companies at something allegedly below the fair price. I expect Altius to come out of this with something… though I’d never bet meaningfully based on a guess about the outcome of a court case.
Voisey’s Bay is also getting some additional expansion funding, thanks to the sale of their cobalt stream to Wheaton Precious Metals (WPM) and Cobalt 27 (KBLT.V) a couple months ago, so that could also further extend the value of this hugely valuable royalty (assuming, of course, that Vale ends up paying the royalty again)… with production expected to ramp up again in two or three years as the underground mining expansion begins to produce. This is also meaningful for Royal Gold (RGLD), by the way — RGLD owns a much larger chunk of the royalty on Voisey’s Bay (Royal Gold and Altius are partners on a 3% NSR royalty on the whole Voisey’s Bay area, RGLD owns 90% of the partnership and Altius 10%, so it’s effectively a 0.3% royalty to Altius).
This used to be the flagship royalty for Altius, and in the early days, when I first owned shares, this royalty often covered their corporate overhead and operating expenses by itself… though they’ve grown their royalty portfolio considerably over the past decade, and now Voisey’s Bay is not quite as material. It still matters, but it won’t kill the company if they lose the lawsuit (it might be a bad precedent for older royalty owners in Canada in general if Altius and Royal Gold lose, since it could give operators an easier way to invest in their mines instead of paying royalties, but that’s for the court to decide — and more recent royalty deals seem to be far more specific than this one was, so probably deals made in the past few years wouldn’t be impacted at all).
I haven’t added to my Altius holdings in a while, and the shares are flat while most of my other large holdings have been soaring, so this week I continued my gradual portfolio building and balancing process and added a few more Altius shares. This is a holding I’ve had in the portfolio for almost a decade, and it’s pretty clear that I’m not terribly adept at trading in and out of the market based on cyclical prices for commodities… but Altius management is pretty good at that countercyclical investing that requires a combination of patience and opportunism.
The market hasn’t been recognizing Altius’ skill in that area in recent months, which is fine, I’ve learned to be patient with this one, but the world isn’t going to keep growing and keep developing without more iron ore and more copper and more potash, and I wouldn’t be surprised to see any of those commodities have a very strong performance over the next year. Copper has been fairly weak of late, though Altius’ big copper royalty on the Chapada mine is looking even better than it did when they first made the deal about 2-1/2 years ago… Iron Ore cash flow to Altius should get a nice boost this fall as the Labrador Iron Ore labor dispute ends, and Altius remains highly levered to any possible resurgence of iron ore prices thanks to Alderon’s Kami project and some other early-stage assets in the area… and potash, importantly, seems like it might be heading into a bit of a bull market again.
Potash is an essential fertilizer, and production is controlled by a relatively small number of long-lived miners in Canada, Russia and Belarus — the breakup of the Belarusian cartel a few years ago crushed the price, but it’s been solidifying recently and the big deals that China and India sign for potash are likely to keep driving the market higher (India just agreed to a long term deal with Belarus at a 20% higher price than last year, China is on deck next) — that’s also meant that the big Canadian potash producers, Nutrien (NTR) and Mosaic (MOS), have been among the few relatively strong natural resources stocks recently… and with Potash Corp and Agrium combining to form Nutrien, it’s an even stronger group of operators running the extremely long-lived mines on which Altius has royalties, and an even more manageable two-headed cartel in Canada (those two are the owners of Canpotex, the potash exporting organization).
And while we’re on the topic of China… I also added a little bit to my Naspers (NPSNY) position this week, when pessimism took another chunk out of Tencent’s valuation and Naspers fell even harder than Tencent did. That’s the reverse of what should happen in the long run, the discount for Naspers’ Tencent shares has been growing in recent years, and it should over time be shrunk… and provide some minor protection against Tencent’s value dropping over time.
I do still think Tencent is likely to return to favor, and probably fairly soon, though that depends a lot on external factors — partly on Chinese regulation of gaming, but more so on just general China sentiment, which is driven more than anything else by the current trade disputes between Trump and Xi Jinping. So this isn’t going to become my largest position, to be sure, but I’m happy to add a bit at lower prices this week and I think it’s likely that Naspers will be continue increasing the transparency with which they talk about investments and overhead, including their richly compensated executives, and that they’ll be trying to close that discount in the years to come by continuing to monetize and publicize their other venture investments — small though they are in the context of their Tencent holdings.
As of right now, Naspers’ 31.5% stake in Tencent should be worth $129 billion… so the rest of the company, which consists of more than $10 billion in cash and dozens of mostly relatively small (though several are in the billion+ range) venture investments, is valued at nothing and Naspers still trades at roughly a 25% discount to the Tencent stake today. You get some South African regulatory risk along with your discount, since Naspers is domiciled in South Africa and has much of its operations in that country, and it gets attention since it’s the largest company in Africa by market cap and yet pays not so much in taxes in its home country (the investments are generally held overseas), and some folks can’t stomach that, but at this discount I’ll take it.
Where did that money come from to add to these positions? Well, partly from options profits — I sold my remaining stake in Square (SQ) 2020 call options after Square’s huge move in the past week, and shaved off some profit from a couple of my other options speculations. I cut my Intel (INTC) and NVIDIA (NVDA) options positions in half, guaranteeing a substantial profit even if the rest of each position goes to zero.
Both strikes are currently out of the money (NVDA at $380 in March is highly speculative, Intel at $55 in January 2020 much less so but certainly not guaranteed to be hit), and this is how I generally try to treat time-limited positions like options and warrants: There’s no predicting the next 6-18 months with any accuracy, so I take profits along the way when I’m right. I don’t always do that with equity positions, because for many of my equity holdings I’m willing to sit through declines and be patient, without any pressure for me to match the S&P 500’s performance in any given quarter or worry about a 10-20% move… but with options and warrants there’s no “sit tight and be patient” — they can and often do expire worthless, or lose 90% of their value if the stock bumps down by just 10-20%, so it’s important to realize some of those gains along the way. Since I’m ever hopeful of a real “melt up” blowout top to this bull market, I try to keep a small portion of those kinds of speculations after taking profits — just in case. But either of those two speculative options positions could easily have gone to zero… so in some ways this is just a very small rebalancing of risk, take those blowout gains and put them into something that can compound over time.
Though, of course, that’s just one way of looking at the narrative behind my Real Money Portfolio… I also bumped up my investments in some other speculations this week, though on a very small scale, including a very small addition to my Teladoc (TDOC) position (increased it by about 15%) and a few more dumb long-term option speculations.
In the dumb speculations department, I basically just added on to some of my 5G-related options bets… increasing the size of my call option positions on both Nokia (NOK) and Qualcomm (QCOM), and opening a small speculation on Nokia competitor Ericsson (ERIC). Won’t know much about how dumb those ideas are for a while, but I expect 5G to be a driving narrative among investors over the next year, and I think there’s a chance for a great many associated companies to pop higher at some point.
There is, to be clear lots of hair on all of these companies, all of which are disappointing in different ways right now and really dependent on 5G investment to boost their fortunes over the next couple years, so I’m not willing to commit a lot of capital… but I’m willing to bet a little bit. The details are in the updated Real Money Portfolio but these bets are essentially that Qualcomm will rise close to 40% by January 2020, that Nokia will essentially double in that time, and that Ericsson will rise 40% over the next 8-1/2 months. Those are low likelihood bets, which is why they’re cheap — and, of course, I may well not hold them through expiration. If we do get a speculative liftoff in any of these 5G stocks, I’m likely to take some profits along the way… if we don’t, there’s every chance that these options positions, like somewhere between 25-50% of such speculations have tended to do for me, will expire worthless with 100% losses. And they’re small enough that such an outcome is OK and won’t have a significant impact on my portfolio.
In other news, Boston Omaha (BOMN) did its third acquisition in the billboard space in a very short period of time, and it was a doozy — the big one is Waitt Outdoor, announced just today as an $82 million cash acquisition for 2,500 advertising faces across the midwest, and earlier they bought Key Outdoor for $38 million, bringing 1,800 advertising faces, also in the midwest (more focused on the Chicago-St. Louis region), and the much smaller Tammy Lynn Outdoor for an undisclosed amount plus 85,000 shares, bringing 250 faces in West Virginia. I’m assuming the Tammy Lynn deal was for a few million dollars, so I’ll just guess that it’s $5 million, including the share portion. That’s a total of $115 million or so (roughly $25,000 per billboard face, though of course some are far more valuable than others), which is close to half of the cash that Boston Omaha had on hand and a really substantial change for a company that has a market cap of only $550 million.
I don’t really know how to value the billboard business, other than comparing it to the few other publicly traded comparables. Boston Omaha had previously spent about $36 million building up their initial billboard portfolio at Link Media Outdoor, and as of the 2017 annual letter that portfolio included 864 faces in four states (that’s just under $42,000 per face). The revenue from those faces for the first six months of 2018 would annualize to $6.5 million in sales for billboard rentals, so I guess you could say their investment was about 6X annual revenue, though they’d argue that the portfolio grows stronger and rents increase as they own more assets and take better care of them and market them better. If they paid something similar for their bigger purchases made this month, and that’s a wild guess, then that would mean Boston Omaha is going to start to have some meaningful numbers on their income statement — billboard rental revenue could close in on $30 million/year pretty quickly if the ratios are similar (they may not be, remember, I’m just guessing).
That doesn’t necessarily mean we’re going to see Boston Omaha shares suddenly look undervalued — but it does mean that their income statement will start to look better (they had only $11 million in revenue over the past year), and that they might be close to covering their overhead pretty soon and could, theoretically, stop posting losses. They’re still in a growth and accumulation phase, and we don’t really know, but I’ll be curious to hear what they say at the annual meeting in about three weeks.
By way of context, the biggest player in this space, Lamar, trades at almost 5X sales, but they have huge economies of scale and advantages over small owners… somewhat smaller Outfront Media, which is a REIT that owns billboards, trades at 1.8X sales. Clear Channel Outdoor is another large one and trades at a tiny price/sales ratio, but that’s at least partly because it has a massive and unsustainable (at least to my eye) level of debt. If we continue to value Boston Omaha based on book value, then you’d probably want to use something close to 2X book value for the surety business, and 1X for the cash, but you might be generous in assigning a book value of 5X for the billboards (Lamar trades at 7X book value, for example). That’s troublesome, too, because the book value would be based on the purchase price and therefore there’s no “hidden value” in that real estate like there probably is for Lamar (that purchase price has to be accounted for somewhere, so if it’s not in the total value of the structures it’s in goodwill to account for how much Link Media Outdoor overpaid beyond that “value,” and goodwill, though intangible, is also part of book value), but we’re really just spitballing to help us think about fair valuations for a growing company that hopes to be a meaningful consolidator in its core surety bond and billboard businesses.
I’m confident, at least, that those assets are going generate cash flow, and therefore they’re worth more than cash… so this is better than Boston Omaha just sitting on the cash and being valued at 2X book value. The company has been a “buy the managers” promise for a year now, and that’s still the case to some degree, but with the next couple quarters we’re going to actually start to get some idea of the sustainable economics of the billboard business, and how that fits in with their other investments. It’s still a small position, and the stock surged on the news of these new billboard investments (presumably other folks like the idea of the business generating some cash flow and owning some assets, too), so I’m not adding after this surge… but I remain drawn to this stock, and I’ll keep watching.
Warren Buffett visited with his favorite TV acolytes on his birthday this week, and mentioned on CNBC that he’s been buying more Apple (AAPL), which got me to thinking: I can’t remember a late summer that had LESS chatter about the “next iPhone” or less wild speculation about which features or chips will be in that new product. Does that mean we’ve gotten past the cycle of manic iPhone predictions? We haven’t even seen the usual suspects trotted out as “you must buy this stock before Apple’s announcement” ideas, whether it’s the perennial hype around Energous (WATT) or the push for various component makers that we usually see at this time of year.
That’s a bummer, because I was hoping for a chance to short Energous if we got a big rally again on some spurious rumor that WattUp would be in the next iPhone, but it’s also perhaps an indication that Wall Street is accepting the growing steadiness of Apple’s business… people are pretty well locked in to buying a new phone every two or three years and staying within the Apple ecosystem, and there will be bumps along the way but investors appear to be believing in the idea of iPhone sales as a recurring “subscription,” almost, with less risk of a bad year or a bad product hurting sales. Or maybe it’s just an odd couple weeks — now that we’ve officially gotten word that Apple’s next product-introduction event will be September 12, perhaps the hype will start sprouting again.
That steadying of the business is probably part of what attracted Buffett to build such a big position so quickly, the fact that Apple is really being seen as a cash-gushing consumer products brand with strong recurring revenue (both from fairly predictable upgrade cycles and from increasing services revenues). I’m a little surprised that the shares have surged this high, this fast, up almost 50% in a year, but it’s hard to argue that Apple is overvalued… and with Buffett and the company itself putting so many billions of dollars into buying shares (buying back shares, in the case of Apple), it’s hard to see the stock falling very far anytime soon.
A lot of the improvement in Apple shares has come because they’ve so dramatically reduced the number of shares outstanding through buyouts — there were 6.3 billion shares outstanding five years ago, and that number is now down to about 4.8 billion (that was as of July, it’s probably below that now). Berkshire Hathaway (BRK-B) owned 252 million of those shares at the end of June and added more between then and when they reported their quarter a few weeks ago… and Buffett said they’ve bought “just a little” more since then… so that’s about 5.25% of the company and rising. In related news, Warren also noted that he has also bought back a little bit of Berkshire’s stock following that new authorization from the board last month, which serves as, at least, a signal that perhaps we’re moving that “floor” for the shares up now — it used to be that investors (or me, at least) thought of 1.2X book value as the floor for Berkshire, since they were authorized to buy back shares below that level (we haven’t hit that level since the buyback authorization was made public, but the couple times when we came close it was a great buying opportunity). Now the market’s getting their head around the fact that Buffett already bought back some shares, and therefore probably did so when the stock was above 1.4X book value… so maybe something in that neighborhood is our new “floor” for the stock, below which we can be pretty sure that Buffett and Munger would dig deeper into buying back stock.
That essentially means, “buy Berkshire when it gets close to $200” — 1.4X book value would be about $202 right now. Book value per share can, of course, also decline, as can the “intrinsic value” that Warren uses to make his buyback judgements, but with a strong market and solid underwriting, and no big hurricanes, it’s not likely to fall very fast anytime soon.
Probably the most impressive thing about the cash-rich giants in technology, like Apple, is how much they’ve been able to grow while also resisting the siren song of empire building — CEO’s have a terrible tendency to make huge and expensive acquisitions when their companies are loaded with cash, and Apple hasn’t… the buybacks make sense for them, further improving profitability as they have no possible way to spend that kind of money on anything that would be more profitable than their current businesses.
Better to spend that cash internally on R&D and new projects, even sometimes dumb ones, like Alphabet (GOOG) has done, and let those percolate outside of public view even if they cost a lot of money and develop more slowly than hoped (like Waymo and its self-driving cars, which are annoying other drivers and facing a new round of skepticism in Arizona, as reported by The Information this week). If Waymo was its own company, that news could have brought a 20% drop in the share price and a new round of investor panic… but as it is, it’s still a comfortable R&D project hiding inside Alphabet’s gargantuan income statement, and Alphabet investors don’t need it to be ready for prime time this year.
Apple is still pushing forward with its own automotive testing, too, and has been rumored to be developing an “Apple Car” for something like five years, but they can afford the R&D and they learn something from everything they do — some investors continually throw out ideas about Apple using its cash to take over Tesla (TSLA) and supercharge its auto development programs… but instead, they’re poaching worried Tesla employees who are probably tired of Elon Musk’s Quixotic nature and building their own internal capabilities. To which I say, “Phew!” And actually, it might be better for Tesla investors if Apple just bought Twitter (TWTR) and kicked Elon off the platform (kidding! I don’t want them to buy anything huge… though TWTR would be a more rational purchase for them than Tesla, to my mind).
Finally, Berkshire also bought into India through a small stake in a leading private e-payment platform (think PayPal or Square) called Paytm — which isn’t really an investment that’s of meaningful size or importance for Berkshire (it was about $300 million), except that it’s perhaps newsworthy that they’re doing something that sounds more like a venture investment. This is an idea from Todd Combs, one of the hedge fund guys who Berkshire brought on to gradually take Warren’s place as chief investors for Berkshire, and he will also go on Paytm’s board, so that is a reasonably large commitment and maybe it will lead to more risk-taking in venture ideas, or more international investment (Buffett has often professed an interest in getting more investments outside the US, and he’s done some piecemeal deals, but they remain a small part of the Berkshire portfolio). Doesn’t change my thinking on Berkshire at all, and I’m already pretty bullish on India, particular travel and consumer and financial services investments in that country, so this is just a nice little reinforcement for that sentiment.
And that, dear friends, is about all the blatheration I can ask you to tolerate for one week. Enjoy your Labor Day weekend, and feel free to share your thoughts (or questions) on any of the above with a comment below… thanks for reading!