International Trade and Investing

It is useful to develop "long view" before investing - to identify long-term trends which influence national economies and the prospects of individual companies.

A recent addition to my reading list is resourcetrade.earth, a site which is maintained by Chatham House, one of my go-to sources of information for "the global view".  You can read about resourcetrade.com here: https://resourcetrade.earth/about#section-5

Resourcetrade.com says of itself:

The volume of natural resources traded globally has increased over 60% since the turn of the century, reflecting and reinforcing new economic and geopolitical realities and bringing new environmental and social challenges – as well as opportunities. Now everyone can explore these fast-evolving dynamics through Chatham House’s comprehensive and accessible data and insights into resource trade.

Via an interactive section of the site, you can explore trade patterns for various commodities, including: export/import sources, destinations, values and volumes; environmental impacts associated with various commodities; national indicators of the importance of exports/imports to national economies; and, other indicators of a country's performance.  It is revealing.  If anything, it effectively demonstrate the interconnectedness of world trade.  

Another feature of the site is its "Stories" section which features insightful articles on resource exploitation and trade.  An inaugural article entitled, Food security, trade and its impacts, introduces the topic with the following paragraph:

Our globalised agricultural system provides cheaper food for all at the same time as it allows countries with a significant agricultural economy to benefit from exports. An outbreak of protectionism affecting the key food commodities – or fertilizers – could lead to price shocks, ecological damage, and the undermining of food security for some of the most vulnerable populations.

This perked my interest.  The article is supported by extensive footnotes for those wishing to pursue the matter in greater depth.  As always, I am on the hunt for investments which could benefit from higher order long-term trends.  These tailwinds, coupled by companies with able management, good financials and products tailored to provide future benefits have the potential to reward investors richly.  

McKinsey & Company - A Great Source for Investment Ideas

I read widely.  About every month, I log into McKinsey & Company to get their take on a wide variety of topics.  I would advise readers to subscribe (free) to their offerings.  They are well presented, cogent and stretch your thinking beyond the confines of conventional thought.

Sometimes, there is a gleaming gem - in this case, an article entitled: McKinsey on Industrials - A Phoenix Ready to Rise Again (January 2017).  The purpose of the report is presented as follows:

This report provides a comprehensive assessment of the sector’s historical performance and outlook. It begins with an analysis of the overall sector’s performance over the past 15 years, including the three distinct economic profit creation cycles that characterize this period. 

The analysis then de-averages performance across the different subsectors and companies to shed light on four key levers that leading Industrials companies have employed to outperform their peers. The report closes with the McKinsey perspective on the sector going forward and the strategies Industrials companies can deploy to reignite value creation.

The Executive Summary

Over the past 15 years, the Industrials sector quietly ranked third among all sectors by economic profit creation.  During this period, the sector also outperformed the S&P 500 on margin improvement and total return to shareholders (TRS).

The past 15 years were not, however, a single period but were instead characterized by three distinct economic profit creation cycles: Rapid growth (2001–07), slump and recovery (2008–10), and flatlining (2011–15).  De-averaging economic profit creation to revenue across subsectors and companies during these cycles revealed significant performance variance within and across cycles. While three  subsectors (test and measurement, building technologies, and multi-application components) excelled, every subsector had companies that consistently created economic profit and far outperformed their peers.

Four distinct company profiles emerged based on economic profit creation through time—Leading, Rising, Declining, and Trailing. Leading and Rising companies held or extended their lead based on the management choices they made rather than their starting point. In particular, four factors separated Leading and Rising companies from their Declining and Trailing peers—the quality of revenue growth they sought, their ability to maximize margins, the soundness of the M&A strategies they pursued, and their ability to optimize resource allocation.

As the sector looks to the future, several macroeconomic trends (demographic, geographic, social, regulatory, technology, and end market) will create tailwinds for the sector. However, the willingness to make the bold management choices that differentiated performance in recent cycles and the ability to get the three “Ns” right— new offerings/business models, new capabilities, new operating models—will determine which companies profit from these tailwinds.

For me, the report was useful from a variety of perspectives:

• It shed light on approaches to assess the sustainability of enterprises over extended periods of time including factors which authors felt were most important.  Financial metrics, while important, are only indicators of the most important ingredient: the sagacity of management in making choices.  
• The report identified subsectors and companies which outperformed their peers within the industrial sector. 
• It presented a global view, reflecting the globalized economy as opposed to a more restricted national/continental view. 
• The presentation of global trends is very useful in establishing a "view" about strategic investment possibilities. 
• The report contained clues about companies able to sustain the profitability of their enterprises (and rewards to share owners) over extended periods. 

A few conclusions:

• Many of the companies noted in the report are not listed on North American exchanges and, therefore, are not generally included in reports of American analysts.  (This said, many of the companies are listed as ADR's.)
• In visiting the web sites of most of the companies, I was impressed by the international scope of their operations and the economies of scale achieved in the rollout of products and services developed through the companies' R&D activities.  This has several other aspects of interest to investors: a) some "insulation" from protectionist measures which appear to be gaining ground in reaction to "globalization" (hard to implement when companies have significant operations in a diversity of areas); geographic diversification which may offset to some extent, differences in regional economic performance.  
• The trends to automation, more effective analysis and decision-making (read artificial intelligence) and inter-connectedness through the Internet of things are well-established and represent a fertile "hunting ground" for investors.  
• The report confirmed my belief that the quality of management and its decisions are crucial to the long-term performance of a company.  These are things which are difficult to assess through the use of standard parametric measures.  Since I invest on the basis of the "long view", I place a greater reliance on identifying long-term trends and the associated demand for products and services and then searching for companies which are positioned strategically to meet those needs.  Only then will I use parametric metrics to assess the strength of a company, especially its "financial fitness". 

The report led me to investigate a few companies in more detail.  Included are:

FANUC

DUERR AG

WATERS CORP
KEYENCE CORP
THE MIDDLEBY CORP

Most of them are listed on exchanges outside of North America; however, most of them can be purchased as ADR's with the disadvantage that some of them trade thinly.  However, for those willing to take the "long view" this need not be a major disadvantage.  

Again: read the article both to appreciate the thinking process and the identification of some possibilities for investment.  

Note:  You will have to register (free) with McKinsey to access the report which can be downloaded as a PDF.  You can also register to receive periodic e-mails which address a variety of topics.  Highly recommended.  

The Changing Face of Indian Society - a few investment themes

India is a dynamic country.  Despite its reputation for corruption, over-regulation and government inefficiency, a persistent caste system, and other impediments to growth, the country is in a sense, a miracle of human co-operation.

Imagine ... a country with 1,652 languages (according to the 1961 census), more than 2000 ethnic groups, the second largest (soon to be the largest) population in the world ...  Despite these challenges, the country is held together by a few traditions which I consider are resilient to internal and external challenges.  Here are a few of the ties which bind:

• the legacy of a British legal system which is shared throughout the country (It is often plagued by corruption, inefficiency and other sins of commission, but despite this, it provides an aspirational and legal framework for societal processes.)
• an extensive rail network which connects the regions (Under tremendous pressure, it nevertheless manages to work)
• English as the lingua franca (This facilitates communication within India and with the rest of the world.)
• geography: a more or less clearly identifiable geographical unit bounded by coastlines to the east, south and west and by high mountains to the north. 

Some Investment Themes

In an effort to narrow the search, I have identified a few themes which: a) interest me personally, and b) appear to be developing trends with investment potential.

Infrastructure

Transportation: roads, bridges, rail, air - all in need of upgrading and expansion to service a growing economy

Energy: renewables, electricity distribution, efficiency, energy security (read self-sufficiency in the face of potential disruptions in the supply of fossil fuels from places such as the Middle East)

Here is a selective listing of current infrastructure projects which are currently underway.  (Note the substantial involvement of multi-national companies.)

https://www.ibef.org/industry/infrastructure-sector-india.aspx

I am exploring various ways to invest in this area: 

• multinationals that manage projects in India
• domestic companies

My sense is that domestic companies may have an edge provided that they have the financial resources and technical and managerial skills.  With this in mind, I invested in Fairfax India Holdings Corporation as soon as it was listed on the TSX.   

Fairfax India Holdings Corporation is an investment holding company whose objective is to achieve long term capital appreciation, while preserving capital, by investing, either directly or through one of its wholly-owned subsidiaries, in public and private equity securities and debt instruments in India and Indian businesses or other businesses with customers, suppliers or business primarily conducted in, or dependent on, India (‘‘Indian Investments’’).

For the most part, Fairfax appears to invest in companies which enable the development of infrastructure by providing financial services, chemicals, freight logistics, and the storage of agricultural commodities.  I like this thoughtful approach as it exposes Fairfax to opportunities in broad swaths of the India economy.  I wrote about this stock in an earlier post.  Here are the most important reasons for my investment:

• seasoned management with a sustained successful track record and a reputation for honesty 
• management which has cultural roots in India and is embedded in the country's business community
• the opportunity presented by a dynamic country with a growing economy and excellent prospects for the future
• diversification beyond North America and direct ownership in Indian companies (this as opposed to multinationals with interests in India) 

The Domestic Consumer

In my recent reading, I was impressed by a cogent article in The Diplomat (this publication should be must reading for investors seeking the "wide view").  It is entitled: 

India's Consumer Caste System. 

Here are a few excerpts: 

In other words, material wealth serves a purpose beyond financial security and prosperity — it’s also a prominent social marker. While that may not be surprising, it does seem that the instrumental value attached to affluence in India is particularly notable. According to the 2013 Ipsos Global Trends Survey, 58 percent of Indians measure success on the basis of what they own — the global average was 34 percent.

Until the 1990s, India was largely an isolated nation. Successive state leaders preferred an inward focus on economy, culture, and security. It was only when Prime Minster Narashimha Rao’s government in 1991 adopted liberalization policies — which deregulated the private sector and lowered trade and investment barriers — that India truly announced itself on the world stage.

That transformation was meteoric. For measure, the stock of foreign direct investment in India rose from just below $1.7 billion in 1991 to $206.4 billion in 2011, according to UNCTAD data. With the new funds — and global business activity, growing Internet access, and international media penetration alongside it — Indian society became increasingly exposed to new brands, cultures, and ideals.

The effects were almost immediate. India’s nouveau riche began to adopt a more cosmopolitan, and Western, tinge to their food, clothing, and lifestyle appetites. Fast-food has become a billion dollar industry, while the number of shopping malls has grown exponentially, from just a handful in the early 2000s to well over 500 today. Bollywood film plots — a bellwether for societal trends — now lead with more liberal and youth-based storylines, ahead of the conservative and family-centric plots of the early 1990s.

I would urge readers to explore the links internal to the above-noted article - absolutely fascinating.  In recent months, I have started to focus on perspectives of the artistic community as they are often more sensitive to societal change than investment apparachicks.  They have a real strength: they not only identify change - they also import meaning to that change and context.  

At present, I am exploring opportunities associated with this trend:

• branded consumer goods (beauty products, products associated with conspicuous consumption e.g. eyewear, clothing) with an international cache
• domestic brands which have status internally and cater to a growing sense of the "modern Indian self."

To this end, I've started to read national and local Indian newspapers and delve into Indian trade publications.  What a vibrant milieu: entertaining, salacious, sometimes thoughtful, always opinionated ... and a welcome diversion from the partisanship of US news outlets and the timidity of many mainstream rags in Canada which usually focus on what a neighbour of mine labels as "first world problems" e.g. triggering words and safe places for university students, the plague of rising house prices etc.  - problems which people in most of the world would love to have.  

In future posts, I will record my findings. 

John Deere - Right to Repair - Corporations versus Farmers - A Possible Solution

A case of corporate greed ... or an evolving context?  John Deere contends that it has the exclusive right to repair its tractors, citing provisions of the Digital Millennium Copyright Act (1998).  If followed to the limit, this means that farmers would have to engage a Deere service representative to make repairs to any part of the tractor system which is regulated in some way by software i.e just about everything in today's new models.

Farmers have challenged this notion and have used good old American (Ukranian) ingenuity as a workaround:

https://motherboard.vice.com/en_us/article/why-american-farmers-are-hacking-their-tractors-with-ukrainian-firmware

To avoid the draconian locks that John Deere puts on the tractors they buy, farmers throughout America's heartland have started hacking their equipment with firmware that's cracked in Eastern Europe and traded on invite-only, paid online forums.

Tractor hacking is growing increasingly popular because John Deere and other manufacturers have made it impossible to perform "unauthorized" repair on farm equipment, which farmers see as an attack on their sovereignty and quite possibly an existential threat to their livelihood if their tractor breaks at an inopportune time.

"When crunch time comes and we break down, chances are we don't have time to wait for a dealership employee to show up and fix it," Danny Kluthe, a hog farmer in Nebraska, told his state legislature earlier this month. "Most all the new equipment [requires] a download [to fix]."

Here is a link to the license agreement for embedded software that farmers are required to sign as part of their purchase agreement:
https://www.deere.com/privacy_and_data/docs/agreement_pdfs/english/2016-10-28-Embedded-Software-EULA.pdf

In addition to restrictive covenants on rights to use the software, the company has absolved itself of any substantial liability for damages caused by the licensed materials (software) - see article 9 Limitation of Liability.

Tractors and other agricultural equipment are increasingly being controlled by software.  I would argue that software is the differentiator between brands: manufacturers are in a race to develop machines which are faster, smarter and more productive.  In essence, the mechanicals have become commoditized. Parts can be bolted on - it's all about co-ordination of the moving parts.

An Inherent Risk to Deere's Corporate Policy

My belief is that Deere has fallen into the pit of having its corporate outlook shaped by MBA's and lawyers.  They seem to have ignored the perspective of their customers, the people who pay to keep them in business.  When did "muddy boots" last grace Deere's boardrooms?

An agile competitor could quickly gain a market share by adopting a different policy; namely, taking a more relaxed attitude to intellectual property.  In short order, this could generate a lot of goodwill and capture disgruntled farmers who have long memories.

Some aspects of a more enlightened policy for intellectual property could include:

• measures to prevent the appropriation of intellectual property by competitors (this is already done)
• provisions for owners to make repairs using company software (this would include feedback loops to the company so that it could identify shortcomings and improve its software)
• "rewards" for farmers and others who make improvements in software and its application
• software training for farmers (to make them more competent and generate goodwill) - this would be part of the purchase agreement and would enhance machine performance and indirectly, company reputation
• company-moderated forums (on line or otherwise) whereby farmers could share their experience

In my search for investments in agricultural equipment manufacturers, I will be mindful of more enlightened intellectual property agreements.  While Deere may win in the courtroom and legislatures in the short term, they have much to loose over the longer term, especially when confronted with more customer-oriented competitors.  

Deere's massive distribution network is often held up as a barrier to competitors, but the market is evolving to one of fewer and bigger customers, an outcome of consolidation in the the farming business.  Customers are smarter, more driven by business outcomes and less driven by loyalty.  Well funded innovators have the potential to upset what has worked for Deere and others for more than a century.  

I am on an alert to this possibility.

I am invested in Deere and Rocky Mountain Equipment, a Canadian distributor for CASE  which has a similar policy.  Both are good companies: well managed with the experience of having successfully negotiated troughs in the agricultural cycle.  In my view, they will do very well once things recover ... but ... innovation and "creative destruction" are forces which cannot be ignored.  My hope is that Deere and Case will adopt more customer-friendly policies.