Good Reads 3 - February 2019

Nowhere is the impact of Trump's tariffs presented better than here:

Tariffs Hurt the Heartlands

Surf the site and note the bi-partisan nature of a growing groundswell of opposition to the tariffs.  Will this force Trump to reverse his ill-advised policies?  I think "yes".  A serial bankruptcy artist hardly qualifies as a figurehead for the American economy.

Hemp Report

The hemp industry is on the point of a major expansion.  Why?

• a change in regulations both federal and state
• the emergence of CBD for medical use
• a desire on the part of farmers to diversify and exploit new market opportunities

An interesting observation about the role of regulation:  While many decry regulation by government, there is ample evidence that government regulatory standards for quality can actually confer a marketing advantage to producers.  For example, Canadian marijuana products are prized internationally because of the "government seal of approval" for growing conditions (no pesticides) and qualities such as potency.

The Value of a Picture

I like reading Musings on the Markets, a blog maintained by Aswath Damadoran.

I especially like the thinking behind one of his recent posts, The Pricing Game.  It is elegant.



The reason that I reuse this picture so much is because, to me, it is an all-encompassing snapshot of every conceivable investment philosophy that exists in the market:

Efficient Marketers: If you believe that markets are efficient, the two processes will generate the same number, and any gap that exists will be purely random and quickly closed.

Investors: If you are an investor, whether value or growth, and you truly mean it, your view is that the pricing process, for one reason or the other, can deliver a price different from your estimate of value and that the gap that exists will close, as the price converges to value. The difference between value and growth investors lies in where you think markets are most likely to make mistakes (in valuing existing assets or growth opportunities) and correct them. In essence, you are as much a believer in efficient markets as the first group, with the only difference being that you believe markets become efficient after you have taken your position on a stock. 

Traders: If you are a trader, you start off with either the presumption that there is no such thing as intrinsic value, or that it exists, but that no one can estimate it. You play the pricing game, effectively using your skills at gauging momentum and forecasting the effects of corporate news on prices, to buy at a low price and sell at a high price.

Market participants are most exposed to danger when they are delusional about the game that they are playing. Many portfolio managers, for instance, claim to be investors, playing the value game, while using pricing screens (PE and growth, PBV and ROE) and adding to their holdings of momentum stocks. Many traders seem to think that they will be viewed as deeper and more accomplished if they talk the value talk, while using charts and technical indicators in the closet, to make their stock picks.

Take-away message

When assessing a potential investment one should be flexible and approach the analysis from a variety of perspectives.  All too often, a one-size-fits-all approach will either expose one to undue risk or miss opportunities for profit.

Thinking About Investment Leads

It's always interesting to learn from another person's perspective on potential investments.  Here's one take by a venture capital firm:
Collaborative Fund - about
It's worth exploring the web site.  For example here are a few leads:

And we’re not alone. We increasingly see more investors joining us at the intersection of for-profit and for-good. Established partnerships like Sequoia Capital and Founders Fund have evolved to stress world-changing aspirations. New entrants like Obvious Ventures, Social Capital, Sherpa Capital, and others have joined the fun as well.

Recession Risk 

Two articles about the risk of a recession.  To my mind, it's a question of "when" - not "if".  One never gets poor by avoiding losses and as John Mauldin opines,

When people say they’re worried about holding cash, I remind them cash is an option on the future. It’s not earning very much right now but could potentially earn a lot more when you buy at the bottom.

I’m not looking at this and panicking at all. I’m rubbing my hands at the coming chance to buy solid assets cheap.

Debt-clogged world close to tipping point of recession

2019 Economic Outlook: Recession Probability, Credit Conditions And Stock Valuations

This said, economists are bad at forecasting.  However, it is useful to take a peak at their thinking in order to get a sense of the market buzz as they do influence institutional money managers.

I generally discount the "noise" produced by economists and talking heads on business networks.  For example, with agriculture, I am more interested in following indicators:

• trade barriers e.g. tariffs 
• competition between North and South America
• commodity prices
• the state of farm finances and sentiment in the farming community

Good Reads 2 - February 2019

The EU looks like the Soviet Union in 1991 – on the verge of collapse

An interesting piece by George Soros.

Europe is sleepwalking into oblivion and its people need to wake up before it is too late. If they don’t, the European Union will go the way of the Soviet Union in 1991. Neither our leaders nor ordinary citizens seem to understand that we are experiencing a revolutionary moment, that the range of possibilities is very broad, and that the eventual outcome is thus highly uncertain.

The Major Players in Agri-Finance

The types of players include banks that specialize in agricultural loans, nonbank finance companies that do land and equipment loans, farmer-owned lending co-ops, REITs that own and manage farm real estate, private equity funds that buy cropland, sovereign wealth funds, and, of course, pension funds.

There are some interesting investments leads in this crop but some of them will need a more vibrant agricultural economy to produce profits for retail investors.  Best to look now and winnow down the list in order to be positioned for better times.

For example, farmland values have declined in line with commodity prices as noted by Farm Credit Services of America.

Farm Values Soften

Compared to the market’s peak, farmland values are down 19.5 percent in Nebraska, 18.1 percent in Iowa and 12.0 percent in South Dakota. Continued pressure on profit margins could lead to additional softening in 2019. However, the same factors that have helped to stabilize the market for the past three years remain in place, including interest rates near historic lows and strong demand for quality land that is in tighter supply.

Canadian Canola Runs into Chinese Delays After Huawei Arrest

 A political dispute between China and Canada over the arrest of a Huawei executive is slowing canola shipments through Chinese ports and causing some importers to hesitate to buy from their biggest supplier, according to interviews with a dozen traders.

Fairfax India Holdings Corp.

Fairfax India Holdings Corp. (FIH.U)

Fairfax India Holdings Corporation (“the company” or “Fairfax India”) is an investment holding company whose objective is to achieve long term capital appreciation, while preserving capital, by investing 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”). The company makes all or substantially all of its investments either directly or through one of its wholly-owned subsidiaries, FIH Mauritius Investments Ltd (“FIH Mauritius”) and FIH Private Investments Ltd (“FIH Private”).

Fairfax Financial Holdings Limited ("Fairfax") is Fairfax India's ultimate parent and acts as its administrator. Fairfax is a holding company which, through its subsidiaries, is principally engaged in property and casualty insurance and reinsurance and the associated investment management. Hamblin Watsa Investment Counsel Ltd. (the “Portfolio Advisor”), a wholly-owned subsidiary of Fairfax and registered portfolio manager in the province of Ontario, is the portfolio advisor of the company and its consolidated subsidiaries, responsible to source and advise with respect to all investments.

At September 30, 2018 Fairfax, through its subsidiaries, owned 30,000,000 multiple voting shares and 21,558,422 subordinate voting shares of Fairfax India. Fairfax India’s subordinate voting shares trade on the Toronto Stock Exchange ("TSX") under the symbol FIH.U. The multiple voting shares of the company are not traded. At September 30, 2018 Fairfax's holdings of multiple and subordinate voting share represented 93.7% of the voting rights
and 33.5% of the equity interest in Fairfax India (December 31, 2017 - 93.6% and 30.2% respectively). See note 12 for additional details on the increase in Fairfax's equity interest in the company.
https://s1.q4cdn.com/293822657/files/doc_financials/quarterly_reports/2018/2018-Q3-Interim-Report-(FIH)-(Final).pdf

The company's financial documents are written clearly and without hyperbole.  In light of this, I will not provide a synopsis as the process of reading through them does a far better job of giving potential investors an appreciation of the company's operations.

The Investment Thesis

India has a vibrant and growing economy which should outperform most other countries on a sustained basis.

The management at Fairfax has a great understanding of the intricacies of navigating through the complexities of Indian society and has deep roots cultivated through many years of investing in the country.

Management is honest (this through years of conversations with a trusted friend in the investment business who has long-established social connections with the crew at Fairfax).

Management has "skin in the game" (see above) and as a result, will be inclined to work in the interest of share owners.

The investment model is akin to that used with great success by Berkshire Hathaway.

Commentary

1. While the price of the shares will fluctuate due to factors such as the inevitable fluctuations in Indian stock markets and currency exchange rates, I feel that the long-term prospects for sustained gains over time are excellent.
2. There are few other vehicles for North American investors to invest in India with the potential to outperform index funds and mutual funds.  
3. The recent dip in the share price represents a buying opportunity.  
4. Fairfax India will be a core holding in the Financial Log Book.  (It was a former crew member but I sold it figuring that I could time the market.  As it turned out, I got lucky ... but maybe this time I'll hang on for longer ... the eternal debate between "buy and hold" and Mastering the Market Cycle a la Howard Marks.) 

Closing Note

1. In recent years, my perspective has changed slightly.  I am biased in favour of nascent companies with innovative business models and technologies which give them a market advantage, preferably by great strategic positioning and technologies/services that confer real benefits to clients. 
2. My portfolios are concentrated:  a few well positioned companies with great management, sound financials and good strategic positioning (competitive products/services to meet the demands of an expanding market).
3. A defensive posture is being taken in light of the potential for major economic dislocation, hence investments in precious metals and what I hope will be recession resistant companies such as CO2 GRO.   
4. A list of potential investments has been assembled with the thought that I'll pull the trigger when the time is right.  In some cases, I'll ease gradually into the market and increase my stake as companies achieve various milestones.  The recent establishment of a position with Rocky Mountain Equipment is an example. 
5. A substantial cash reserve is being maintained.  It's not often that a compelling investment proposition comes into view and in today's uncertain climate it makes sense to be very selective.  
6. The writings of Howard Marks and his approach to market cycles have influenced me greatly.  In my view, it is particularly applicable to individual investors who have the capacity to develop an independent view and the agility to implement it - this as opposed to the constraints which burden the efforts of most institutional investors.

Readers will note that the portfolio has undergone a substantial change over the past 18 months with the adoption of this approach.

Noteworthy Reads I - February 2019

January 2019 Data Update 7: Debt, neither poison nor nectar!

This is a fabulous post from a blog entitled, Musings on the Markets.  It starts with:

Debt is a hot button issue, viewed as destructive to businesses by some at one end of the spectrum and an easy value creator by some at the other. The truth, as is usually the case, falls in the middle. In this post, I will look not only at how debt loads vary across companies, regions and industries, but also at how they have changed over the last year. That is because last year should have been a consequential one for financial leverage, especially for US companies, since the corporate tax rate was reduced from close to 40% to approximately 25%. I will also put leases under the microscope, converting lease commitments to debt, as I have been doing for close to two decades, and look at the effect on  profit margins and returns, offering a precursor to changes in 2019, when both IFRS and GAAP will finally do the right thing, and start treating leases as debt.

The piece is thought provoking.  For example:

Thus, if you want to argue as some have that the Fed (which is blamed for almost everything that happens under the sun), low interest rates and stock buybacks have led US companies to become over levered, you will undoubtedly point to book debt ratios to make your case. In contrast, if you have a more sanguine view of financial leverage in the US, you will point to market debt ratios and perhaps to the earnings and cash flow ratios that I will report in the next section. On this debate, at least, I think that those who use book value ratios to make their case hold a weak hand, since book values, at least in the US and for almost every sector other than financial, have lost relevance as measures of anything, other than accounting ineptitude.

The article also looks at international levels of indebtedness by country and industry - a better treatment than many I have seen to date.

I have subscribed to this blog for a few years ... one of the best in my opinion.


Political Reality Meets Economic Reality

Another tour de force by Howard Marks - a very thoughtful piece about the many facets of tariffs and thoughts about public attitudes towards the capitalist system.

I think that he has ignored some of the reasons why an increasing segment of the public is developing a jaundiced view of the capitalist system:

• the unbridled greed and self-serving attitudes of the uber rich viz. the inability/disinclination of Trump's inner circle to do anything that might benefit anyone other than the members of his club
• government bailouts of institutions which engaged in reckless risk taking at tax payer expense and the outcomes of that malfeasance which led many to lose their jobs and homes
• the hollowing out of manufacturing and globalization
• a sense that life expectations for many offspring may not match those of their parents.

On the other hand, I detect a few influences that may hamper the spirit which drives economic growth:

• a tendency for government to enact ever more measures to regulate the behaviour of its citizens - there should be a "regulation neutral" regime whereby the enactment of a new regulation would mean the repeal of one on the books (one can argue about "equivalency") - it's unbelievably hard to launch a new enterprise as red tape is increasing diverting the precious energies of entrepreneurs away from the vital task of getting new products and services to the market 
• a tendency for some media (most notably The Canadian Broadcast Corporation) to celebrate grievance and failure as opposed to "success" - the thing which makes our caring society possible 
• that many "crusaders for good" do not have skin in the game and that they are encouraged by some to make ever more demands without suffering any consequences - they willingly transfer costs to others who are less able to resist e.g. most egregious example is the banning of trade in seal fur and the devastating impact it had on Inuit communities

Marks makes a plea for a more nuanced and comprehensive discussion.  Perhaps the polarization which characterizes much of politics these days will diminish ... my hope.  

System of Rice Intensification - SRI

A recent article in The Guardian caught my attention recently:

The miracle method for sustainable rice that scientists dismissed 

An excerpt

Governments and global bodies must act too, says tropical agronomist Erika Styger, director of climate-resilient farming systems at Cornell University who led a three-year World Bank study of 50,000 farmers using SRI methods in 13 west African countries. This saw a 56% rise in yields in irrigated areas, an 86% increase in rain-fed areas and an average 41% increase in income.

It led me to investigate further by visiting the  SRI International Network and Resources Center

The results of this approach are astounding.  Here is an overview:

The System of Rice Intensification, or SRI -- le Système de Riziculture Intensive in French and la Sistema Intensivo de Cultivo Arrocero (SICA) in Spanish -- is a climate-smart and agroecological methodology to increase the productivity of irrigated rice (and, more recently, other crops) by changing the management of plants, soil, water and nutrients. Using the SRI methodology, yields are increased by 20-50% or more, while reducing inputs: seed by 90%, irrigation water by 30-50%, chemical fertilizer by 20-100%, and usually reduced need for pesticides. For the farmer, SRI brings greater returns to labor, land and capital.

WHAT ARE THE UNDERLYING PRINCIPLES OR SRI?

SRI methodology is based on four main, interacting principles:

Establishing plants early and quickly, to favor healthy and vigorous root and vegetative plant growth.

Maintaining low plant density to allow optimal development of each individual plant and to minimize competitions between plants for nutrients, water and sunlight.

Enriching soils with organic matter to improve nutrient and water holding capacity, increase microbial life in the soil, and to provide a good substrate for roots to grow and develop,

Reducing and controlling the application of water, providing only as much water as necessary for optimal plant development and to favor aerobic soil conditions.

Based on these principles, farmers adapt SRI practices to their climate zone, and to their agroecological and socioeconomic conditions. Most common adaptations respond to soil conditions, water control, changing weather patterns, access to organic inputs, the decision to practice fully organic agriculture or not, access to labor, mechanization, and other socioeconomic factors.

In addition to irrigated rice, the SRI principles have been applied to rainfed rice and to other crops, such as wheat, sugarcane, teff, finger millet, mustard, and pulses all of which show increased productivity over current conventional planting practices. When SRI principles are applied to other crops, we refer to it as the System of Crop Intensification or SCI (see SCI section of the website for details.)

The basis of the system is described as follows:

Climate of opinion is very important for promotion and sustainability of any innovation in agriculture. ‘Modern agriculture’ has proceeded from the paradigm of the Green Revolution, which specifies that productivity improvements will be best achieved by making genetic improvements in crops, and then making appropriate increases in the application of external inputs.

SRI operates from a different paradigm, positing that existing genetic potentials can produce more agronomic output and economic returns by modifying growing environments,
specifically improving soil health, root growth and performance, and inducing greater abundance, diversity and activity of soil biota. Getting these differences in paradigms understood, providing scientific evidence and explanations for their acceptance, reducing
reliance on the preceding paradigm and gaining adherence to the newer one, are all part of the process for creating ‘favourable conditions’ for SRI spread, with both short-term and
long-term impact.
http://www.europarl.europa.eu/RegData/etudes/etudes/stoa/2009/424734/DG-IPOL-STOA_ET(2009)424734_EN(PAR05).pdf

Strangely, there is almost no information about the use of this method in North America and Europe.  Wonder why?

• The present approach to agriculture generally insists on uniformity and the input of massive amounts of energy, water and chemicals to create standard growing conditions.  In contrast to the one size fits all approach, SRI demands a more nuanced methodology which appears to reduce the amount of these inputs with the attendant reduction in commercial inputs such as fertilizer.
• SRI is highly labour intensive.  Would the trade-off between increased yields but increased labour costs be applicable in most of "western" agriculture?  Is there a role for artificial intelligence and mechanization to make SRI more viable, especially with high value crops?  

Rocky Mountain Equipment - A former crew member is brought aboard

A Prolonged Introduction

I been down so long it seem like up to me - so goes the refrain of an old blues song, I Will Turn Your Money Green by Furry Lewis.

For those with the short-term view, this could apply to RME.  A look at the chart for RME shows the cyclical nature of RME's worth in the eyes of investors.  In the last 12 months the share price declined by more than 30 percent and, in contrast to most of its peers, the price has not rebounded in 2019.

However, Rocky Mountain has good bones and its management knows how to dance to the rhythm of the agricultural sector.  If RME could have a corporate poem, it would likely be this:

Sure On This Shining Night

Sure on this shining night
Of star made shadows round,
Kindness must watch for me
This side the ground. 
The late year lies down the north.
All is healed, all is health.
High summer holds the earth. 
Hearts all whole.
Sure on this shining night I weep for wonder wand'ring far
alone
Of shadows on the stars.

This was written by James Agee.  A remarkable author, he was involved with the screen play for The African Queen.  He also produced a book on share croppers, Let Us Now Praise Famous Men in concert with the famous photographer, Walker Evans.  The experience, no doubt, influenced the thinking behind the poem.

Incidentally, it has been put to music by two composers:

Sure on this Shining Light - James Barber

Sure on this Shining Light - Morten Lauridsen

I was stunned by Lisa Fischer's rendering of the song in 20 Feet From Stardom - the first time I heard it ... and perhaps the best rendition (all parts were sung by her) ... too bad that the production quality was not better.  If ever you have the chance to hear her live in concert, run - don't walk to buy tickets.

And here is Morten Lauridsen's rendition:  Lauridsen

Yes ... there's far more to life than the search for money.

Why Invest Now?  

1.   Good Bones

• Management is experienced and has a long affiliation with RME.  It understands the business - guys with "muddy boots". 
• The balance sheet is conservative.
• RME is in a position to manoeuvre: it has established an outlet for used Canadian equipment in a US farming community with needs for similar equipment - this to take advantage of currency differentials and to lower transportation costs by backhauling equipment to the US from Canada; and, it continues to acquire dealerships.
• Rocky Mountain has a record of successfully integrating new acquisitions into its network.  This reduces back office costs and enables RME to negotiate better terms with manufacturers than standalone dealers. 
• The current stock price is below book value and the P/E ratio is low in comparison with its peers.  (The recent drop in profitability is likely a transient state and I figure that it has spooked investors unduly.) 
• While its leverage is high, the debt is manageable in the present environment of low profitability.  Long term debt has slowly been reduced.   
• RME is out of favour and forward earning forecasts are not bright (as if they are ever all that accurate).  Inventories are high and the turnover rate is low in comparison with years previous with the result that it burdens carrying costs.  However, things change and Rocky Mountain is well positioned to make significant profits when things improve. 

2.   Conditions Are Likely to Change - agriculture is cyclical

• Trump is under great pressure from his key supporters to reduce tariffs on steel and aluminium - something that should benefit equipment prices as by some estimates, they have added about 5 percent to retail prices.  
• Trump's trade policies have hurt his farm community base: it appears that cracks are starting to weaken his support - pocket books trump tweets.  
• Commodity prices are low but they will recover eventually.  RME pays a healthy dividend for investors who are prepared to wait for the recovery in commodity prices.  

Where to From Here?

The following article presents a useful overview of the challenges facing farm equipment dealers at present:

Dealer Financials Improving, But More Work Needed

Although the data is from 2017, it provides a useful baseline for evaluating dealerships.  I'll use it to assess other dealership networks such as Cervus.  

This is the first foray into re-investing in agriculture.  I'm now looking closely at equipment manufacturers.  A key consideration will be their financial health.  I am mindful of the spectre of major economic dislocation as a result of trade disputes, geopolitical events and the like, and will be conservative.  The Financial Log Book portfolio has been constructed with this in mind.