Weekly Bulletin #13
Weekly Bulletin #13
Portfolio: DOLE, PANR, YCA | Monitoring: APF.LN | Developing: Berkshire Hathaway's bets in Energy & Special Situations (CVX, OXY, ATVI)
Disclaimer
Value Situations is NOT investment advice and the author is not an investment advisor.
All content on this website and in the newsletter, and all other communication and correspondence from its author, is for informational and educational purposes only and should not in any circumstances, whether express or implied, be considered to be advice of an investment, legal or any other nature. Please carry out your own research and due diligence.
Model Portfolio Updates
There are brief updates for three of the Model Portfolio names from last week:
DOLE
Dole Plc (DOLE) peer Fresh Del Monte Produce Inc (FDP) reported Q1 FY22 results last Wednesday, with revenues +4.5% in Q1 YoY but gross margin down ~14% and EBITDA down ~24% primarily due to inflationary cost pressures, as CEO Mohammad Abu-Ghazaleh explained:
During the first quarter, our net sales increased by $49 million compared with the prior-year period – a direct benefit of leading the industry in the implementation of inflation-justified pricing actions. However, our cost of product sold increased by $64 million due to across-the-board inflationary pressures, resulting in lower operating income.
FDP’s stock closed down -3% on the update, while DOLE’s shares closed flat, with investors seemingly holding off a direct read across for DOLE, perhaps based on previous quarters’ divergent experience between the two companies (as I highlighted here).
DOLE announces Q1 FY22 results on 24 May pre-market opening, and I expect DOLE’s Q1 performance to have held up better than FDP for the reasons outlined before (scale advantage, superior supply chain, more diversified operations and better management) - an expectation not reflected in the current valuation, with DOLE valued at 6x LTM EBITDA vs. 9.4x for FDP.
PANR
Last Wednesday, Pantheon Resources Plc (PANR) disclosed a further partial conversion of the convertible bonds held by Heights Capital Ireland LLC.
Heights exercised conversion rights in respect of $3.8m of principal, resulting in the issuance of ~3.7m new ordinary shares. Following this, the outstanding principal on the converts is ~$46.6m. The timing of this conversion by Heights is conspicuous following the recent webinar and resource upgrade, and I view this as a further vote of confidence at to the enormous value gradually being unlocked by management.
Separately, last week I published my updated valuation analysis on PANR, in which I outlined how I now value PANR’s equity at ~£6/share (vs. current price of ~£1.30) in a Base Case, and comfortably above that level including the to-be-tested Theta West UBFF and Kuparuk reservoirs. This latest valuation analysis can be found here.
YCA
Last Wednesday, Yellow Cake Plc (YCA) announced an extension of its $3m share buyback programme. The Programme commenced on 4 April and was originally scheduled to run for an initial period of 30 calendar days, which has now expired.
During the initial programme, YCA purchased in aggregate 432,331 shares for $2.3m at an average price of ~£4.23. The new extension period is for another 30 days, during which the Company will seek to deploy the remaining $0.7m of unspent buyback funds. YCA’s intention is to buyback shares when the market price is at 10%+ discount to PF NAV.
Current PF NAV is ~£4.64/share after the buybacks and based on last Friday’s closing price YCA is trading at a relatively steep ~17% discount to NAV (0.83x NAV) following the uranium and wider mining sector sell-offs recently. This discount seems anomalous given the Sprott Physical Uranium Trust (U.U / SRUUF ) currently trades at 0.95x, with both vehicles having the same risk exposure.
Following the extension announcement, YCA bought back a further ~135k of stock over three separate tranches, at an average price of ~£3.92/share (~£527k deployed) as management sensibly look to close the valuation gap.
Situations Monitor
In Weekly Bulletin #12 I highlighted green-metals focused royalty company Anglo Pacific Group Limited (APF - APF:LN / APY:CN) as an interesting potential play on an expected green metals shortage.
Last week I noted an interesting Bloomberg article that further indicates a positive set-up for this theme, and by extension APF. In the piece, Bloomberg reported that the outlook for lithium producers is strengthening due to the soaring demand for electric vehicles, stating that:
The popularity of electric vehicles has driven prices for battery metals sharply higher, even sparking fears of shortages of materials like lithium, cobalt and nickel.
The article cited two listed companies that are set to benefit from this situation, namely Albemarle Corp (ALB), the #1 lithium miner and Livent Corp (LTHM), the #3 player. Notably, both these capex-heavy producers trade at growth-y multiples of 19.3x and 14.4x NTM EBITDA respectively. By comparison, the capital-light APF, with no mining or operational risks given its royalty model but which should benefit from the same EV tailwinds, trades at just ~6x NTM EBITDA. Of course, this isn’t a straight apples-to-apples comparison (comparing miners to a royalty company) but it is at least broadly comparable. And as I highlighted last week, the more comparable metals royalty companies trade at similarly high NTM multiples of ~18x, suggesting real upside re-rating potential for APF as the green metals thesis plays out.
I should point out that APF currently does not have a lithium royalty asset, but 50% of its portfolio value is derived from cobalt, which is a key metal used in lithium-ion batteries which power EVs (as well as cell phones, laptop computers, and other consumer electronics devices). So increased demand and usage of lithium should also drive increased demand for cobalt, and is therefore supportive for APF’s cobalt-related income stream.
With respect to cobalt itself, one point to note is that cobalt mining is controversial, with ~70% of the global cobalt supply coming from the Democratic Republic of Congo (DRC). This is problematic in that as well as representing both supply concentration and political risks for EV manufacturers, ongoing worker exploitation and abuse (including child labour) is also an issue in the DRC, making ethical supply an important consideration for auto manufacturers. By contrast, APF is insulated from these risks in that it has no exposure to the DRC, with its key cobalt asset being a 22.8% stream from the Voisey’s Bay nickel-cobalt-copper mine in Canada, operated by Vale SA, the multinational mining major.
From my initial review, APF appears to be a very interesting potential value situation and so merits a place on my idea bench.
Developing Situations
Berkshire Hathaway’s recent Annual Shareholder meeting was well reported on as usual, with interesting comments from Warren Buffett and Charlie Munger on various topics including bitcoin, the current casino-like market environment and how inflation “swindles” investors. However, in my view the most interesting takeaway from the Berkshire meeting was the manner in which Berkshire deployed $51.1bn into US equities during Q1, a time when the S&P 500 declined ~5%, and during which the global economy (and the world more generally) became much more uncertain due to rising interest rates, rampant inflation, the war in Ukraine and fears of slowing economic growth as a result of these factors.
Berkshire invested a gross $51.1bn in US equities, or ~$41bn net following ~$9.7bn in sales of other equity holdings in the quarter. This seems somewhat curious given that mid-quarter in February, Buffett lamented how inflated equity valuations were, writing in his Annual Shareholder Letter:
Our second choice is to buy non-controlling part-interests in the many good or great businesses that are publicly traded. From time to time, such possibilities are both numerous and blatantly attractive. Today, though, we find little that excites us.
(emphasis in bold above mine)
So in the space of a few weeks Buffett seemingly shifted from a position of seeing little of value to pursuing Berkshire’s most active quarter since 2008 for investing in public equities. Does this then suggest Buffett is now more positive on US equities and economic prospects? A quick dissection of the actual positions acquired implies a clear NO in my opinion.
Of the net $41bn invested in Q1, ~$31bn / 76% of this capital was deployed across just two themes or strategies:
~$27bn invested in energy inflation, specifically incremental investments in two existing O&G positions held by Berkshire - Chevron (CVX) and Occidental Petroleum (OXY).
~$4.7bn invested in a special situation, a merger arb trade on the Microsoft / Activision Blizzard (ATVI) acquisition.
Firstly, regarding the energy investments, Berkshire was already an investor in CVX and OXY, but massively increased its ownership in both during Q1. At the end of last year, Berkshire reported a ~$4.5bn position in CVX; this was increased to a ~$25.9bn position during Q1 as disclosed in the 10-Q, making it Berkshire’s fourth largest public equity position.
Similarly, Berkshire was an existing investor in OXY, holding $10bn in preferred stock and ~83.6m in share warrants through its financing of OXY’s acquisition of Anadarko Petroleum in 2019. Through March this year, Berkshire invested ~$7.1bn in OXY common stock, and following a further top-up investment of ~$336m disclosed just last Wednesday, Berkshire has now spent ~$7.5bn on OXY stock YTD and owns ~15.2% of the company (a ~$9.2bn position excluding the prefs at the current OXY stock price), which increases to an effective 21.6% total interest including the warrants.
The scale and sector concentration of these investments clearly indicates Buffett and his investment team at Berkshire have a high degree of conviction in the energy inflation theme, and specifically rising O&G gas prices.
The next largest investment from Q1 is an enormous special situations trade, being a merger arbitrage play on Microsoft’s proposed ~$69bn acquisition of video game developer Activision Blizzard. Again Berkshire was an existing investor in ATVI, holding ~1.87% of the company at the end of 2021. During Q1 however, Berkshire acquired an incremental ~7.6% or ~59.5m shares of ATVI as an explicit arbitrage play, which at an average share price of ~$80 during Q1 implies a ~$4.76bn investment. This must rank as one of the largest merger arb trades in recent times, and Buffett specifically stated at the shareholder meeting that this was one of his investment decisions rather than one by his investment managers:
“It is my purchases, not the manager who bought it some months ago … .If the deal goes through, we make some money and if the deal doesn’t go through, who knows what happens.”
Merger arb is a classic special situations strategy, and a key one employed by Buffett when he ran the Buffett Partnership funds during his pre-Berkshire days, when “Workouts” (as he referred to merger arbitrage and other special situations strategies) comprised 30%-40% of the Partnerships’ assets. Merger arbitrage (aka risk arbitrage) involves buying stock in a company that is the subject of a takeover in an attempt to capture the “spread” between the current market price of the target and the proposed deal price announced. As such it is an absolute return strategy with a low correlation to the wider equity markets. The the principal risk with the strategy is if the deal fails to close (e.g. due to antitrust concerns, deal termination etc.) and the target’s stock price declines in response to this.
Workouts have proven to be a highly successful strategy for Buffett and Berkshire over the years, with Buffett himself estimating that over a 65 year period to 1988, his workout trades produced an average unleveraged annual return of 20%, with Berkshire achieving a 53% return on its arbitrage book in 1988 during the height of 1980s junk bond-takeover boom). Indeed the usefulness of merger arbitrage as an investment strategy is perhaps best summed up by Buffett in his 1988 Shareholder Letter:
“Give a man a fish and you feed him for a day. Teach him how to arbitrage and you feed him forever.”
Coming back to the current ATVI trade, if the deal closes at $95/share Berkshire will earn a ~20% / 1.2x MOIC return on the arb portion of its ATVI investment or ~$950m; if the deal closes by 31 December this roughly equates to a ~24% IRR on the arb trade, in line with Buffett's historic average workout performance.
I think it’s worth noting here that Buffett and Berkshire have a totally unique investment mandate unlike that of any other institutional investor, given the scale and nature of Berkshire’s operations. Therefore I’ve always believed one cannot extrapolate Berkshire’s investment activities as being appropriate or suitable for others, despite the widespread coat-tailing of Berkshire by many in the investment community.
That said, I think Berkshire’s very significant investments in energy and merger arb in Q1 offer an insight into Buffett's current perception of market risk and how he’s tilting his portfolio accordingly - rather than these reflecting bullish market sentiment, I interpret these as being defensive and tactical in nature, along the following rationale:
The investments in CVX and OXY provide exposure to rising oil and gas prices, and so are energy-inflation positions or even hedges, implying Buffett sees sustained high energy prices in the coming years.
The wider equity markets remain very expensive with little value to be found, and so Buffett sees special situations such as merger arb as an area of opportunity, offering attractive risk-adjusted returns uncorrelated with a highly risk and overvalued equity market.
Coincidentally, this market perception chimes with my own - as I’ve written previously, I believe the types of special/value situations that I write about in this newsletter provide highly attractive and actionable opportunities regardless of where the wider market ends up going. Some recent energy and special sits ideas that I’ve featured in the newsletter include:
Alphamin Resources Inc (AFM) - leading tin mining company currently in play, subject to takeover discussions.
Hibernia REIT Plc (HBRN) - an Irish office REIT at a steep discount to NAV - this idea recently played out as I expected when Brookfield announced a takeover in March, with indicative return on my idea of ~34.8% IRR / 1.35x MOIC.
Kenmare Resources Plc (KMR) - a leading mineral sand miner that has reached an earnings inflection and is now a likely takeover target.
Pantheon Resources Plc (PANR) - an enormous oil asset play, with eventual sale/takeover catalyst.
Wickes Group Plc (WIX.LN) - undervalued spin-off situation, mispriced due to non-fundamental selling.
Yellow Cake Plc (YCA) - uranium/nuclear energy commodity play.
Reflecting on Berkshire’s latest equity activities re-confirms my view that selected special situations are the best pond to fish in for ideas in the current market, particularly in the area of real assets (including energy-related commodities).
In this regard, I am working through a pipeline of ideas that fit this framework and from which I’ll be publishing what I believe are some very interesting and actionable situations in the coming weeks.
Any Other Business
Sticking with Berkshire Hathaway-related matters, for this week’s AOB I thought I’d highlight the At Home Podcast’s interview with Ted Weschler, one of two investment managers hired by Warren Buffett to co-manage Berkshire’s public equities portfolio.
In the interview, Ted discusses his background, working at Berkshire and how he makes investment decisions among other topics.
Regarding APF - why do you look at EBITDA instead of NAV? Their mines have finite lives so no matter how cheap on EBITDA you are paying, what matters is how much EBITDA you have left...