Crisis Investing, Prejudice, 'Blink' Investing, In Addition To Ferrexpo Every Minute A Compelling Long

I similar to choke hunting for bargains inwards off-the-beaten-path places, as well as specially inwards areas of distress. When a figurative fiscal bomb goes off, I similar to run towards it.

This is non an practise inwards fiscal masochism. There is a logic to this eccentric proclivity. If yous receive got a aspect at a long term nautical chart of the S&P 500, it is fairly obvious when the best times to purchase were – they were during recessions and/or fiscal crises (e.g. 2000-03; 2008-09). That was when the best bargains were to last found. One selection is to sit down around as well as hold back for a once-in-a-decade marketplace seat downturn. Another is to actively seek out parts of the basis where downturns are already inwards motion.

This inclination Pb me to poke around as well as aspect for opportunities inwards the Ukraine. After Russia’s Chimera invasion/annexation, the economic scheme has been a mess, with the currency declining yesteryear ii thirds; the economic scheme contracting yesteryear 20%; as well as inflation reaching good into the high double digits. There were saltation to last amazing opportunities amidst the figurative (if non literal) rubble.

Unfortunately, Ukraine it is a small-scale as well as relatively closed economic scheme that is hard for non-Ukranians to invest in. My side yesteryear side pace was thence to covert for stocks domiciled inwards the Ukraine that were listed on overseas exchanges, including London. That search procedure threw upward a society called Ferrexpo (FXPO LN). Alas, it was an Fe ore company. 

Like most investors, I had/have an aversion to Fe ore companies. I combat to encounter how PRC tin proceed to import 1bn metric tonnes of Fe ore a twelvemonth – a staggering number (about 32 tonnes a second), as well as I percentage Jim Chanos' skepticism most the sustainability of China's electrical flow existent estate boom, which volition almost for sure goal inwards tears (and that is where a lot of Fe ore is going). I almost gave it a quick pass. But so it occurred to me – this stock has non 1 but two stigmas attached to it – it is inwards the Ukraine, as well as it is inwards the Fe ore business. How many investors are going to bother to aspect at it? Not many. I forced myself to receive got a closer look.

Stigma as well as prejudice inwards fiscal markets run inwards much the same agency every bit they run inwards the existent world. They are the antithesis of meritocracy, as well as they resultant inwards judgments beingness cast earlier all the facts are inwards as well as are considered inwards an unbiased manner. If yous desire to regain bargains inwards the market, it pays to maintain an middle out for widely held stigmas as well as prejudices – even ones yous concord yourself – because that is where other investors’ prejudgments are likely to receive got resulted inwards neglect as well as the associated mispricings that tin sometimes result.

What I found

I’m glad I did receive got a look, because what I flora at the fourth dimension (August 2016) was really interesting:

*As a commodity exporter, FXPO earned unusual exchange, whereas a lot of its costs were denominated inwards Ukrainian Hyvnia. Consequently, its USD-denominated production costs had fallen sharply amongst Ukraine's currency devaluation, as well as its margins were benefitting. In addition, its operations were located inwards regions unaffected yesteryear the Chimera conflict. Ironically, FXPO was really doing better because it was based inwards the Ukraine, non worse. Indeed, the costs savings were so important that FXPO had choke the lowest cost pellet producer inwards the world.

*Secondly, the society was primarily a producer of Fe ore pellets – a relatively small-scale business office of the global Fe ore marketplace seat – non Fe ore fines, for which the Pilbara is famous. Pellet production requires both higher character ore every bit good every bit important as well as expensive processing installations, as well as non much of the latter was beingness built given the nation of Fe ore prices (US$50/MT at the time) as well as full general pessimism towards the industry's outlook. Also interesting was that the total global provide of pellets had only risen yesteryear most 50% during the yesteryear decade, compared to many multiples for fines, as well as comprised only most 10-15% of the overall Fe ore marketplace seat yesteryear volume. The potential 'decoupling' of need as well as provide dynamics inwards this niche segment was intriguing.

*Thirdly, 1 of the largest as well as lowest-cost pellet suppliers inwards the basis was the Vale-BHP Samarco JV inwards Brazil (20% of global supply), as well as every bit many receive got no doubtfulness read most inwards the fiscal press, this functioning suffered a major tailings dam failure inwards tardily 2015 that resulted non only inwards a major ecological disaster, but also a mine shuttering that had removed 20% of the global pellet provide from the market. A quick google search revealed that the earliest production was expected to resume was mid 2017, as well as extensive farther delays were quite possible, if non probable. A abrupt as well as unexpected 20% reduction inwards provide is unremarkably a expert affair for prices. Pellet premiums (above base of operations 62pc Fe fines prices) were starting to rise, as well as at that spot was a strong declaration to last made that that would continue, every bit this sub-segment of the Fe ore marketplace seat tightened.

*Forthly, based on the company’s lately released 1H16A result, the stock was trading at a PE multiple of most 3-4x the company's recent earnings run-rate, fifty-fifty with average 62pc Fe fines prices averaging only US$50/MT (well off their highs), as well as with TTM pellet premiums having averaged levels significantly below spot premiums (as at August 2016).

A xv infinitesimal question process

The story seemed compelling as well as I directly bought some shares. Indeed, I bought my starting fourth dimension block of shares inside xv minutes of starting fourth dimension looking at the company, every bit the higher upward factors chop-chop became evident. This is my fastest turnaround betwixt uncovering as well as purchase to date. The master purchase was small-scale – most 20bp of the fund – as well as I later did a lot to a greater extent than run to confirm my initial judgment earlier increasing the seat size meaningfully (subsequently to most 3-4% of the fund, acquired betwixt 62-75p). However, this sense drives dwelling yet over again something I receive got come upward to strongly believe with investing - that to a greater extent than data or a to a greater extent than extensive question procedure does non necessarily Pb to meliorate investment decisions or outcomes, as well as is simply non necessarily to brand a lot of coin inwards markets. All yous involve to know is what is genuinely important, as well as yous also involve an might to ignore everything else, which is unremarkably irrelevant dissonance (and at that spot is a lot of irrelevant dissonance inwards markets). 

I desire a stock to last so patently inexpensive that I tin determinate almost instantaneously that it is a buy, inwards Malcolm-Gladwell-style ‘blink’ fashion. Many of the world’s greatest investors, such every bit Buffett as well as Greenblatt, are similarly minded inwards this regard. Buffett is famous for making decisions inside 10 minutes. He bought a US$500m seat inwards PetroChina inwards 2002-03 after doing petty to a greater extent than than reading company’s the annual report. He sold his seat inwards 2007-08 for US$4bn (the lx minutes or so it took him to read the annual study was a fairly productive hour). 

People familiar with my prior run every bit a securities analyst volition regain this quite ironic – I was famous for writing extremely long as well as detailed notes (I wrote a 70pg quarterly resultant Federal Reserve annotation once). However, with my investments, I unremarkably know almost directly whether something is a purchase or not.

What I also flora that was less relevant

The other directly observable but less relevant fact was that the stock had already rallied from a depression of 12.5p inwards Jan-Feb 2016 to most 70p at the fourth dimension I starting fourth dimension looked at it inwards August. I.e. the stock had nearly 6-bagged inwards the prior vi months. As a value investor that likes to purchase grapple issues, it is piece of cake to last psychologically deterred yesteryear this. After all, you've already missed a 500% return.

What I receive got discovered through long as well as painful sense is that at that spot are ii piece of cake mistakes to brand inwards markets – the starting fourth dimension is to purchase a stock (or last influenced to purchase a stock) exactly because it has fallen significantly from its recent highs; as well as the 2nd error is to not purchase a stock (or last influenced to non purchase a stock) exactly because it’s gone upward a lot from its recent lows.

The old error – aka ‘bottom fishing’ – is specially unsafe because hither yous are non exactly looking at the prospect of a missed opportunity, but also the prospect of losing existent money. Seth Klarman set it best – you should purchase a stock non because it’s down, but because it’s cheap. Stocks tin significantly overshoot on the upside, so 1 should non assume a stock is inexpensive simply because it has fallen 30-40% from its highs. Indeed, old marketplace seat darlings that receive got already de-rated 30-40% from their highs are oftentimes the most hazardous stocks to buy, because these issues receive got unremarkably already been picked over yesteryear many investors as well as sell-side analysts as well as were formerly good owned. If a stock such every bit this is going down, at that spot is probably a expert argue for it, as well as those reasons may non yet last fully visible to outsiders. Caution is good advised. One expert antidote is to compare a stock non to its recent highs, but to its prior cycle lows.

The latter error is non buying something exactly because it has gone upward a lot from its recent lows. This is the mirror icon of the higher upward mistake. This error lies inwards the ‘errors of omission’ campsite – i.e. no coin is wagered as well as thence no coin is lost, but important potential gains tin last foregone. But stocks tin also overshoot significantly on the downside, as well as soundless last inexpensive despite important recent gains. A useful antidote is to compare a stock non to its recent lows, but to its old cycle highs. That helped. FXPO was soundless to a greater extent than than 75% off its prior highs. This procedure is soundless irrational, but it's slightly less irrational, as well as so it helps.

Fortunately, I’ve made a lot of mistakes every bit an investor over the years, which has battle-hardened me into a meliorate investor (there are no curt cuts inwards this business, as well as most lessons involve to last learned - or relearnt - the hard way). Fortunately, I didn’t receive got to to relearn the error over again with FXPO, as well as plowed inwards with alacrity despite the important YTD gains. 

Recent updates

Since my master purchase inwards August 2016, FXPO has moved upward to 166p – a 137% gain. Luck has played a usage – Fe ore fines prices receive got risen unexpectedly (to me) from US$50/MT to US$85/MT. That was non business office of the thesis, as well as it for sure didn't make whatsoever harm. However, pellet premiums receive got also risen from US$20-30/MT to US$45/MT - something that was much to a greater extent than predictable. And to a greater extent than generally, a truism is that good things tin lead house to inexpensive stocks.

FXPO lately announced its Dec-16 one-half operating results, as well as it tin last easily inferred from the motion inwards the company's cyberspace debt seat during the one-half that the society generated US$196m inwards equity FCF inwards the 2nd one-half alone. That is a non inconsiderable amount for a society with a US$1.2bn marketplace seat capitilisation (and US$1.8bn EV) at introduce (at 166p). Furthermore, that was inwards a one-half where base of operations 62pc Fe fines prices averaged only US$65/MT – significantly below spot levels of US$85/MT. I directly bought to a greater extent than at 132p. The marketplace seat took a few days to make the math as well as cotton wool on, but the stock so started to displace higher. 

In my view, it soundless hasn't moved enough. The market's math is improving, but it is soundless a scrap slow. FXPO’s all inwards cost of production (including D&A, SG&A, royalties, etc) is most US$50-60/MT at present. Pellet premiums receive got reportedly reached every bit high every bit US$45m/MT of late, as well as the spot Fe ore fines cost is currently US$85/MT. FXPO’s ASPs are thence likely approaching US$130/MT at introduce (85 + 45). I volition usage US$120/MT ASPs as well as US$60/MT inwards costs to last conservative. This suggests they should last making most US$60/MT inwards operating profits at present. 

Meanwhile, FXPO produces around 11.5m MT a year. Last I checked, 11.5m x US$60m = US$690m. At this earnings run-rate, the society is trading at exactly 2.5x EV/EBIT, as well as volition last able to pay downwards its US$600m of remaining cyberspace debt inside 12-18 months (after factoring inwards involvement costs as well as tax) if electrical flow prices hold. This is likely to de-risk the equity as well as resultant inwards a re-rating.

I also guess FXPO's total deployed working capital alphabetic character - 1 time forex translation marks are excluded (which are an accounting fiction) - to last US$2.5-3.0bn (including debt). For the lowest-cost producer inwards the basis of pellets at present, with an extremely long reserve life, replacement cost should stand upward for an absolute flooring on valuation. If Fe ore prices tin rest high for a spell as well as they tin pay downwards the concluding of their debt, this advise at that spot is soundless 100-150% upside from electrical flow prices. A US$2.5-3.0bn EV would also soundless only stand upward for most 4x the company's electrical flow EBIT. Per-tonne margins volition likely autumn over time, but the society would also similar to expand production to 20m MT, which volition likely human activeness every bit a partial offset.

What’s the downside? I shout back Fe ore fines prices are quite likely to autumn dorsum towards US$50/MT over time, as well as could make so at whatsoever moment. I could last wrong, yet (I promise I am). Pellet premiums volition likely also eventually normalise – to mayhap US$25/MT. If both of these things occur, FXPO volition brand a to a greater extent than normalised US$150-200m inwards NPAT excluding involvement costs (i.e. after debt is paid down). This is soundless quite satisfactory relative to the company's US$1.2bn marketplace seat cap, as well as implies a reasonable amount of downside protection is inwards place.

Of course, the stock volition likely merchandise downwards if spot Fe ore prices curlicue over. That is the biggest curt to medium term percentage cost risk. However, inwards the curt term, the chance is mitigated yesteryear the company’s upcoming FY16E result, which is likely to highlight to investors to a greater extent than clearly exactly how much coin this society is making at present. I soundless similar the risk/reward. 

Portfolios I deal proceed to maintain a 4-5% portfolio seat inwards the name.

Comments welcome.

LT3000

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