Variant Perceptions

Category: Pabrai

Sinochem likes Potash Corp

The announcement is not very much of a surprise

Sinochem, the Chinese-state owned chemical group, said on Friday it would “pay close attention” to BHP Billiton’s $39bn hostile bid for PotashCorp, and added that it was “interested in overseas potash investment opportunities

Given the confrontational history of BHP with Chinese government companies, this is only just one more chapter in the battle for control of key natural resources supporting the fast growth of the emerging economy.  More interesting is the description of the distribution monopoly used to control prices and provide a stable supply of fertilizers in China.

PotashCorp has strong links with China, the world’s biggest fertiliser importer. The Canadian company owns a 22 per cent stake of Sinochem’s listed subsidiary Sinofert, China’s biggest fertiliser maker and distributor and the country’s biggest importer of Potash. PotashCorp is a leading member of Canpotex, a cartel system that Chinese buyers favour because it ensures reliable annual prices….

… China considers agricultural self-sufficiency a matter of national security, but only produces enough potash to cover about half of its fertilising needs. The country also favours the current system of annual price contracts for potash. BHP has suggested it would shake up the nearly 40-years-old potash pricing system

… Sinochem is China’s largest fertilizer distributor, and until 1998 held a government monopoly on fertilizer imports. Sinofert on Friday handles all of Sinochem’s fertilizer business, running 2,000 distribution centers throughout China. The subsidiary was listed on the Hong Kong stock exchange in 2005, and now has a market cap of HK$30bn.

This possible shake up is similar to the negotiations with BHP over iron ore. The Chinese are not standing still and they are moving to expand fertilizer capacity and access

Sinochem has been hungry for agribusiness opportunities abroad, but was humbled last year by its failure to secure a deal with Nufarm after six months of talks. After the Australian firm accepted a rival Japanese bid, Sinochem vowed to “continue to strengthen our co-operation with the world’s agrochemical enterprises and unswervingly push forward the globalization of our agrochemical business.”

China has been aggressively expanding the country’s domestic potash production, with output doubling between 2005 and 2009. China’s potash demand was 7.9m tonnes last year, down from a 2007 peak of 11.93m tonnes, said Wang Ling of China Fertilizer Market Week.

Some of you may ask why this interest in potash. Well, fertilizers is an industry close to my heart despite some people’s opinion that it is “by and large, an unexciting business” (Heidi Moore, WSJ). One person’s fish eggs are another person’s caviar. Non renewable limited resources, high barriers to entry, controlled by a few players can be a road to riches. Also, I stumbled upon one potash opportunity while researching mining stocks and with all the M&A hoopla might be time for a deep analysis. If readers have recommendations in the phosphate or potash industries I would gladly take a look.


Bloomberg on Potash

Short Bloomberg video on the importance of Potash

Fertilizer industry prospects

As part of the rejection of BHP’s acquisition proposal, Potash Corp (POT) released an interesting report about the fertilizer industry and its prospects. On the question of why a mining company could be interested in the fertilizer industry, it is worth remembering that this business is segmented in the three primary crop nutrients (nitrogen, phosphate and potash) and potash in particular is mined. Potash Corp controls 22% of the worldwide potash production capacity.

As side notes, Potash Corp is one of Mohnish Pabrai largest holdings and is interesting to see SQM, one of my first investments, as part of the melodrama. SQM is one of several minority participations that, according to Potash Corp, BHP’s offer is not valuing at their true worth.

The key phrase in the presentation?

Industry characterized by substantial barriers to entry, few producers and no known product substitutes

No position

The Great Gift of Uncertainty

Continuing with the short posts until I finally manage to transition to the new laptop. Peter Bernstein’s “The Great Gift of Uncertainty” describes the views on risk and uncertainty of two stubborn economists with strong ideas about almost everything, usually on opposite sides of the argument, that had to live in very uncertain times. And I think it is a good reminder that traditional value guidelines like cheapness, quality or downside protection are probably better compasses that inflationary and deflationary macro views that change with each new piece of information.

Turnaround Cases: Penn Traffic ($PTFC)

Let’s make a break with the Premier Exhibitions series. While doing some well deserved procrastination, I crossed paths with Penn Traffic Co a supermarket chain filling for chapter 11 a couple of days ago.

Retail is combat sport. Having worked for a very successful and admired retailer I learned to never start a retail business and to avoid investing in one. Why not?

Another big problem with retail is the transparency of the business. Sam Walton spent thousands of hours inside his competitors’ stores. It’s virtually impossible to have any trade secrets in retailing. Your competitors can walk into your stores and, in about 15 minutes, understand your entire business-model advantage and how to replicate it. There are very few industries that are as openly transparent, and that’s problematic for the long-term investor. – Pabrai

Large retailers are constantly trying to pick the next good location while running out of space to grow, with the competition right behind them, and paranoid of the possible appearance of a new demographic trend. “Location, location, location” and “retail is detail” does not seem too much of a competitive advantage. Because of this, retail is a low margin business with little margin for error.

It is also a business that heavily depends on the trust and credit of its suppliers. Suppliers do not want to be the last one standing with distressed receivables so in difficult times retailers can suffer the equivalent of a bank run and swiftly collapse. This makes turnarounds in retail particularly difficult.

After that nice intro you might wonder what intrigues me about Penn Traffic. Actually, it is a very good case study of what you want to avoid in a turnaround investment: a marginal business in a difficult industry. But it may also be, and may is the key word, a liquidation opportunity. To get up to speed you can find a couple of good VIC reports here and here. (subscription free)

Penn Traffic is what I call an unrepentant alcoholic with their third trip into chapter 11: not an unusual record in retail. The reasons for their problems are the two Ws: Wal Mart and Wegmans, two of the strongest retailers out there. Meanwhile, Penn Traffic has to compete with a unionized work force and small stores in suburban locations (approximately 35K ft per store).

During their previous chapter 11 they sold Big Bear their crown jewel: a bad sign. Asset divestments are common in turnarounds but you want the company to sell their marginal assets not their core. If they were forced to sell their core assets, it is very probable that their marginal assets were un-sellable.

I would say that at its current stage, Penn Traffic could still be interesting as a liquidation play and as a potential case study on the margin of safety provided by real estate assets. It still owns 17 stores and 2 shopping centers whose value is not reflected in the books, with a market value probably north of $50 million.

However, we have also to take into account the long term leases. These can be undone or renegotiated in Chapter 11 but I would be much more comfortable if the company manages to sell those stores. In the case of Penn Traffic:

I have not done the heavy lifting yet. However with the leased stores shopped around, hidden assets potentially way north of $ 50 million and still reporting $15 million of book value there might be something there for a company valued at $15 million $1.5 million. Buyer beware, bankruptcy is a highly uncertain process and I am definitely no expert.

Would love to discuss this idea with readers more informed in liquidation plays.

No position

Pabrai on checklists

Pakiya Funds is an interesting new blog. I have followed his posts in Seeking Alpha and they are insightful. What else can I say, he recommends Wellcare, Global Ship Lease and Constellation Energy Partners. He MUST be insightful.

He also provides a link to a Mohnish Pabrai pdf on the use of checklists. Recommended

Charlie Munger is famous for saying that investors should use a checklist for selection of companies to invest in. Mohnish Pabrai recently presented on the lesson he learned from the 2008 Credit Crisis and talks about his process for creating his extensive investment checklist.