Sunday, September 24

Week 325 - Sans Artifice Is The Preferred Look

Situation: Objective reality is mercenary. Business deals are largely about “transferring risk to a less knowledgeable party.” We know better than to take these things personally, but we tire of the rat race and look forward to drinking with friends on the weekend. 

We often take risks ourselves, to recover from our mistakes (divorce, buying a “fixer-upper” in a changing neighborhood, not kicking adult children out to face the world, etc.). 

To avoid becoming alcoholics or gamblers, we must tend better to our personal relationships and try not to be an avatar of money. How does one do that? Three ways: One is about the way we invest, making wise choices. That would include having a large cash position, and a nest egg of stocks and bonds that aren’t gambles. Another is in the messages we give off, the optics and emojis we emanate. Finally, we must place a high value on family life, loyalty.

We all know how to give the impression that we’re about money, which is to “dress for the job you want”. At the opposite end of the spectrum, you’ll find people who are sans artifice but steady and reliable. They don’t armor themselves in upscale clothing, makeup, or scents. Men would then find themselves leaving the suit jacket, the sport coat, the tie, the permanent-press shirt, and the shiny shoes in the closet. And maybe think about replacing that expensive ride with a Prius Two or small Tesla. 

For women, it would mean falling out of bed in the morning to compose her ensemble, which may include clothing that doesn’t cover up tattoos, no makeup, and Skechers as the default choice in footwear. Once so-attired, openness toward whomever comes naturally, without giving a thought to talking up or down to that person. 

Let’s look at the money side. What does “having a large cash position” mean? It means you either hold Treasury Bills at (and dollar-average into 2-Yr Treasury Notes as well as Savings Bonds), or you hold a large cash balance at an FDIC-insured bank. 

Why is cash important? A recent Wall Street Journal article titled “Longer CFO Tenure is Good for Companies” has a good explanation. When faced with the Lehman Panic in 2008, the CFOs who kept their jobs used good people skills to hold on with successive CEOs but also went into the crisis with large cash positions on the company ledger. Not surprisingly, the companies that have these long-tenured CFOs tend to have unusually good stock performance. Simple message, isn’t it? Good people skills combined with a propensity to hold large cash positions. And, it doesn't depend on a lot of experience. Some of those CFOs were barely 30 years old when the Lehman Panic hit. It's a matter of values.

Mission: Assemble a list of A-rated Dividend Achievers that have Tangible Book Value and also have shown less volatility than the S&P 500 Index over the past 20 years.

Execution: see Table.

Bottom Line: This is a “tortoise and hare” blog, the Central Thought being to “live long and prosper.” Use little debt and maintain a large cash position, that’s the easy part. You just need to say “no” a few times, and walk the talk (meaning no artifice or excess in your habits). The hard part is hewing to family life. Believe it or not, that’s the best way to prevent high blood pressure. I know. I’m a doctor. (Try getting through a divorce without high blood pressure.) 

For equities, the 10 stocks in the Table have returned almost 12%/yr since the S&P 500 peak on 7/19/07 vs. ~7%/yr for the S&P 500 Index ETF (SPY). For cash, the iShares 1-3 Year Treasury Bond Index ETN (SHY) has returned 2.0%/yr (vs. inflation of 1.7%/yr).

Risk Rating: 4 (where 10-Yr US Treasury Note = 1, S&P 500 Index = 5, gold = 10)

Full Disclosure: For equities, I dollar-average into JNJ, PG and NEE, and also own shares of HRL, TRV, MMM, and WMT. For cash, I dollar-average into ISBs (Inflation-Protected Savings Bonds).

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Sunday, September 17

Week 324 - Farmland REITs; Contract Farming

Situation: Farmland prices have come down over the past 3 years, reflecting the drop in prices paid for farm commodities and the resulting loss of farm income. This year’s harvest may be a record-breaker, further aggravating the problem. In central Nebraska, cropland prices have fallen from almost $11,000/acre to less than $8000/acre, and rents have fallen from almost $500/acre to less than $250/acre. Now is not a good time to speculate in farmland, unless you’re knowledgeable about local agriculture. Even then, you’d need to employ two experts: a farmland broker and a farm management company. 

Why not simply buy shares in a farmland Real Estate Investment Trust (REIT)? Until 2013, those didn’t exist. Now there are two small ones: Farmland Partners (FPI) and Gladstone Capital (GLAD). “These REITs generate income by leasing land to tenant farmers. But rents can slump when crop prices are soft.” 

The problem for investors is that there is a lot of marketing hype about the enduring and recession-resistant benefits of owning a working farm through several market cycles. But derivative ownership shares, that is, in REITs and companies having large holdings of cropland rented to tenant farmers, tend to track spot prices for the crops being harvested. Those prices vary remarkably, depending on weather, logistical bottlenecks elsewhere on the planet, and technological innovation. Trends in farmland value are closely tracked by the US Department of Agriculture, confirming that cropland rents vary more than farmland prices. 

Moving on to ranch land valuations, we again see that rents are driven by commodity prices but to a larger degree. This is because meat processing companies closely control their supplier’s use of land and inputs, so as not to be driven out of business by unpredictable oversupply or undersupply events. For example, drought or disease can cause a collapse in herds or flocks.

Over the past 50 yrs, farmland has not been a significantly more rewarding asset than stocks. For example, farmland in southwest Iowa (Audubon County) that sold for $379/acre in 1967 is now worth ~$7200/acre, giving a price return of 6.1%/yr. Compare that to the 6.7%/yr price return for the S&P 500 Index. Both asset classes produce income (rents or dividends), with farmland rents being higher than dividends on the S&P 500 Index. Total return for each asset class has been impacted by inflation, which has averaged 4.1%/yr since 1967. Cropland rents have been little better than 3%, bringing total return to 5.6%/yr after inflation. Reinvesting dividends on the S&P 500 Index over the past 50 yrs also brings total return to 5.6%/yr after inflation. 

     A: Explain the 4 ways to invest in farmland (other than buying parcels of good cropland and renting those out): Those are to buy shares in 1) a farmland REIT; 2) a land trust that rents cropland to tenant farmers; 3) a seed producer that contracts for using part of a farmer’s land for research on different genetic strains; 4) a meat packer that contracts for conditions under which a farmer will produce broiler chickens, hogs, or beef cattle.
     B: Generate a spreadsheet with valuation metrics that illustrate the benefits and risks of owning shares in each publicly-traded companies in those 4 categories.  

Execution: see Table.

        Farmland REITs: Farmland Partners (FPI); Gladstone Land (LAND).
        Land Trusts: Texas Pacific Land Trust (TPL); Alexander & Baldwin (ALEX).
        Seed Producers: Monsanto (MON); Pioneer Hybrid (a subsidiary of duPont, DD); Syngenta AG (SYT). 
        Meat Packers: Hormel Foods (HRL); Tyson Foods (TSN); Sanderson Farms (SAFM); Pilgrim’s Pride (PPC); Seaboard (SEB); Leucadia National (LUK).

Bottom Line: Farm operations are high risk endeavors. An investor can only ameliorate those risks by learning to farm, and having the good fortune to have a significant equity position in several hundred acres of irrigated cropland. That will offer the scale (and financial underpinning) needed to efficiently deploy the equipment and agronomy tools needed for precision agriculture. For those who only want “a piece of the action,” there are 10 publicly-traded stocks issued by companies that either own farmland or control the way it is used (see Table). Aside from Hormel Foods (HRL), those are high-risk stocks. 

Risk Rating: 8 (where 10-Yr US Treasury Notes = 1; S&P 500 Index = 5; gold = 10)

Full Disclosure: I dollar-average into MON, and also own shares of HRL.

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Sunday, September 10

Week 323 - “Toto, I’ve A Feeling We’re Not In Kansas Any More.”

Situation: A storm has hit international relations. It’s not as though we haven’t been warned. In his 2014 book, “World Order,” Henry Kissinger mentions dark trends could undermine the principles of international governance, which were established by (and adhered to since) the Peace of Westphalia ended the Thirty Years War in 1648. Those principles are 1) the inviolability of national sovereignty, and 2) the self-determination of peoples free from religious intolerance. But Russia has recently annexed Crimea, and Great Britain’s vote to leave the European Union reflects growing religious intolerance. Here in America, we have echoed Brexit by electing Donald J. Trump to be our President. 

Investors abhor uncertainty and wonder whether they’ll continue to prosper in the absence of International Order. The issue is one of governance. Picture a tent with many people of various nationalities inside, debating ideas about how best to get along together. This metaphor worked for hundreds of years, even though a camel would occasionally stick its nose under a tent. Now countries and economic unions are having to grapple with anarchists seeking Jihad.

What does it all mean? Investors need a mental picture, one where cause and effect assume a pattern that allows us to anticipate how events on the world stage are likely to play out. Artists often arrive at formulations before events unfold. The disruption of Victorian Order that culminated in World War One is one example. The writings of Franz Kafka and paintings of Picasso spring to mind as heralds of Modernism. Similarly, Existentialists like Albert Camus and Jean Paul Sartre anticipated the Second World War and gave us The Theatre of the Absurd. The effect reached music with the 12-tone scale, choreography with ballets no longer anchored in stories, paintings lacking both content and message, and the “deconstruction” of classical poetry

The art world has evolved beyond Modernism to become Post-Modern, but more recently that has been replaced by Contemporary Art, which anticipates the crumbling of World Order we’re now seeing. Formerly, art was about feelings, music, and imagery; reasoned discourse was left out. In Contemporary Art, the intellect is finally engaged but still without reasoned discourse. The tent ropes have come loose. We are left to manage without Cliff’s Notes, religious precepts, party politics, or judicial constraint; mood-altering drugs are used to let light in as often as to keep it out. A piece of Contemporary Art (if we are open to it at all) might lead any one of us to see, hear, read, imagine, or think along a unique trajectory, then use that as a basis for free association. 

There are no guideposts, and the unhinging has been accelerated by the ready availability of computing power and networking via one’s cell phone. The artist typically has no interest in channeling the viewer or listener’s thoughts, feelings, or mental images. Why presume, given that each of us is unique? A poet might apply the words levitation, unmooring, kaleidoscopic, or ricochet to characterize the mental effects that the artist ignites in some people. If people join together, it might become participatory theater. Think of stadium performances by iconic figures like The Grateful Dead, Janis Joplin, or even Donald J. Trump. The traditional format used by the music industry is also “going down the tubes.” Few artists make an “album” any longer with a recording studio contract. It’s all small entrepreneurs selling a single song via the internet, using social media as advertising.

Prepare your portfolio. Think about limiting key retirement investments to US Treasury bonds and well-capitalized A-rated stocks that have a Durable Competitive Advantage (see Table). VYM is the Benchmark Index for Russell 1000 companies that pay at least a market dividend. “Durable Competitive Advantage” (see Column O in the Table) is a term that Warren Buffett coined to denote a 7% (or higher) rate of growth in a company’s Tangible Book Value (TBV) over the past 10 yrs, provided that TBV is down no more than 3 years (see Week 158 and Week 241).

Administration: The sky is not falling. Civilization won’t end, and neither will Westphalian Principles of Governance. Be patient but don’t take risks. Some good is bound to come from abandoning “received wisdom” or “group think.” Why? Because “received wisdom” gives rise to dogma, and dogma prevents innovation. Don’t worry about nuclear war. Sure, it could happen. Maybe there’s even a “material” risk (odds higher than one in twenty). That would amount to an existential crisis for many survivors. We’d all become more focussed on survival, so behavior would become more collegial. 

Bottom Line: Uncertainty is on the move. So, this is not a good time to speculate in financial assets. Hard assets like farmland are another matter (see next week’s blog).

Risk Rating: 6 (where 10-Yr T-Notes = 1, S&P 500 Index = 5, gold = 10)

Full Disclosure: I dollar-average into MSFT and NEE, and own shares of NKE, TJX, ACN, JPM, and TRV.

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Sunday, September 3

Week 322 - Global Buildout of Combined Heat & Power (CHP) Systems

Situation: Cogeneration of heat and power is a method that has long been used to capture waste energy remaining in the heat generated to produce electric power. That residual heat is used to generate steam--to heat nearby buildings. However, the Rural Electrification Act of 1936 subsidized the buildout of large, centrally located Regular Electric Generation Facilities (REGFs) to bring all homes onto the national power grid. That subsidy aborted the buildout CHP systems. Nonetheless, CHP systems accounted for 9% of US electric power generation in 2008. Worldwide, the growth of CHP systems is predicted to be 4.38%/yr from 2014 to 2024. 

CHP systems are becoming more commonplace in urban areas, now that natural gas is replacing coal as the cheapest energy source. The idea is to add a heat exchanger that will generate steam from exhaust gases produced by newly installed electricity-generating gas turbines. This means that “energy wasted” is reduced to 20% from the 55% loss that is typical of REGFs. Unlike having a central station to generate electricity for wide use, CHP requires the station to be near heating and cooling application sites ( Most large applications are at industrial sites, typically oil refineries. But small applications used to heat or cool nearby buildings are also ideal. For example, the University of Cincinnati built a gas turbine powered CHP plant in 2004 with a capacity of 47,700 KW. The Department of Energy has identified a potential for over 290,000 sites in the US with more than 240GW of estimated output. That’s double the installed capacity of wind and solar power in the US.

Mission: Analyze 12 Electric Utilities that support electric grid connections to CHP power plants, including the 3 US companies highlighted in a recent study: “Some of the major players identified across the Global CHP system market for data centers include ENER-G, Korea Electric Power Corporation, National Grid plc, Exelon Corporation, NextEra Energy, Inc., Chubu Electric Power Company, American Electric Power Company, Inc. and others.

Execution: see Table.

Administration: Our best example of a CHP system is the one supporting the Phillips 66 (PSX) facility in Linden, NJ: “Linden Cogen Plant Gas Power Plant NJ USA” is owned by PSEG Power LLC, a division of Public Service Enterprise Group (PEG - see Table). The main purpose of this 1566 MW power plant is to provide Cogen-mode steam to the adjacent Bayway (Phillips 66) Refinery. It provides power to that refinery, and connects to the electrical grid operated by Consolidated Edison (ED) which provides power to the New York City and New Jersey markets.

Bottom Line: There are large up-front costs for building a cogeneration plant, but these pale in comparison to the long-term savings. But “the devil is in the details.” Plant engineers tend to focus on the avoided natural gas costs while assuming that the reliability benefit is approximately the same as for a Regular Electric Generation Facility. But it isn’t. Operating hours are lower and have a larger standard deviation. The key requirement for deciding to build a CHP plant is that it will provide steam for heating (and cooling) nearby buildings.

Risk Rating (for aggregate of 12 utilities): 4, where a 10-Yr T-Note = 1, S&P 500 Index = 5, and gold = 10. 

Full Disclosure: I dollar-average into NextEra Energy (NEE).

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