1Q17 | Bill Nygren Market Commentary (Abridged)
March 31, 2017
March 31, 2017
Sergio Marchionne Has Seen the Auto Industry’s Future: He’s Not Interested
By Sviatoslav Rosov, PhD, CFA
Sergio Marchionne often raises eyebrows.
This time, the Fiat Chrysler CEO went a step further than usual by declaring that the latest plan for the company is essentially a one-way bet on cheap gas. Production of compact cars will end to free up production capacity for high-margin, low-mileage Jeeps and RAM trucks.
This, combined with Fiat’s more or less complete lack of a fuel economy or electrification strategy beyond buying emissions credits from other manufacturers “foolish” enough to produce electric and hybrid “compliance cars,” is quickly making Marchionne, if not an industry joke, then certainly yesterday’s man.
At least, that is what people are saying. I have an alternate hypothesis.
The Auto Industry Is Not Heading to a Good Place (The author, in my opinion, has the correct thesis. Ride sharing, Uber, Tesla, more complex electronics mean less demand and more investment to run in place).
Fiat vs. Ford above
The context is frightening. Global fuel economy and emissions regulations are becoming so strict that it is possible to meet them only with partial or full electrification of the automobile. And the existing automobile production system, based primarily on stamping sheet metal and amortizing heartbreaking development costs and capital expenditures over millions of units, is incredibly capital inefficient.
What’s more, the industry’s move towards electric vehicles represents a significant challenge to the traditional strategic landscape an automaker faces. An electric vehicle has drastically fewer moving parts than an internal combustion vehicle and is, by design, far more modular, meaning that barriers to new entrants are significantly lower.
Electric vehicles are also far more uniform in their driving dynamics, because there is little scope for refining an electric motor with one moving part. Swathes of engineering and marketing investments become irrelevant. And both ride-sharing enterprises and developments in automation seem increasingly likely to grow beyond niche markets into something properly disruptive to the car ownership business model.
Marchionne Knows This
Last year, Marchionne presented a uniquely critical slide deck about the way the auto industry destroys capital. His argument was that, unless the industry consolidates and stops duplicating engineering costs (e.g., every car manufacturer has its own separately developed but fundamentally identical 2.0L 4-cylinder petrol engine), then the market will eventually force its hand, having gotten sick of miserly returns on billions in investments.
The industry response to this slide deck was more or less complete agreement, with the caveat that competitors would not have to outlast the market so much as merely outlast Fiat Chrysler. Marchionne then pursued an odd and ultimately unsuccessful merger with GM’s Mary Barra, who confidently rejected Fiat Chrysler’s plan, noting, “We are merging with ourselves.” (This presumably referred to GM’s decades-long quest to bring rationality to its stable of brands.)
GM is not only merging with itself, it is also “disrupting” itself — as evidenced by their recently announced Chevy Bolt long-range, affordable electric car. The company claimed the Bolt was designed to be the perfect car for ride-sharing apps. Just before launching the Bolt, GM announced a $500 million investment into Lyft, the main competitor to Uber.
This no doubt surprised competitors who have been making efforts to disabuse markets and investors of the notion that they would become mere providers of hardware to ride-sharing companies like Uber or autonomous car suppliers like Google. Dieter Zetsche, CEO of Daimler, remarked “We do not plan to become the Foxconn of Apple.”
Manufacturers Are Going to Have to Invest
In fact, the bosses of Daimler, BMW, and Audi went looking behind the couch for some spare change to buy joint ownership of Nokia’s (remember them?) mapping service HERE, and did so primarily to stop their rival bidder – Uber – from buying it. High-resolution maps are crucial to autonomous cars; Uber’s CEO has said that, if Tesla can make good on their promise of a long-range, autonomous electric car, he would buy “all” of them.
The Germans are thus investing billions into electric vehicles made out of carbon fiber that pilot themselves using super-high resolution maps, all the while fighting back against Apple and Google’s requests for access to their cars’ infotainment systems. Their global leadership of the auto industry will have to be pried from their cold, dead hands.
Meanwhile, all the difficult bits of the Chevy Bolt (“custom-built” for Lyft, remember) are built in large part by Korea’s LG. One wonders why Lyft (or Uber) would not simply buy the next model directly from LG? I guess even if there is no Foxconn for cars yet, there may be soon. Remember, electric cars are far more modular than internal combustion cars.
Marchionne Says “No Thanks”
Or, if not him, then certainly the Agnelli family. A sort of Italian royalty who control Fiat Chrysler (and Marchionne) via their ownership of the Exor holding company, the Agnellis have been showing signs that they are tiring of the endless drama surrounding Fiat and the auto industry in general. They bought a stake in The Economist in 2015 in a move towards media, but the recent de-conglomeration of Fiat has been noticeable in other ways.
First, in 2013, Fiat’s industrial division was de-merged and combined with CNH Global (maker of tractors under the Case IH and New Holland brands) into a separate company, CNH Industrial. Most recently, Ferrari, the jewel in the Fiat Chrysler stable of brands, was floated in New York.
Speaking of Ferrari, Marchionne took advantage of a recent dip in the fortunes of Ferrari’s eponymous Formula 1 team to unceremoniously eject Luca di Montezemolo as president and chairman of Ferrari and replace him with . . . himself. It should be noted that di Montezemolo was appointed by Gianni Agnelli himself after the death of the founder, Enzo Ferrari, and is a bona fide business superstar in Italy. Marchionne has been playing an increasingly active part in the politics of Formula 1 recently, something that will no doubt continue to make for a less stressful (but still stimulating) retirement when Marchionne puts on his famous blue sweater for the last time in 2018.
But for now, Marchionne has seen the future. Large subcontractors will produce partially or fully autonomous electric vehicles, with the sole differences between them being brand value and design. The car makers that survive may well simply produce cars for Google (Ford recently signed an agreement along these lines), Apple, or Uber. Some, like BMW or Mercedes-Benz, may survive because of their brand and design qualities. Fiat Chrysler does not have this.
Marchionne doesn’t care about expensive gas or electric vehicles because his plan is simple:
Sell the profitable Jeep/RAM brands to another conglomerate that does not compete in these segments (for example, Hyundai KIA).
Sell the unprofitable Fiat to anyone who will take it. Perhaps synergies in the lucrative European light commercial vehicle segment will attract another European maker, such as PSA Peugeot Citroën, whose CEO, Carlos Tavares, has ambitions that were thwarted at his previous employer, Renault.
Sell Alfa Romeo and Maserati to someone who could use a strong brand. Perhaps Volkswagen will finally get hold of its prized Italian trophy if they can sort out their global legal woes.
Retire to play with his giant Formula 1 Scalextric set.
Marchionne has been mocked for his firms’ strategy, which has been attributed to hubris. But perhaps he is the one seeing clearest of all.
Is the best way to deal with disruption simply to step out of the way?
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Question: Who wins when–in a perfectly competitive market–competitors fight each other? Prize awarded for best answer.
The above seems to answer the question above. But what if the returns are heavily skewed to only a few stocks? Look deeper: Bessembinder Do Stocks Outperform Treasury Bills
The chart above shows gold “outperforming” stocks, but note the time period. 1971 was when President Nixon unhinged the dollar from gold. Be careful when assessing performance over a set time period.
I don’t always agree with Dr. Damodaran, but the video can help any analyst writing a research report. You have to link your story to numbers. He mentions that he prefers to teach history majors how to value than teach engineers how to be creative/tell a story with their numbers.
The mistake Prof. Damodaran made on Vale was not normalizing the biggest cyclical boom in iron ore prices in the past five hundred years.
Follow the discussion on valuing UBER. This is a good exercise for valuing platform/network companies: Damordaran on UBER FiveThirtyEight
Global Warming? https://youtu.be/SXxHfb66ZgM
It sounds gruesome, but essentially, it is a liquidating trust with no-or-few expenses. See a 1995 report on the TPL trust that turned out to be prescient.
TPL Annual Report 2016 Go to last page to see acreage map. Use Google Earth to go view the terrain, then search for oil and gas activity in the area(s)
More annual reports: http://www.tpltrust.com/annual-reports.html
Texas Pacific Land Trust discussion
Part of my search strategy is to look for the quirky, weird stuff.
|“The one who follows the crowd will usually get no further than the crowd. The one who walks alone, is likely to find himself in places no one has ever been.” — Albert Einstein|
What do YOU think?
PS: Weekend Reading
OMC_Omnicom_Singular_Diligence I wish for more brevity!
One trick that Warren Buffett uses when he first looks at a company is NOT to look at the price OR another person’s opinion. He doesn’t want price to influence his valuation of the company, and he seeks his own counsel.
Why don’t we test our valuation skills and do a valuation of Core Labs (CLB) with the data below.
Do your own work BEFORE looking at the post below. See how you compare or differ Einhorn’s short thesis on CLB. Do you differ? Why and how.
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1) I (Whitney Tilson) attended the always-excellent Ira Sohn conference on Monday and, as often happens, Bill Ackman and David Einhorn stole the show with two outstanding, incredibly-well-researched ideas, long Howard Hughes (which has been one of my largest positions since it was spun out of GGP when it emerged from bankruptcy after the credit crisis) and short Core Laboratories (CLB), respectively.
They have posted their presentations here:
If you’re interested in learning more about HHC (and seeing the incredible development underway at South Street Seaport), the company is hosting its first investor day there a week from today, Wed. 5/17 from 8:00am to 1:30pm. Email Tracey.Wynn@howardhughes.com to register. I hope to see you there.
As for CLB, it doesn’t happen very often – maybe once every two years – but sometimes I (Whitney Tilson) see (at a conference) or read (on something like ValueInvestorsClub) an investment thesis that is so compelling and blindingly obvious that I immediately put the position on – which is what I did on Monday just after Einhorn’s presentation. Check it out for yourself – it’s that good. A highly cyclical company masquerading as a secular growth story – trading at nearly 9x REVENUES!
Must see video on indexes: https://vimeo.com/216016883/10b948b174
I highly suggest you view the video—Yeah, there is hope for value investors.
May 8, 2017This Time is Not Different, Because This Time is Always Different
“History repeats – the argument for abandoning prevailing valuation methods regularly emerges late in a bull market, and typically survives until about the second down-leg (or sufficiently hard first leg) of a bear. Such arguments have included the ‘investment company’ and ‘stock scarcity’ arguments in the late 20’s, the ‘technology’ and ‘conglomerate’ arguments in the late 60’s, the nifty-fifty ‘good stocks always go up’ argument in the early 70’s, the ‘globalization’ and ‘leveraged buyout’ arguments in 1987 (and curiously, again today), and the ‘tech revolution’ and ‘knowledge-based economy’ arguments in the late 1990’s. Speculative investors regularly create ‘new era’ arguments and valuation metrics to justify their speculation.”
– John P. Hussman, Ph.D., New Economy or Unfinished Cycle?, June 18, 2007. The S&P 500 would peak just 2% higher in October of that year, followed by a collapse of more than -55%.
“Old ways of valuing stocks are outdated. A technological revolution has created opportunities for continued low inflation, expanding profits and rising productivity. Thanks to these factors, the United States may be able to enjoy an extended period of expanding stock prices. Jumping out now would leave you poorer than you might become if you have some faith.”
– Los Angeles Times, May 11, 1999. While it’s tempting to counter that the S&P 500 would rise by more than 12% to its peak 10 months later, it’s easily forgotten that the entire gain was wiped out in the 3 weeks that followed, moving on to a 50% loss for the S&P 500 and an 83% loss for the tech-heavy Nasdaq 100..
“Stock prices returned to record levels yesterday, building on the rally that began in late trading on Wednesday… ‘It’s all real buying’ [said the head of index futures at Shearson Lehman Brothers], ‘The excitement here is unbelievable. It’s steaming.’ The continuing surge in American stock prices has produced a spate of theories. [The] chief economist of Kemper Financial Services Inc. in Chicago argued in a report that, contrary to common opinion, American equities may not be significantly overpriced. For one thing, [he] said, ‘The market may be discounting a far-larger rise in future corporate earnings than most investors realize is possible, [and foreign investment] may be altering the traditional valuation parameters used to determine share-price multiples.’ He added, ‘It is quite possible that we have entered a new era for share price evaluation.’”
– The New York Times, August 21, 1987 (the S&P advanced by less than 1% over the next 3 sessions, and then crashed)
“The failure of the general market to decline during the past year despite its obvious vulnerability, as well as the emergence of new investment characteristics, has caused investors to believe that the U.S. has entered a new investment era to which the old guidelines no longer apply. Many have now come to believe that market risk is no longer a realistic consideration, while the risk of being underinvested or in cash and missing opportunities exceeds any other.”
– Barron’s Magazine, February 3, 1969. The bear market that had already quietly started in late-1968 would take stocks down by more than one-third over the next 18 months, and the S&P 500 Index would stand below its 1968 peak even 14 years later.
“The ‘new-era’ doctrine – that ‘good’ stocks (or ‘blue chips’) were sound investments regardless of how high the price paid for them — was at bottom only a means for rationalizing under the title of ‘investment’ the well-nigh universal capitulation to the gambling fever.”
– Benjamin Graham & David Dodd, Security Analysis, 1934, following the 1929-1932 collapse
“The recent collapse is the climax, but not the end, of an exceptionally long, extensive and violent period of inflation in security prices and national, even world-wide, speculative fever. This is the longest period of practically uninterrupted rise in security prices in our history… The psychological illusion upon which it is based, though not essentially new, has been stronger and more widespread than has ever been the case in this country in the past. This illusion is summed up in the phrase ‘the new era.’ The phrase itself is not new. Every period of speculation rediscovers it.”
– Business Week, November 1929. The market collapse would ultimately exceed -80%.
Referred to: This time seems very very different Grantham
This time is not different, because this time is always different.
Throwing in the towel
When a boxer is taking a beating, to avoid further punishment, a towel is sometimes thrown from the corner as a token of defeat. Yet even after the towel is thrown, a judicious referee has the right to toss the towel back into the corner and allow the fight to continue.
For decades, Jeremy Grantham, a value investor whom I respect tremendously, has championed the idea, recognized by legendary value investors like Ben Graham, that current profits are a poor measure of long-term cash flows, and that it is essential to adjust earnings-based valuation measures for the position of profit margins relative to their norms. In Grantham’s words, “Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism.”
He learned this lesson early on, during the collapse that followed the go-go years of the late-1960’s. Grantham once described his epiphany: “I got wiped out personally in 1968, which was the last really crazy, silly stock market before the Internet era… I became a great reader of history books. I was shocked and horrified to discover that I had just learned a lesson that was freely available all the way back to the South Sea Bubble.”
In recent weeks, Grantham has essentially thrown in the towel, suggesting “this time is decently different”:
“Stock prices are held up by abnormal profit margins, which in turn are produced mainly by lower real rates, the benefits of which are not competed away because of increased monopoly power… In conclusion, there are two important things to carry in your mind: First, the market now and in the past acts as if it believes the current higher levels of profitability are permanent; and second, a regular bear market of 15% to 20% can always occur for any one of many reasons. What I am interested in here is quite different: a more or less permanent move back to, or at least close to, the pre-1997 trends of profitability, interest rates, and pricing. And for that it seems likely that we will have a longer wait than any value manager would like (including me).”
I’ve received a flurry of requests for my views on Grantham’s shift.
My simple response is to very respectfully toss Grantham’s towel back into the corner.
First, Grantham argues that much of the benefit to margins is driven by lower real interest rates. The problem here is two-fold. One is that the relationship between real interest rates and corporate profit margins is extremely tenuous in market cycles across history. Second, the fact is that debt of U.S. corporations as a ratio to revenues is more than double its historical median, leaving total interest costs, relative to corporate revenues, no lower than the post-war norm.
The last three months of 1999 were just about the sickest thing I’d ever seen. It was an orgy, but I simply couldn’t bring myself to buy a stock that was up $10m, hoping it would go up $15, even though it was overvalued by $100. But by choosing to sit out most of the ramp, determined to wait for the inevitable implosion, I was the Greatest Fool of All, as those around me made mind-numbing profits as, day after day. YHOO, AMZN and CGMI would gap $10 a day, immune to gravity as the Nazz, aka NASDAQ, ripped right past 3000 and didn’t even blink rocketing past 4,000. At the end of the year, the Nazz was up 83 percent, a far cry from the 5 to 7 percent stocks had returned historically. People were too busy celebrating and shouting “It’s different this time.” to realize such an adjustment was unsustainable. It is like a guy who averages five home runs a year suddenly hitting fifty. Something is not right in Mudville. —Confessions of a Wall Street Insider: A Cautionary Tale of Rats, Feds, And Banksters by Michael Kimelman
Note what Prof. Greenwald says about Amazon and Apple. If Apple is JUST a product company then I would agree, but what if Apple has network effects with its music and iPods for example?
Don’t take expert opinion without heavily salted skepticism. What do YOU think?
SHORTING the FANGS: http://www.businessinsider.com/fang-stocks-have-cost-short-sellers-this-year-2017-5 How do you value a company with almost $0 (zero) marginal costs?
We will delve deeper in the next post.
PS: info@Santangels.com to sign up for value investing info.
The NASDAQ bubble showed the highest P/E ratios in stock market history due to low or no earnings technology companies.
Kopernik 1Q 2017 – Conference Call – Final Worth a read–note high and low market cap sectors of the market (see page 9)–a proxy for expensive and cheap. A search strategy.
Time in a Bottle – Final A good discussion of valuation methods in an era of distorted interest rates.
http://tsi-blog.com/2017/04/are-rising-nominal-interest-rates-bullish-or-bearish-for-gold/ A discussion of how to understand interest rates and gold. Note the analysis using data going back 90 years. Do not use a small smaple size.
https://youtu.be/bZfPJCAVQg0 Recent Greenblatt talk at Google.
Hunt for value in high priced stocks: http://otcadventures.com/?p=1912