“We know it’s easy to get swept away in a growth market. But I’ve been in this business more than 25 years and I’ve watched investors figure out a way to justify incredible multiples, only to see valuations collapse back to the underlying worth of the company. We are value investors, and at these prices, we aren’t going to buy names like SNPK.” –Michael F. Price
A Good Capital Allicator in Asset-Based Industries
As I have stressed, you are either buying a franchise or a non-franchise (assets) when you invest. You want to be searching for those you can learn from and who are successful experts in their field. Charles Fabrikant, CEO of Seacor, Inc. is one such investor in the shipping, barge, and oil services business. He has been an astute allocator of capital for the shareholders of Seacor, Inc. (CKH). I am not recommending the stock for purchase, but I urge you to read his shareholder letter in the annual report found here:Seacor Annual 2011 or download the past five years of letters–you will gain insight. Note how he openly explains his business, goals and mistakes. You don’t find many letters like this, unfortunately, when you peruse annual reports. For example, lets read his discussion of capex and how he views investing:
FILLING IN THE GAAP: CAPEX v. MAINTENANCE EXPENSE
In recent interaction with investors it is apparent some think of “CAPEX” as expenditures for “special” maintenance. In SEACOR’s accounts all outlays for keeping equipment operational, whether for a routine repair, or special overhaul (planned or unplanned), is charged to operations as an expense. We do not capitalize the cost of special surveys. In our vocabulary “CAPEX” (or capital expenditures), means dollars spent to acquire additional assets, or upgrade existing equipment. Our operating income before depreciation and amortization equates to our “free cash flow,” about which investors usually ask, dollars that can be used to pay dividend, retire shares or banked for future investment.
THE SEACOR ATTITUDE
Apart from trying to coax us to predict day rates and grilling us on the commodity business, investors frequently ask how we approach our business. I want to stress and repeat: SEACOR’s mindset is that of a manager of capital. Our primary focus is on returns on capital, taking into account risk, and thinking long-term.
We prospect for assets and businesses whose earning power will outpace, or at the very least keep pace, with inflation and overcome what I dub the “inflation paradox”—depreciating currency, escalating prices, and pressure on asset values because they eventually are discounted by the higher interest rates that central bankers engineer to tame the inflation.
Because we are focused on returns and sustainable value, we do not invest for next quarter or even next year’s “growth” in earnings. We do not use today’s marginal cost of capital (a.k.a.“ROCE”) as a benchmark for investing. I focus more on tomorrow’s cost of capital because it, as well as future earning power, will determine the residual value of equipment purchased today. (I believe he “normalizes the cost of capital rather than taking today’s cost.)
We do not pursue accretion to earnings. As previous letters have noted, it is easy to “buy” earnings when cash earns little or nothing, and the cost of borrowing capital for new equipment is less than the marginal income before depreciation that equipment will produce. Cash today may not earn a return, but we still accord it respect.
We invest in managers who think like owners and entrepreneurs who are hands-on and understand the “nuts and bolts” of their businesses. Over the years a lot of senior managers via restricted share and option awards have accumulated and retained ownership, often a meaningful interest, relative to their resources.
One of the necessary and key elements to running services businesses dependent on assets (think inventory) is periodically to upgrade our asset mix. To that end we build and buy assets, but we do not just add to the portfolio or wait for assets to depreciate fully. We sell assets to maintain capital discipline. These sales, adjusting our “inventory,” are routine aspects of our operations. Historically, our sales have produced gains, although over the years we have occasionally taken a loss on a specific asset, and on very rare occasions taken impairment charges. I strongly dissent from those who characterize these gains as “extraordinary.” They are not second-class contributions to operating income.39 In generating returns on equity, a dollar of gain from sale of an asset is as green as the dollar profit earned from a voyage or time charter: both are available for reinvestment, share repurchase, or payment of a dividend.
We are willing to experiment, and we are opportunistic. By way of example, about seven years ago we recruited an expert in leasing. Although we do very few transactions, as few meet our criteria, we usually find one or two opportunities per year that augment the otherwise meager earnings from our cash. We have leased airplanes, tanks that hold oxygen for hospital systems, aircraft employed in “special government services,” and stripped business jets for parts. We are willing to work with partners and create joint ventures. This tends to make comparison to our peers more difficult, particularly when trying to calculate “earnings before interest, taxes, depreciation and amortization.” This means opportunity for YOU the diligent value investor to do the work that Wall Street Analyst will not do.
We do not hunt for elephants, although we are prepared to take aim at big game. SEACOR is not so big that we must show small investments if they are promising. In the last twelve months, we acquired four new businesses, Lewis & Clark Marine, Inc., G&G Shipping, Superior Energy’s lift boats, and Windcat Workboats Holdings Ltd. We increased our ownership in a grain elevator, and are participating in building a new one in St. Louis. We sired an ore carrier for the Great Lakes, and selectively ordered new equipment for our offshore, inland, aviation, and towing groups. None of these commitments is “transformative.” None has visibility or will grab headlines. However, in the aggregate they add up. We believe they are excellent long-term investments.
Finally, we have made substantial purchases of our own shares. (Every time we reduce shares outstanding those who remain shareholders own a bigger proportion of SEACOR’S diverse array of assets.)
In closing, I feel compelled to reiterate concerns that have been expressed in prior letters: there is a possibility at some time in the future interest rates, without warning, will rise, perhaps rapidly, and a major revaluation of the U.S. dollar will occur (although Europe now seems to be creating money almost as fast as the Federal Reserve). In the 1960s large budget deficits gave rise initially to creeping inflation, which started to accelerate as the decade ended and began to gallop as the 1970s progressed. It was aggravated by the escalating price for oil. Chronic trade deficits during these years were also undermining the dollar, even before the spiral in commodity prices in the 1970s. The era of fixed exchange rates and the latent weakness of the dollar capitulated to a one-day 15 percent revaluation in February 1973, a large move for relative rates of exchange in a 24-hour period.
Once again America is creating a large “due bill.” For the last decade, like Blanche DuBois, Uncle Sam has been living off the kindness of strangers. Until the European crisis, the dollar was experiencing a period of weakness. Today the reference currency is not Europe’s, but rather that of China and other emerging economies, and the price of commodities. The prices for iron ore, steel, industrial metals, and food, not just oil, have climbed significantly in the last ten years.
We make our investments on the assumption that America will have to address its deficit situation. I believe the likely outcome over time will be higher interest rates, and erosion of the dollar’s value, notwithstanding the promising outlook for domestic energy, both oil and natural gas, and the troubles in Europe, which are supporting the dollar’s value against the Euro. The failure to address our issues in a timely and an orderly way will be pernicious, but that failure cannot be ruled out and needs to be considered when deploying capital. The question is whether our political system will confront its obligations before our benefactors start to demand higher interest rates and shed dollars and do so without notice.
 39 I differentiate and accept as “extraordinary” gains resulting from the sale of a business unit such as NRC as contrasted with those that come from sales of equipment. Gains on sales of equipment have augmented results every year since the late 1990s, albeit in varying amounts. In the last five years, proceeds from the sale of equipment totaled $1.2 billion, and OIBDA exclusive of gains on sales of equipment was $1.9 billion.
You must prioritize. However, as a curious person when I see discrepancies in performance, I try to uncover the reasons. This letter on clean surplus compares Ross Stores to Coach, Family Dollar and Wal-Mart:Retail Stores and Clean Surplus.
Why has Ross Stores done so well? Note the ROE earned by Coach, Inc. What can we learn from this–curious minds want to know.