In the end, it’s not all bad news that the world is de-leveraging. As we pointed out in Sydney last month, when companies can’t boost their profits and share prices through the use of leverage, it forces you, as an investor, to actually do proper securities analysis. You can’t just surf liquidity trends anymore. You have to look at a business from the bottom up, and reconcile that with your view of the world from the top down.
Most analysts and investors are too lazy to do real work. You don’t have to in a bull market. You just have to be in the right asset class at the right time and away you go. In a bear market, or in a Great Depression, it’s a lot harder. If you’re willing to do some of the work, or you know someone who loves doing it, then you’re going to be ahead of 80% of the rest of the crowd.
Let’s look at Caltex, for example. Caltex has one of the highest CEO turnover rates in Australia, according to today’s Australian Financial Review (page 34). It is joined by Seven West Media, CSR, and Fairfax Media. “These are companies which have difficult industry structure or competitive environments to deal with,” according to Goldman Sachs analyst Hamish Tagdell.
All businesses have competitive environments to deal with. But that’s okay. History shows that competition between businesses produces a lot more prosperity and wealth than say, more regulation. It’s no accident that media companies, with their advertising-revenue-based model, are finding it hard to compete now that advertising has shifted online. What’s more, media companies are finding it hard to get people to pay for what they can generally get for free. Imagine that.
Caltex is struggling from a combination of factors. Oil is a cost for refiners. The higher the oil price goes, the higher costs rise. That’s bad for margins. Refineries are also expensive to build and maintain. And as the world runs out of high-grade low-sulphur crude oils, refineries have to be upgraded to accommodate the lower-grade, higher-sulphur crude oils coming from places like Venezuela and, increasingly, Saudi Arabia and Iran. Another factor is sheer economies of scale. Caltex is competing with major refineries in Asia, many of which are new and operate on much larger volumes.
The bottom line, as our mate Greg Canavan pointed out via email, is that it may just be a lousy business. That’s why you see fewer refineries being built in the Western world and older refineries being mothballed. It might be a national security blunder, inasmuch as it makes you dependent on importing refined fuels. But it’s hard to run a business at a loss and make money.
Which brings us back to the companies with high CEO turnover. Instability is bad for shareholder returns. Instability comes from changing CEOs a lot. And you change CEOs a lot if your business is either in terminal decline or has been relying on cheap money to make earnings look better.
“The most leveraged sectors, which underperformed the most through the financial crisis, experienced the largest increase in CEO turnover over the past few years,” according to Bianca Hartge-Hazelman. “These included communications, media and entertainment, financials, infrastructure, and utilities.”
If you were making a list of companies NOT to invest in, you might begin with those sectors. That said, the company within each sector that adapts and survives might be just the sort of sneaky investment you can buy at a big discount during a correction like the one Slipstream Trader’s Murray Dawes forecast last week. You can find good value, in other words.
It’s the idea we left off with yesterday: where will your money work hardest for you in the coming years? Which CEOs will generate the highest returns on equity? And which shares are capable of decoupling from the performance of the index and going higher based on a business not dependent on leverage? Our mate Kris Sayce thinks he has the answer to THAT question. Stay tuned for more.
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From the Archives…
Fake Savings, Detached Investments and the Mining Boom
2012-04-06 – Nick Hubble
2012-04-05 – Greg Canavan
How to Avoid Investing Idiocy by Ignoring the Fed
2012-04-04 – Dan Denning
Warren Buffett Scorns Gold. Bad Move!
2012-04-03 – Addison Wiggin
Heralding the Unsung Benefits of Frontier Markets
2012-04-02 – Joel Bowman