BlackJack3D
While a peak wasn’t expected yet since rate increases have only just started, higher than expected CPI figures does create worries for equity markets that the Fed will push more aggressively than expected again when they next hike rates. The problem is that cost push inflation is a real problem that monetary authorities can’t solve without creating unemployment, and that means real declines in consumer spending are a risk. Sentiment will favor surefire end-markets or stocks that directly benefit from higher rates, in other words a flight to safety. What the market considers a safe haven is different from what we consider as one, since we don’t care about price volatility and aren’t scared of mid-cap exposures in a downturn. We think there are great tangible asset picks that have come down substantially in price, despite the fact that they are very unaffected by the current environment. These are eternal buys at the current levels, and warrant consideration by investors as long-term picks at opportune prices.
CPI and Commodities
The target for the Fed is to bring down the demand of goods, which markets know will show up as a fall in commodity prices which have been the measuring stick for inflation trends for a while now. With commodities having been at the top of the cycle this last year and a half, their cycle is presumably over as monetary tightening expressly looks to take them down in price. This has caused broad selling in lots of commodities that have until recently been riding high. Lumber stocks have come down, as have some food stocks, and plenty other companies including E&P stocks are already trading at late-cycle, single-digit multiples.
It is quite justified to be wary of a persisting up-cycle for commodities, so those stocks trading down doesn’t present an opportunity directly, but they have many cousins who’ve similarly been discounted despite their economics not depending on the price of commodities. In some cases, even when commodity-exposed, unusual value situations make them worthwhile anyway. Below we give some of our picks that take advantage of what will be persisting market jitters to buy valuable companies with difficult-to-replicate hard assets that can become lifetime holdings.
Our Recession Picks
DDH1 (OTCPK:DDHLF)
DDH1 makes a bit of its money by renting out its drills and crews to sample areas that could contain valuable mineral deposits for mining. These drills need to go very deep as valuable deposits are increasingly difficult to find close to the surface, and once a deposit is found a mine can be constructed. While exploration is a bit of their business, the brunt of DDH1’s income comes from multi-decade service agreements to continue working on the same mine periodically in order to assess it for expansion and one day also for closure. As long as mines are operating, and when they are profitable enough to operate the most economical thing they can do is maximize volumes, their mines will steadily be depleted and intervention by DDH1 to find ways to expand the mine will become necessary. So as long as commodities are at economical prices for miners the company should be in normal business.
The company trades at a tax normalized 5x PE multiple and has consolidated with Swick Mining for an implied 3.7x EV/EBITDA valuation. A very low multiple for a business with margins in the mid-20s and revenue growth. Their fleet is growing and they are exposed mostly to gold and copper, where gold reserves have secularly fallen for years and need to be restored and copper is supported by the EV push. While DDH1’s price has fallen with the rest of Australian markets, Major Drilling (OTCPK:MJDLF) in Canada has risen ad trades at a 12x PE, which is about three times more than DDH1. DDH1 is a smaller company, but liquidity is fine, so there is no reason for this at all. The company pays a 6% dividend yield at a 25% payout ratio and is buying back up to 10% of its shares. With superb economics and undervaluation relative to international peers despite strong Australian mining outlook from regulatory perspective, the company appears very undervalued. They have some iron ore exposure, which is more subject to risk due to its connection with the state of the Chinese economy, but as long as iron ore is profitable enough to mine there shouldn’t be any issues.
Japan Petroleum Exploration (OTCPK:JPTXF)
JAPEX owns primarily oil rigs in Japan but also some in Iraq, and the other 50% of their business is operating the heating gas transmission system in Northern Japan. The latter business only depends on commodity volumes and not price, benefiting fully from toll-road economics. The former is of course exposed to the price of oil. With President Biden making his middle-east rounds to work on the oil price, some oil declines are to be expected, but there is a limit to how much oil can still enter the market.
However, even if the price of crude were to again fall to $30 per barrel, JAPEX is still a buy. The company’s net cash and stock balances almost equal the market cap. Their assets are free, and really not much more needs to be said than that.
The only conceivable risk to JAPEX is its interest in the Sakhalin project, obviously affected by sanctions. But even without that asset which accounts for quite a small part of the portfolio, the valuation is too attractive to pass on, especially with 50% of the business being totally toll-road.
Rubis (OTCPK:RBSFY)
The last pick we could recommend along similar lines is Rubis, which has been trading down regardless of its results. Its gross profit is rising, and volumes in the Caribbean for its retail gasoline assets are also rising thanks to reopening and the tourism recovery. It is a reopening play, and all its retail businesses price product on a fixed markup basis, meaning constant absolute margins. The EBIT only declined 10% at the worst of COVID-19 lows. Some of its infrastructure businesses are also totally margin-constant. They have refineries in the French Antilles, but those margins aren’t based on crack spreads, they are regulated as constant. Moreover, their terminal assets should also deliver decent economies even in commodity price declines, perhaps especially in commodity price declines since there’d be less demand destruction and more capacity needed. Their terminal assets are premier, located at the most important ports in Europe. The only exposure to commodity prices is their logistics businesses, but those only risk about 10% of overall EBIT were the logistics cycle to finally reverse on monetary policy actions. There is likely no way the company will do worse in a recession than it did in the lows of COVID-19 when the plurality of their business is retail gas stations, yet the price is about 25% less than it was at COVID-19 lows in 2020. With a P/E of 8x and a yield of 8%, the company has a lot in the way of income too with a safe payout.
Bottom Line
Babies getting thrown out with the bathwater is the best opportunity to make money in stocks in our experience. We think that the CPI figures which scare commodity stocks has meant indiscriminate selling including the picks above. With valuable assets and a classic value proposition, we think they are all potentially lifetime buys at these levels, or at the very least high conviction places to park cash during this challenging market environment.
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