In my previous post i talked about buying into Mount Gibson on the basis of value. My investment thesis is straightforward: buy as it is trading near net working capital. Any other assets including the going concern of the business would be considered a bonus. As most of their net working capital comes in the form of cash, there is a slight problem which is lingering. MGX's break-even point is $75 with iron ore prices around $79 it's a small margin. The larger miners, mainly the likes of BHP and RIO are by far the lowest-cost producers and are attempting to over-supply the market to drive prices down and essentially drive competition out with it. As there are question marks over China's growth rates (more specifically, steel production) the problem is exacerbated.
What does this have to with anything you may be thinking. Well, to weather the potential storm if the prices of iron ore trade below Mount Gibson's break-even point, then they might have to draw on their surplus cash position to maintain business. As the cash position reduces, my investment thesis also breaks-down (and as the cash represents a large portion of my thesis, the validity could diminish rapidly.) Some economists are arguing the price of iron ore has been oversold and that the prices may go higher. This is not my game and iron ore forecasting is out of my reach. If the investment decision trickles down to this sort of thing, then I'll leave it alone. I had an order in for this company for $0.43 but cancelled it as I'm unsure of the potential problems.
Although the lower dollar should help, and the mid-tier miners are rushing to cut costs, it may only be a matter of time. Another scenario may be that the company defaults without drawing on too much cash, then it would be fine (as they redistribute the money in the business back to the owners), but that's too much guesswork for me. Even though it surpasses my idea of what would be considered logical or "rational", i simply cannot rely on something like this. For now, I'm on the sideline until i can gather more information.
As a side note, if you do follow my writings, you may have noticed that when i talk about the "circle of competence" I've said that mining/resources and the like are out if it. However, on the basis of sub-liquidation valuation, i would buy into them. Never would i be forecasting miners EPS growth or anything like that. Because if you are forecasting miners growth rates, in essence, you're also indirectly forecasting commodity prices which is not something i partake in. This is an exceptional case of a traditional deep value investment where I'm paying for the business. In other words, I'm buying the balance sheet and that's all. Fund managers always tell you that you need an edge to outperform the market. What I've noticed is that many of them analyse industry's that are likely to experience structural tailwinds in the future and trickle the argument down to individual companies (top-down) that are likely to benefit. While it's not the only method, and investors should investigate a range of methods, it's one to consider. If you can find a situation where you have a range of benefits, you have a higher probability of excelling. This is extremely difficult and requires an inordinate amount of time, playing out scenarios, conducting "what if" analysis and thinking independently (this is, that from what I've read and realised, is something that many value investors spend a lot of time thinking about.)
This is extremely important, and many investor's don't pay enough attention to this part of the investing spectrum, which plays a key role in how fund managers do outperform. This is what i spend most of my own time on analysing, trying to get as much probability of success on my side, which isn't easy and there's not only one way of going about this. One piece of advice I'd like to share is that when conducting these types of activities, you should always have at the forefront of your mind the notion of capital preservation. By this i mean that if you were to invest in company A, how much can you lose (or gain) if it defaults? Naturally, you gravitate towards the balance sheet first. However, some businesses aren't very tangible and have wide economic moats in the likes of large network economics, for example Ebay, which are hard to crack. Drawing a line here is something that is tough and is something that i battle with consistently. I believe Warrem Buffett, is a somewhat cross-breed between the traditional value investor and the "growth" investor. He employs techniques from both schools of thought, but always has capital preservation at the forefront. He is willing to buy a terrible business, if the price is right. But, as good business are hard to find at good prices, he pays so-so prices for them. Ideally, you would want to buy these businesses during bear markets, which would most likely help maximise the probability success factor which i talk about.
Research shows that value companies (by value i mean companies that are trading at low price to book ratios) tend outperform the market over the long-term, and sometimes by a large margin. However, this doesn't mean you shouldn't be buying into businesses that have high price/book ratios because, as i mentioned before, they tend to be businesses that sell products which are highly desired, hard to replicate and have wide moats and at times, various moats working in their favour at one time which may be why you pay a premium for their earnings (subjective.) The best example i can give is Coca-Cola, which in my opinion is the best business the human race has ever seen.
This example also demonstrates a weakness in my investing acumen, namely, that I'm not pre-empting enough thought into my investment decisions prior to making them. This will need to be worked on. Luckily though, i haven't had to lose real capital before realizing this as my prior investments (which i still hold) have performed well. Although, the depth of my research on the other companies (ones that i have bought into) is much greater than my effort to date on Mount Gibson.
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