Ride my buy-cycle
It’s easy to fall into the trap of thinking that the good times or the bad times will last forever. The world is dynamic and so are the forces of supply and demand.
If you’re a Formula 1 fan, watching Lewis Hamilton fail to make it out of the first qualifying session on Saturday is a useful analogy for cyclical businesses. The Mercedes was unstoppable for several seasons before things changed.
There are cyclical industries everywhere. On the global stage the microchip industry is cyclical. We’ve seen a supply crunch play out over the pandemic as demand for electronic goods surged and supply couldn’t keep up. The knock-on impact for industries like computer hardware and automobiles has been extraordinary to witness.
It takes a great deal of time and investment to ramp up the “foundries” that manufacture microchips. I believe we will see deglobalisation of that supply chain to an extent, as tech giants in the West are now reliant on Taiwan Semiconductor Manufacturing Company. The geopolitical risks in the existing climate are obvious, with China as the everpresent risk for Taiwan. Watch out for companies like Intel looking to capitalise on this.
Another cyclical global industry is shipping. A long-term chart of the Baltic dry index is one of the most fascinating charts you’ll find in the investment industry. This index is a composite of subindices that measure the price for three different sizes of bulk carriers: Capesize, Panamax and Supramax.
The index includes information about numerous shipping routes and many commodities, so it is seen as an important proxy for the shipping industry.
Shipping cycles are caused by fluctuations in the supply of vessels. When there is an oversupply, shipping rates decline and marginal companies fail. Their ships find their way into the market, and the oversupply continues until the weak players are flushed out and uneconomical vessels are scrapped. As demand increases, the need for vessels returns and orders are placed accordingly. If demand continues to outpace supply, rates keep increasing even as capacity is reintroduced.
The shipping industry benefits from a commodity up-cycle. Another factor affecting the industry is the global shift towards decarbonisation, a trend that introduces uncertainty into the ordering of new vessels and may render older fleets uneconomical. Grindrod Shipping
always reminds investors that much of its fleet is already eco-friendly, an important underpin to the investment thesis that has supported an eyewatering share price performance since March 2020. The share price has risen over 650% in that period.
As juicy as Grindrod Shipping has been, the cyclical industries that are most relevant to SA are in the mining and resources industry. Gold miners tend to trade on higher p:es than the likes of platinum group metals (PGM) miners. This is because gold is theoretically supposed to tick up over time as an inflationary hedge and a store of value for central banks, while on the contrary, PGMs are used in industry (especially in the automobile manufacturing industry), so they are subject to supplyand-demand forces in those industries.
The gold price has behaved strangely in the past month, as the combination of high inflation and a major conflict should have been the drivers of a significant upswing in the price. The price increased sharply in the initial stages of the Ukraine crisis but gave back all those gains in subsequent weeks.
Beyond the gold and PGM examples we find companies that trade at low p:es as investors are concerned about whether the strong cycle can continue. Of course, if it does, these companies can be bargains. When you buy on an earnings yield of 25% (a p:e of four) you just need a few good years and most of your investment would have been returned through dividends.
Gemfields has just released its 2021 results. It was a record year of revenue for the primarily ruby and emerald miner, with headline earnings per share of $0.05. On a share price of about R3.60 Gemfields is trading on a p:e of below five. Merafe also recently released its 2021 results, reflecting headline earnings per share of 67c for the ferrochrome miner, which operates with Glencore as its partner. The p:e is well below three, and ferrochrome prices are 20% higher in the second quarter of 2022 than in the first quarter, so earnings momentum should be strong.
Those looking for a through-thecycle commodities play could consider Afrimat. With a compound annual growth rate of 22% for profit after tax from 2009 to 2021, the company’s track record is exceptional.
There’s an interesting world of cyclicals beyond gold and PGM miners. In case you need any further convincing that your time is well spent digging around here, just remember Thungela — proof that all that glisters can sometimes be coal. It’s hard to think of a less glamorous substance, yet shareholders will have seen their money grow eightfold since June 2021.
As juicy as Grindrod Shipping has been, the cyclical industries most relevant to SA are in mining and resources