Best of Credit Bubble Stocks - 2022

Last New Year's Day we published "Best of Credit Bubble Stocks - 2021". Some of those may be worth rereading:

• Rethinking Inflation: "'Inflation or deflation?' is a political question; you can't determine the outcome from modeling of macroeconomic variables without reference to what the people who control the central bank want."
• What Intellectual Progress Did I Make In The 2010s?: "The reason that I had to become an entrepreneur was that I could not get a job for a big corporation doing things that I found interesting because I did not have "experience". There must be so few Americans with the intelligence, curiosity, and neuroplasticity to learn how to do something new that big corporations will only hire people who have done the exact function that they need performed for years on end. When you think about how sclerotic the world is, remember that everyone's neural synapses are now made of oxidized fats from soybean oil." 
• The Chad Value Investor vs The Virgin "Growth" Investor: "Imagine doing a timber cruise on your logging roads in a manly vehicle like a lifted 4Runner or a Bronco or a Jeep Gladiator. You stop for a smokos break and take a quick measure of merchantable lumber volume. You're a frontiersman, a settler, a pioneer; in the woods in the tradition of great Americans like Teddy Roosevelt and Norman Maclean."
• Re-Nicotinization: "Society is craving nicotine after a few decades without it. If they can get it from reduced harm nicotine products, people might eat less and be thinner and healthier. Maybe more sociable too. And if big tobacco squeezes out smaller vaping competitors, they will print money selling the new delivery vehicle."
• 2020 Prediction Contest Results: "What seems to happen specifically is that a very rigid set of expectations, a very definite view, a simple narrative, crashes on the rocks of reality. In fact, I am learning to avoid any kind of simple narrative for thinking about the future. Consider predictions such as, "there's going to be hyperinflation / a crash / a civil war" next year. Reality is a lot more complicated. Bitcoin hit an all time high and oil hit an all time low in 2020. What probability would anyone have given that? And does it fit a simple label like "hyperinflation"?"
• Sector Rotation Value Strategy: "We are looking for two things: Capital expenditures in the sector are low (at a local minimum, nadir), while at the same time, Cash being generated, and returned to investors (dividends, debt reduction, share buybacks) are high relative to enterprise value and market capitalization."
  

The "best of" tradition seems to be worth keeping. Here are our nominations for the Best of Credit Bubble Stocks - 2022, in chronological order from the year:

• Cheap Cyclicals and Value vs Growth: "It is particularly interesting to see this undervaluation of cyclicals in industries besides coal or oil. That means it is not just the 'energy transition' or fossil fuel divestment responsible for the low multiples. In fact, those themes, if they in fact played out, ought to be bullish for steel demand in particular. What is happening with cheap cyclicals is a perfect example of a redemption flywheel, as described by Lyall Taylor..."
• "The Hard Math of Minerals" - Why the "Energy Transition" Won't Happen: "Canadian oil majors, royalty owners, and hydrocarbon pipelines are all priced as though disruption - actual replacement by wind and solar and electric vehicles - is going to happen in the next five years or so. But simple back of envelope economic calculations based on physics and energy density tell us that replacing fossil fuels (again, 80% of current world energy consumption) with those energy sources, the so-called 'energy transition,' is impossible. That means that the world is seriously under-investing in hydrocarbon production and traditional energy infrastructure, and over-investing in electric vehicles (TSLA) and in wind and solar boondoggles that will collapse the way the previous iteration (e.g. Suntech Power, Evergreen Solar, A123 Systems) did a decade ago."
• Chevron's Low Capex Budget for 2022 Bodes Well for Oil Prices: "Chevron is one of the 10 largest oil producers in the world. They spent $6 billion on capex last year, and have announced that they are going to spend $15 billion this year. Global oil demand will be likely be up ~10% this year over 2013, but they are going to invest only 40% as much as in 2013. It reminds me of how first the airline industry, and now auto manufacturers, figured out that its smart not to constantly expand production capacity. When they restrain themselves, they get a double benefit because they can charge more (capture more consumer surplus) and they have more cash for shareholder returns instead of capex."
• Altria Reports 2021 Fourth-Quarter and Full-Year Results: "In the past when we have sold dying businesses short - something we have done quite a lot of - they have had certain elements in common. Falling revenue, low gross margins, high fixed costs, low operating margins, operating income declining faster than revenue (operating losses), high (and increasing) debt, no dividends (raising money from capital markets, not returning it), high debt yields. Altria does not match any of those criteria of dying businesses. There is a big question with tobacco investments, and that is whether cigarette sales will ever stop declining, and whether cigarette price increases can compensate for volume declines in perpetuity. This is a question about the elasticity of demand for cigarettes. We have some reason to believe that there is a core cigarette customer that is very price insensitive. Also, Altria's price increases - mid single digit percentage increases - used to be greater than inflation, but now they are arguably less than inflation. So that should be building in a little bit of cushion to take the price of a pack higher if needed."
• Morning Earnings: Philip Morris International Inc.: "You pay a premium to Altria and British American for great capital allocation, strength in the Marlboro cigarette business, geographic (and regulatory) diversification, and a growth business in smoke-free alternatives. Thought experiment: if you had to pick two securities to leave to your heirs, might they be Philip Morris and Dorchester Minerals?"
• Morning Earnings: Peabody Energy: "It is amazing watching these natural resource management teams - Canadian oil majors are a great example - so scarred by the recent bear market that they want to run basically deleveraged companies. They're using free cash flow to pay off debt with negative real yields!"
• New Milestones in the Value vs Growth Trade: $90 Oil and 2% Ten Year Bond Yield: "Our value versus growth trade started in the second half of 2020 when two key ideas clicked together for me. The first happened when I was writing a post, 'What I Would Buy Instead of Tesla?', when Tesla had a $460 billion market capitalization. To put together my shopping list - a hypothetical trade of a business valued at half a trillion with zero or negative free cash flow for a collection of businesses at the same price and tens of billions of dollars of cash flow - I dived into the sectors of the market that had the lowest enterprise value to free cash flow valuation multiples."
• Thoughts on Big Tobacco and Compendium of Tobacco Books Read in 2021: "There are two big questions for the tobacco investments. First, can they maintain operating income from their cigarette businesses despite the long term secular volume decline? This question is one of consumer preferences (for cigarettes versus reduced risk alternatives or even other dopamine modifiers), politics (of taxation and regulation, both of cigarettes and the replacements), and demand elasticity for cigarettes (the price-volume tradeoff). The second big question for tobacco investments is, assuming that the reduced risk businesses continue to grow and that they do cannibalize the cigarette businesses, how much of that new business will be captured by the big tobacco incumbents? This is where the big tobacco 'cigar butt' investments have the potential to be growth stocks if things go right."
• Swedish Match Reports Earnings for 2021: "Zyn has giant growth potential, it is profitable, and yet it is available for a value stock price. If you saw a company selling a high margin, recurring usage non-tobacco product with a hockey stick chart like the one above, the company would be selling for 18x sales right now, not earnings."
• Credit Bubble Stocks 2021 Book Review Compendium: "We have read a great deal of what John McPhee, Bernd Heinrich, Bill Bryson, and Peter Hessler have written. That is not an exhaustive list: we could also include Jane Austen, Warren Buffett (his public writings), Ben Graham, Michael Lewis, as well as many online writers in the blogosphere. It is not necessarily clear when one writer is more obscure than another."
  
• Goehring & Rozencwajg: "The Distortions of Cheap Energy": "We have mentioned in the past that we have settled on long-life Canadian oil majors and royalty trusts for our energy investments. Some key concerns that informed this: Avoiding (or benefiting) from escalating production costs, which other E&Ps will have. Avoiding reinvestment risk / principal agent conflict with managements, which seems to be the key reason that the E&P sector fails to build value over time. Oil sands are almost royalty-like, in the sense that (a) the capital costs are front loaded, unlike drilling wells, so they should benefit more from inflation than an E&P and (b) they have decades of sands to mine, so you avoid the forced reinvestment at inopportune times."
• Is Dorchester Minerals LP Just a Depleting Asset?: "If Dorchester were just a depleting asset, their sales of oil would result in a finite pool of oil shrinking over time. Since the reserves are growing, it means one or both of two things: the proved reserve metric understates the total amount of ultimately recoverable oil in their land, and/or the acquisition of new land using partnership units is having an accretive effect. But either way, the partnership was not just a 'depleting asset' over the past 15 years."
• Electric Vehicle Transition Slower than Expected: "The data from Norway is impressive for the bullish oil case. We first mentioned this in the Links almost a year ago. Note that Norway subsidizes electric vehicles lavishly, more than any other country is going to be able to afford, so they have had much higher uptake. Still the reduction in oil demand is so low that even if you assume that rich nations continue with the subsidized EV boondoggle, the growth in petroleum demand from poorer nations (and aviation, and diesel, and petrochemicals in rich nations) should cause oil demand to stay steady. That was the big threat to oil. The other, smaller threat was some kind of carbon tax or prohibition of fossil fuel use for 'climate' related reasons. It is great to watch politicians cry uncle so early in the oil rally. How are they going to implement a carbon tax that 'strands' our oil if they can't stomach $5 gasoline and $110 crude? It would appear that ESG is going to go in the discard pile pretty soon."
• Canadian Natural Resources Limited ($CNQ) - Q4 and FY 2021 Results: "What we like about royalty trusts and long reserve life, slow decline Canadian oil companies is that they both avoid the principal-agent problem that afflicts other types of oil and gas producers with small amounts of reserves. Managements have to buy new reserves in order to keep their jobs, and they typically have the money to do this (whether through earnings or capital raises) when the industry is doing well and valuations are high. Hydrocarbon E&Ps with rapidly declining production (shale) have a poor track record of creating long term value for shareholders because of this incentive conflict. They need to buy assets to keep their companies from liquidating (and losing their jobs), but they only have the money to buy assets at the top of the cycle when properties are expensive. The companies that fracked for shale over the past decade managed to transfer almost all of their investors capital (both equity and debt!) to sellers of land and service providers."
• Books Read - Q1 2022: "Ruhlman didn't set out with this angle in mind, but what he ended up concluding was that some surgeons (and centers) are vastly better at repairing congenital heart defects than others, and that this difference is partly a function of the volume of procedures conducted. There is a conflict of interest problem between the parents and the cardiologists who initially see the babies. Surgery is lucrative, and 'most cardiologists refer their patients within their systems regardless of those systems' results.' So, Ruhlman is part of our stable of high performing writers like John McPhee, doctors trust nicotine as a cognitive enhancer when babies' lives are in the balance, and parents of babies with CHD need to be high agency and not passively take the first recommendation because the variance of outcome is enormous (~10^2)."
• PrairieSky Royalty Ltd. Reports Q1 2022 Earnings: "It seems like the big question for the 'dying industry' value strategy right now is: how much of the tobacco stocks (i.e. Altria and Philip Morris) are optimal to given the higher valuations than the oil and gas investments? It probably depends on how confident you are that oil will be $100/bbl, not $50 or $75, over the coming years. The tobacco companies may be a good portfolio diversifier as well, in that lower oil prices would increase consumers' discretionary spending ability, and probably help sales."
• Enterprise Product Partners L.P. Reports Q1 2022 Earnings: "Pipelines are a kind of hedge against over-production by E&P firms. If they bump up against the pipeline transport capacity in a given location (like the Permian), the pipelines' profits should increase sharply since they are bidding for an inelastic supply."
• Review of Numbers Don't Lie: 71 Stories to Help Us Understand the Modern World by Vaclav Smil: "A great thing about Smil is that he (rightly) considers smartphones and advertising website businesses (like Facebook) to be completely irrelevant compared with more important technologies like steel, electricity, nitrogen fertilizers, and shipping. He says that we can't replace fossil fuels without major economic and social dislocations. We know that Bill Gates reads everything he writes. Has Bill Gates decided that it's worth imposing some economic and social dislocations on the rest of us in order to reduce carbon emissions? Why would someone who is so concerned about rising carbon dioxide levels (and who knows that there is no way to having rising standards of living without rising carbon dioxide levels) also be so concerned with research into pandemics and biological warfare?"
• Review of Fossil Future: Why Global Human Flourishing Requires More Oil, Coal, and Natural Gas--Not Less: "As investors what we care about is: are there are more cost-effective ways to provide the energy that humanity needs - about 100 quadrillion BTUs annually in the U.S. - than the fossil fuels we own? Are alternative energy technologies capable of displacing (and leaving 'stranded') our fossil fuels in the near term? Are battery electric vehicles going to be more economical than ICE powered vehicles? Are wind and solar going to be more economical than coal and natural gas? These are technological questions that depend on physics and chemistry, and they are better addressed by writers like Tom Murphy and Vaclav Smil."
• Review of How the World Really Works: The Science Behind How We Got Here and Where We're Going by Vaclav Smil: "His most recent two books have hammered the theme that our civilization absolutely depends on fossil fuels (coal and petroleum) and that this is not going to change, or 'transition' anytime soon."
• Tomorrow's Energy: Hydrogen, Fuel Cells, and the Prospects for a Cleaner Planet by Peter Hoffmann: "The cost of 'renewable' energy technologies like solar, wind, and batteries was falling because we were in a commodity bear market (2008-2020) with the necessary materials being sold below the long run sustaining cost of production. If someone had actually disrupted gasoline/ICE vehicles, or fossil fuels, you would have heard about it by now. There is nothing better than petroleum for transportation fuel. (Nuclear is better than fossil fuels for generating electricity, but that doesn't work for transportation without better batteries.) That means we are probably going to be using it for a long time - probably until it is exhausted. Royalty trusts are yielding 15% and the EV/FCF on Canadian oil producers is north of 20% while Biden is dumping a million barrels a day oil from the SPR and the industry is drawing down its backlog of drilled uncompleted wells. This is perhaps the greatest mispricing we have seen since we started this blog."
• Tobacco Earnings - Q2 2022: "Swedish Match was a great investment but it is also interesting because of what it is saying about re-nicotinization. Given a safe way of dosing nicotine (such as an oral pouch with no tobacco leaf carcinogens), thoughtfully designed with good user attributes, lots of people who were never smokers are going to want to use nicotine for a mood/productivity boost. The FDA is attempting to stand in the way of beneficial re-nicotinization, just like they are constantly gunning for our OTC supplement regimens. But in a sclerotic country, it may be good to bet on regulatory capture and the status quo prevailing."
• Lamar Advertising Company: "Lamar is not super-cheap like our Canadian oil investments, but it is a high quality, niche real estate investment. (Our pipelines are also real estate investments, with impenetrable barriers to entry.) Most of the world's businesses are crappy. They have to advertise to remind people that they exist. It would not be too surprising if Cracker Barrel's percentage of sales spent on marketing is higher than its ultimate profit margin. Lamar is a beneficiary of that."
• United States Steel Corporation: "The market price of U.S. Steel basically implies that this spike in steel prices and company profits will be short lived. (And the spike in steel prices was truly anomalous.) But the question is, how can that be true if we are going to have a renewable energy and electric vehicle transition that requires vast quantities of basic materials?"
• Peabody Energy Corp. - Q2 2022 Results: "As of the end of 2021, Peabody had 2.1 billion tons of proven coal reserves and 374 million tons probable. The proved reserves were comprised of 100 million tons seaborne thermal, 100 million seaborne met coal, 1.8 billion in the powder river basin, and 150 million tons of other U.S. thermal coal. One calculation that you could make is that the enterprise value is under $2 per ton of proved and probable reserves."
• Followup on Magellan Midstream and the Equity Risk Premium Strategy: "Inflation is an incredible tailwind to equity investments with pricing power. You just have to avoid being wiped out by a deflationary crash. Is there going to be deflation? While Prechter may still think so, it is a political question. With Pelosi and her husband still daytrading, it is hard to imagine the elites tightening enough to cause a deflationary collapse. The Fed talks a lot about tightening but hasn't done much tightening. We like ConvexityMaven's theory that the Fed is going to do yield curve control. Instead of letting the bond market crash and taking everything else with it, print money and buy bonds - keep the yields capped. But as the Maven says, in this scenario, 'the other side of the balloon gets squishy' - meaning inflation. If you look around the world, you will notice tons of countries with fiat currencies are running high inflation rates. Meanwhile, deflationary collapses are rare. Can you imagine the central banks of Brazil, Argentina, or Ghana tightening enough to cause a deflationary collapse? It has never happened, because the path of least resistance is inflation. Betting on inflation is the cynical bet. But we have to be cynical enough to realize that the central bank doesn't want us hoarding real assets and is going to try to trick us with jawboning talk. People will believe the talk and there will be violent selloffs."
• Texas Instruments: "We are not selling our oil and gas investments to buy TI today. But we are interested in assembling a buy list of great companies to invest in down the road. Just today, it appears that Biden wrote a put option on oil at $80 per barrel. As someone on Twitter pointed out, next time they can sell crude at $130 per barrel, then refill it at $100, resell it at $160, refill it at $130, and so forth; a 'government-sponsored ascending trading channel for oil'! Investors double count, so if oil goes to $160 not only will our companies' profits increase, but the valuation multiples should go from laughably low to reasonable - maybe even bubbleish!"
• Review of The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival: "Banks own tons of treasuries, and their balance sheets have been devastated by the increase in the ten year bond yield, something that is being chronicled over at Oddball Stocks. Higher interest rates also mean that the interest on the $31 trillion federal debt grows, which is a positive feedback loop since the debt is not being serviced. And high interest rates choke the economy, which is unpleasant and also lowers tax revenue - worsening the debt spiral - and causes banks' loans to default. So it has seemed clear to us that printing money to buy bonds (yield curve control, capping bond yields) is the path of least resistance, 'kick the can' approach that the regime will choose."
• This Earnings Season Vindicates the Value vs Growth Hypothesis: "We are still in the opening innings of the reversal in value versus growth, but today was a big drawdown for growth investors. Do you even hear any of them questioning themselves? From what I can see, they are blaming macro factors and not considering the strategic factor bet."
• Oil Producer Earnings - Q3 2022: "It is really impressive that Marathon disclosed these metrics. I have never seen a company make an acquisition and affirmatively quantify that what they bought is cheaper than their own stock valuation. (It is also impressive that Marathon's own FCF yield is 13% at $81 oil and a $31 share price.)"
• "Why Won't Energy Companies Drill?": "It appears that many investors think that shorting energy is a smart way of hedging recession risk in their 'software eating the world' tech portfolios. The top 800 hedge funds are long 'tech' and short energy, still, a full two years after tech versus energy peaked."
• Oil Inventories: "We know that royalty trusts are not going to go bankrupt. We are getting paid less for our products than we should be right now, but the shortsighted strategy of eating the seed corn is only going to result in scarcity and higher prices down the road."