Best of Credit Bubble Stocks - 2024

[Previously: Best of Credit Bubble Stocks - 2021 and Best of Credit Bubble Stocks - 2022.]

• It is a concern that the miners are expanding met coal production even while the commodity price has been weak and their own shares have been "cheap". Warrior's new Blue Creek mine is expected to produce 5 million tons per year and Peabody's North Goonyella / Centurion mine is supposed to produce 3 million tons per year. To put that in perspective, 8 million tons of new capacity is about equal to what Warrior produces in total now. [Coal Earnings Notes (Q1 2024)]
• The opportunity that we have seen is that these royalty interests in hydrocarbons are bond-like assets priced to give equity-like returns because of ESG investing and because of a brutal bear market, and subsequent investor disinterest, in natural resource production. [Review of Material World: The Six Raw Materials That Shape Modern Civilization] 
• We know that Google is an inferior business to Apple because Google pays a gigantic tithe to Apple. But notice that Apple's most recent quarter cash flow was running at a 5% yield on the enterprise value. That is much more attractive than the other companies in the Mag 7 (which otherwise seem quite expensive). Apple seems to have the best combination of moat and valuation. If you had to own one of the Mag 7, Apple would be our choice, hands-down, based on business quality and valuation. (Maybe you do have to own one. How far from the S&P 500 index and its performance are you allowed to stray?) [Looking at the Magnificent 7]
• We have been reëvaluating Elon Musk over the past two years, based on new events and information. In October 2022, he completed the acquisition of Twitter and has turned it into a free speech platform with quite liberal policies. Last year we read the Issacson biography and discovered that Musk does have some very intelligent ideas, like his Idiot Index (the ratio of the cost of a finished product to its bill of materials) and his Algorithm for making manufacturing processes more efficient. We also noticed that his politics have changed. [Musk as Sovereign]
• Amazingly, in his book The Next Two Hundred Years, he wrote that, "once an effective process for the extraction of oil from shale is developed, the total available supply of fossil energy could be more than quadrupled." Keep in mind that he wrote that in 1976. He just assumed that eventually people would figure out how to extract oil from source rock instead of the reservoir rock, and forty years later the production of "tight" oil from source rock became meaningful. Now the production of this oil using horizontal wells and hydraulic fracturing has surpassed conventional oil production in the U.S. If Kahn had ever gotten interested in commodities investing, his mantra would have been to sell shortages and buy gluts. [On Herman Kahn]
• Hopefully, Trump will replace as many of the monuments that were torn down during the 2020 cultural revolution as possible, and revert back the names of any places that were changed for woke reasons. We really need to change "Denali" back to Mount McKinley to honor a president who believed in the gold standard and protective tariffs and who was assassinated by a communist. It would be good to go on the offensive and build new statues and monuments. There should be a James K. Polk monument. [Reasons to Celebrate]
• What we have come to think is that shale is a cornucopian bounty, and the producers do not make money because they are in a classic bad business (resource extraction), not because there is something unsustainable about producing oil from the source formations. Being the highest cost producer of a commodity is just a constant tale of woe punctuated by occasional profitable times. The good times keep people - both managements and investors - chasing the dream. [Commodity Investments Under Cornucopianism]

Here is a shot at a Best of Credit Bubble Stocks for 2023, since we never published one:

• These are just very discouraging developments at Altria and some tobacco investors are kidding themselves thinking anything else. Juul is the best vaping product, hands-down, the same way that Zyn is the best oral nicotine product. Last year, Altria let Philip Morris buy - practically steal - Swedish Match and Zyn without lobbing a bid or even expressing interest that might have raised the cost for its competitor. [Altria's Bungles]
• Why is it bad that people are quitting cigarettes? Wasn't that our "re-nicotinization" thesis? Yes, but that was assuming that the reduced risk product profit pool would be as big or bigger than the cigarette profit pool, and that it would be captured by the incumbent tobacco companies. The cigarette business is basically a duopoly, hence very profitable. The reduced risk products have tons of competition. [Will "nicotine as a service" be as lucrative as cigarettes were?]
• Ask yourself why the macro environment is so bad for cigarette sales, yet McDonald's had a great quarter (U.S. comp sales up 13%), Chipotle had a great quarter (comp sales up 11% with margins also up), PepsiCo had a great quarter, and Valero had a great quarter (with demand for gasoline and diesel at record highs). The difference is that cigarettes have better, cheaper competition. There are the "open tank" vapes which the user refills with his own nicotine-containing liquids ("juice"), which we think appeal to the downscale ex-smokers, as well as the pothead users who have experience using them with THC liquids. For the younger crowd (which probably has never-smokers), you have closed tank products like Juul or the Elf Bar, which are illicit but selling like hotcakes. The biggest thing that tobacco longs are missing is that competitive intensity in nicotine delivery has gone from sleepy (the cozy Marlboro and Camel duopoly) to ferocious. That is going to make it very difficult for big tobacco to keep raising the price of the pack of cigarettes enough to offset the volume declines. It is also likely to shrink the overall nicotine delivery profit pool (which is more of a function of industry structure than market size) and divide whatever profit pool does exist among more players. Bearish. We think the time to get out of this industry is when you see the competitive intensity increasing. [Altria Reports 2023 First-Quarter Results]
• Zyn has been dominating the U.S. pouch market, but if you go to SnusDirect you can see that the pouch market in Scandinavia is very crowded. You can get a Jalapeño Lime flavored pouch from LOOP or an extremely strong Skruf mint flavored pouch. Perhaps the managers of Swedish Match sold the company because they knew an onslaught of competition would eventually reach America? They had two-thirds market share with Zyn in the U.S., but only about ten percent market share in Scandinavia (see slide 7)! [Young Vapers Like "Watermelon Ice"]
• Interestingly, there were no questions on the fourth quarter conference call, despite the fact that the company trades at 3x EBITDA (with a pure royalty business model) and is committed to shareholder returns! [Natural Resource Partners L.P.]
• There is a great tension between physics-based pessimism about natural resources and economics-based optimism (some might say cornucopianism) about the ability to respond to higher prices with substitution and invention. The LFP battery seems like a major point in favor of the cornucopian, economist viewpoint. We would not have thought it possible a few years ago to make a battery with just lithium and iron. [Review of Crude Volatility: The History and the Future of Boom-Bust Oil Prices by Robert McNally]
• During the years that Powell worked for the Treasury, the think tank, and the Federal Reserve, he was closely involved in six financial embarrassments or crises. Each time, there was a question whether the parties involved should take their lumps, to protect against moral hazard in the future, or whether they should be bailed out in order to protect against broader "contagion" or "panic". The essential takeaway from this book is that Powell has faced six such situations in his career and has recommended, advised, or chosen the bailout every time. [Review of Trillion Dollar Triage: How Jay Powell and the Fed Battled a President and a Pandemic---and Prevented Economic Disaster by Nick Timiraos]
• If you were running things, how would you maximize the amount you could raise via the inflation tax? You need to trick bondholders, otherwise the market interest rate on new debt issues will reprice higher for inflation. This seems to imply that the best strategy is periodic, large devaluations with the rest of the time spent talking very tough about inflation. [Paper: "Fiscal Dominance and the Return of Zero-Interest Bank Reserve Requirements"]
• I now realize there is a bit too much “critique” in Mencken. If you live in a healthy society - and he lived in our golden age - then engaging in criticism is sort of like taking down panels of Chesterton’s fence. On the other hand, you can understand that he was frustrated with two decades of political repression during the prime of his life and writing career. (He blamed Methodists for prohibition.) [Books - Q3 2023]
• It is always tough to tell what is going on as an outsider. Altria's "growth outlays" on Juul and NJOY were really desperate attempts to patch their leaky cigarette boat. The Juul money was thrown away for no increase in earnings, and it is possible that the NJOY acquisition will have the same result. In contrast, the free cash flow per unit of Enterprise has grown substantially (3.3x) over the past five years. And there are no illicit Chinese competitors offering to move the same shipments of oil, natural gas liquids, and natural gas for half of what Enterprise is charging. [Enterprise Products Partners - Q3 2023]
• The Sprouts stores are extremely well run and well merchandised, putting pressure on the tired old grocers that are owned by Kroger and Albertsons. (Imagine how much more run down those companies' stores will become if their merger happens.) And the business generates free cash flow even while expanding, which the company has been using to cannibalize its own shares. Since 2015, Sprouts has grown its store count from 217 to the current 401 while shrinking its share count by almost 40%. Giving customers the best experience while allocating capital for shareholders' benefit has gotten our attention. [Sprouts Farmers Market, Inc.]
• We are skeptical of big capital expenditures at companies with depressed valuations, but that is our outsider, generalist view. Perhaps our friends at Enterprise Products, Warrior, and U.S. Steel look around and see that no one else is making significant investments in coal, steel, and pipeline capacity. Maybe these investments are a cinch? [Coal & Steel Producer Earnings - Q3 2023]
• Something to emphasize about the model: the number of rooms in the Marriott system keeps growing without Marriott shareholders needing to pay for them. In the third quarter, their room count was up 5% year-over-year. Their ecosystem has 1.5 million rooms (around a quarter of the worldwide total), but since third parties own and pay for 99% of them, cash is available for distribution to shareholders. The business is royalty-like, because other investors are building the hotels and Marriott is getting percentages of revenue (and profits) to manage them. That is what allows Marriott to be in the top 2% of free cash flow margin in the S&P 500. [Free Cash Flow Conversion & Marriott International Inc]
• I realize that I underestimated some of his abilities and accomplishments while I was a Tesla bear. For example, Musk has something called the "idiot index," which is the ratio of the cost of a finished product to its bill of materials. The idea is, "if a product has a high idiot index, its cost could be reduced significantly by devising more efficient manufacturing techniques." The idea just occurred to me over the summer ("when a manufactured item costs much more than its bill of materials, it seems more likely that the final cost will continue to decline due to learning curve effects") only to find out that Musk already put the concept into use a decade ago. Musk has something called The Algorithm for making manufacturing processes more efficient: question every requirement, delete any part or process you can, simplify and optimize (only after deleting), accelerate cycle time (only after doing the first three steps), automate (last). It sounds like he read The Goal (which we read in 2019) and improved on it. [Books - Q4 2023]