Tuesday, April 13, 2021

Gold Miners and the Net Issuance Anomaly

From Crescat Capital's March 2021 letter:

Gold and silver companies continue to report exceptionally strong fundamentals. Free-cash-flow estimate for miners keeps improving despite the recent correction in precious metals. As we have seen throughout history, stocks tend to follow fundamental growth. We believe there is a major catch up in prices ahead of us. There used to be a time when all gold and silver miners would do was to invest in unproductive assets and dilute their capital structure to pay for it. Those days are over. For the first time in history, aggregate net equity issuance for the top 10 precious metals mining companies is now falling. In other words, these companies are buying back stock like we have never seen before. These are fundamentally cheap stocks that continue to benefit from this macro environment.

I'm a believer in the taking advantage of the net issuance anomaly (i.e. companies retiring debt and repurchasing shares outperform those raising capital).

Where does the anomaly show up today? Industries with companies that are returning capital to investors are banks, tobacco, energy, miners, pipelines. Industries that are raising capital are electric vehicles and many types of growth and tech - especially considering stock based compensation. (Although some tech is negative issuance, e.g. Apple.)

The net issuance anomaly is related to our Sector Rotation Value Strategy. One logical mechanism which would cause the net issuers to under-perform is that they are in the "over-investment" part of their industry cycle. They take the proceeds of their equity and debt issuances, and they expand capacity, driving each other's economic rents down.

Back in May 2014, I did a large cap value screen. It was based on highest trailing 10 year earnings yield and shrinking share count. The top 15 candidates were:

Apollo Education (APOL) - this went private, would have lost money
American Financial Group (AFG) - this has doubled
Coach, Inc (COH) - now TPR, this is flat
ProAssurance Corp (PRA) - got cut in half
The Gap (GPS) - down about 25%
Magellan Health (MGLN) - up 50%
Bed Bath (BBBY) - down 50%
Exxon (XOM) - down about 25%
Intel (INTC) - doubled
Microsoft (MSFT) - up 6x!
Murphy Oil (MUR) - down 2/3rds
Chevron (CVX) - flat
Apple (APPL) - up 7x!
Occidental (OXY) - down 2/3rds
Marathon (MRO) - down 2/rds

If you had owned them equal weight (6.7%), the Microsoft, Apple, and Intel positions would have returned your whole fund. However, the energy stocks killed the overall return. 

Maybe the key here was that the earnings yield didn't account for capital structure the way the "acquirer's multiple" (EV/EBIT or EBITDA) would.

The other thing is that with the acquirer's multiple, you don't just hold for 7 years but rotate every year to whatever is screening cheapest. So you wouldn't have held the oil (and also probably not the tech) this long. Now you would be in tobacco and mining companies!

No comments: