Friday, 8 June 2012

Leucadia National and the Commodities Supercycle

The recent world economic slowdown has included the developing world, which largely escaped the severe 2008-09 recession.  The prominent BRIC nations, too, have showed surprising weakness, with India reporting disappointing growth figures, Brazil already cutting rates, and Russia sure to slow if the price of oil continues to fall.  But the "C" is more important than the "BRI": not only is China larger than all three countries put together, it's growing faster.  However, even the Chinese juggernaut has begun to slow.  First quarter GDP fell to 8.1%, which is still robust, particularly given the Middle Kingdom's $7 trillion-plus economy.  However, second quarter growth may be still lower, which was likely what prompted the government's recent decision to cut interest rates.
Given the short-term mindset that prevails among financial commentators and investors alike, the end of the commodities "super-cycle" is already being declared.  Perhaps it will indeed slow; only time will tell.  But two of the finest investors of the past few decades don't appear to believe the newfound hype.  Ian Cumming and Joseph Steinberg, the superb two-man team at the helm of Leucadia, state their case on commodities simply in their 2011 annual report: "We continue to believe that as citizens of historically poor countries get richer they will demand higher quality items – and more of them" (1).  Accordingly, they have most of the firm's capital invested in companies that stand to prosper only if commodities remain priced at relatively high levels.
They hold a large position in Inmet Mining, a Canadian firm whose production is centered on copper, along with a few other minerals.  While Leucadia has sharply reduced its common stock position in Fortescue, a miner of iron-ore, it holds a significant royalty interest in the Australian company's production.  Most significantly, Leucadia recently closed its largest ever acquisition by purchasing National Beef Packing, paying $868 million for 79% of the company (2).  Though the company is based in the US, a mature market for beef, the global trade in meat is growing significantly, a market the company will tap into.  As poor people in developing countries grow wealthier, one of the first changes in consumption is a move to add more protein to their diet, mostly by eating more meat.  Only if this trend continues is National Beef Packing likely to grow.
Cumming and Steinberg increased Leucadia's book value 18.5% per year from 1979-2011, despite a large one-time dividend in 1999 that significantly reduced shareholders equity (3).  Over that three-decade-plus time span, these super-investors saw many trends come and go, but they remain confident that the rise of the developing world is a secular change, and the commodity boom that began more than a decade ago will likely continue.  They could be wrong, but bet against them at your own risk.

Sources (1), (2), (3): Leucadia 2011 AR
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