Readings For The Week (27/5) – Off-Piste Investing

Apologies for the radio silence, it has been a rather hectic month with the start of preschool for my son, some overseas travel and then the whole family coming down with Covid. Things are now thankfully on the mend. On a separate note, I can’t believe we are almost halfway through the year already. Time flies!

Horizon Kinetics: Q1 2023 market commentary.

Good read, in particular the section on land investments (pages ~19-34). Land is a perpetual business asset that can serve different and progressively higher-value functions over time. It can be a great long-term return and inflation hedge vehicle. It is also a valuable source of diversification as it has very idiosyncratic return patterns. The challenge, as pointed out, is that the pace of value development can take a very long time. The advantage is there are no meaningful holding costs or ongoing capital requirements. Of course, the overall context regarding private land ownership rights as discussed in the letter is US-specific and may not apply in other countries.

One thing I would add is that when most people think about owning land, they typically think of the surface rights. The other aspect, however, is the mineral rights, which is the perpetual right to explore, develop and produce minerals from beneath the land’s surface (this is only valuable to the extent that the land is prospective from a commodity perspective). In the US, surface and mineral rights can be severed, but mineral rights have historically been considered dominant in that they can use the surface in any way which is reasonably necessary to the development of the mineral estate.

The merits of land ownership are fairly obvious to wealthy families, as evidenced by the list of the largest private landholders in the US. For ordinary investors, however, there are a dearth of land companies in the US public markets (REITs and homebuilders have very different business models and characteristics). There are perhaps about 10 listed names in total, most with limited trading liquidity and representation in the indices. The letter shares a few examples and case studies which might be of interest to readers – Texas Pacific Land (which has been listed for over a century and has compounded at ~9.6% over its history, excluding dividends and a valuable spin-off to shareholders 50 years ago), Tejon Ranch, Gladstone Land etc.

Hosking Partners: Cosmo Energy.

Brief case study on the Japanese refining industry and understanding why an asset is trading at a discount or premium to its replacement value. As the Hosking Partners team writes, “deciding whether an industry is experiencing a period of over- or under-investment is not trivial, nor is it sufficient for us to conclude higher or lower returns for shareholders will follow, but it is an important tool that we use to understand the capital cycle.”

The lack of investment in assets caused by a discount to replacement value starts to result in declining capacity. The Japanese refining industry, for example, has seen a significant amount of consolidation over time, encouraged by the Ministry of International Trade and Industry. The three major refining companies today can trace their roots back to 16 companies. The reason having a healthy refining industry is strategically important is that oil accounts for nearly 40% of Japan’s total energy consumption and is almost entirely imported as crude.

What makes the task harder is that the demand for oil in Japan is also falling as the population shrinks, by ~2.5% a year. “Planned closures at Idemitsu and ENEOS will remove 8% of capacity in the next few years in an effort to maintain equilibrium. Experience tells us this is a very hard balance to strike, and the probability of a squeeze is high, particularly for complex refineries that can produce low sulphur product for export as well as for the domestic market.”