The investing world was consumed with the US Federal Reserve’s musings this past week, but we’re looking around the globe at some other interesting items. First, the Indian railroads minister gave your faithful analyst an unpleasant shock this week regarding a locomotive order from GE’s Transportation business, but it looks like it will turn out to be a happy ending after all. And speaking of happy endings, there was a happy ending to an oil rights auction in Brazil this week, a bit of news that might bode well for oil equipment providers, especially those with a tilt toward offshore production. Despite the good news, there are more than a few black swans lurking out there (and it turns out that the Financial markets are not so good at estimating the probability of those risks), one perhaps related to the similarity of certain world leaders to Kaiser Wilhelm II. You be the judge if the lights really ARE going out in Asia.
Here is a curated list of important stories outside the main headlines that caught our attention this week.
Mastering the Three Strategies of Organic Growth (Kabir Ahuja, Liz Hilton Segel, and Jesko Perrey, all of McKinsey & Company). I am an operations person by upbringing, vs. Erik, who’s been on all sides of the finance and investing industry. I’ve always told Erik that my ops view of things made his entire process understandable to me because of its focus on clearly dimensioning the demand environment. Repeatably capturing growth is elusive because what works today often runs a course and is obsoleted by some other product or approach. So, a company in any industry should be yet more concerned about growth when times are good. Those times, by their very existence, will come to an end. As an investor, I look for companies that are proven to be good at adapting over time and finding new ways to generate growth repeatedly. Sometimes these adaptations are slow or messy or both. That’s ok. That’s what it means to turn a big ship. But companies who repeatably get this right are a good place to park capital and watch it grow. This piece by some McKinsey partners is an excellent primer for some things we ought to look for and be thinking about as we assess a company’s short and medium term growth potential. You will look at your favorite businesses differently after reading it.
Why Financial Markets Underestimate Risk (Project Syndicate). This article points to the very low level of the VIX – which has only touched lower points twice in its history, 2006 and 2007 – and wonders why financial markets are not reflecting heightened levels of uncertainty. Hi points out that North Korea is an erratic nuclear power at odds with another nuclear power whose leader is erratic, that the US may face a constitutional crisis due to the Mueller probe, and that political divisiveness is limiting legislative action on important topics. He believes the market is simply not dealing properly with black swans – “phenomenon whose occurrence can not be inferred from observed data.” For fans of Nic Taleb, this will not come as a surprising conclusion. I would take exception, though, to the writer’s identification of issues. Certainly, nuclear war is a rare phenomenon whose likelihood and effects markets probably cannot assess accurately, but the other two issues are standard political fare. In my opinion, the much more serious black swan is the shift in international trade relationships brought about by Brexit and by the shift toward nationalism in our own country and elsewhere. Whatever the cause, the writer and I agree that present levels of the VIX are…inappropriate.
Brazil Offshore Oil Drilling Rights Draw Interest at Auction (NY Times). With plenty of cheap, fracked oil and reserves from the Middle East’s easily mined fields, the world is awash in oil. So much so that mining for oil in deep offshore fields – the exploration and development of which is notoriously expensive – has largely fallen by the wayside. Wells that have already been drilled are producing – producing is relatively cheap – but not many new wells are being drilled. This dynamic has hurt oil equipment companies that specialized in deepwater exploration and production, with rig leasing company, SeaDrill, being a case in point. Could life be returning to this section of the energy complex? Perhaps, as the NY Times is reporting a fairly successful drilling rights auction for deepwater plots off the coast of Brazil. Rental equipment rates have come down, and we believe that technological improvements are also lowering costs, making offshore exploration more attractive at lower oil prices. While nothing we’ve read suggests that $50 / barrel oil can cover the cost of offshore exploration, with economies around the world growing again, people in the business must believe that there will someday be enough demand to soak up higher priced oil. Before you get too excited, read through the entire article. It looks like some of the interest in this auction has to do with changes in the Brazilian regulatory environment.
The Lamps are Going Out in Asia (38 North – John Hopkins School for International Studies). This is the smartest thing I’ve read about the North Korean nuclear showdown, from scholars at John Hopkins. The author makes the point that the conditions existing between the US and North Korea right now look similar enough to conditions existing in Europe in 1914 to be really concerning. Reading some about Kaiser Wilhelm II (in a book called The Sleepwalkers), who led his nation into a disastrous war that not only destroyed four empires but also set the stage for the atrocities of World War II, I am struck by his many psychological similarities to our present President. At the start of WWI, everyone knew that the Kaiser was a blowhard, and figured that the extensive trade ties between the nations would allow for a limited, regional conflict that would be over in a jiffy. Sound familiar?
In India a Big GE Deal Goes Off the Rails (WSJ). The evening after I published our valuation note on GE, I checked my Twitter feed and was less than delighted to see this headline. Those who have attended our Office Hour sessions know how little fondness I have for GE’s Transportation business – which mainly sells locomotives. Well, I officially like that business less now. GE had negotiated a complex, multi-year deal in 2015 to supply Indian railroads with 1,000 locomotives – GE’s largest equipment order in history. The first 100 units were to be built in the US, with the next 900 to be manufactured in a new plant, sited in the rural Indian state of Bihar. Bihar’s new factory would help lift many families out of poverty and would offer GE a foot in the door for locomotive service and equipment orders in the future. But a new Railroads Minister, Piyush Goyal, mentioned that he thought India’s trains should be electric, not diesel. There are a few problems with that, not the least of which that the contract for 1,000 diesel locomotives was signed back in 2015. Apparently, this issue has been resolved in GE’s favor, with India now saying that the shipments should proceed, but the ministerial head-fake does highlight a real problem with doing business in India and other emerging markets.