The Rational Cloning: Weekly Ideas #81

Praetorian Capital Q1 2023 Letter, A Century of Asset Allocation Crash Risk, Tweets/Ideas That Make You Go… Hmm 🤔

The Rational Cloner

Apr 23, 2023

Welcome to the 81st edition of the Rational Cloning Newsletter (Weekly Ideas Series).

Helping you discover the best ideas of others.

Happy cloning.

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Weekly Investment Ideas

(1) Praetorian Capital Q1 2023 Letter

Position Review (top 5 position weightings at quarter end from largest to smallest)
Uranium Basket (entities holding physical uranium)
It may take some time still, but I believe that society will eventually settle on nuclear power as a compromise solution for baseload power generation. This will come at a time when there is a deficit of uranium production, compared with growing demand. As aboveground stocks are consumed, uranium prices should appreciate towards the marginal cost of production. Additionally, there is currently an entity named Sprott Physical Uranium Trust (U-U – Canada) that is aggressively issuing shares through an At-TheMarket offering, or ATM, in order to purchase uranium (we are long this entity). I believe that these uranium purchases will accelerate the price realization function by sequestering much of the available above-ground stockpile at a time when utilities have run down their inventories and need substantial purchases to re-stock. The combination of these factors ought to lead to a dramatic increase in the price of uranium as it will take multiple years for sufficient incremental supply to come online—even if the restart decision were made today.
Ironically, I believe uranium will be a prime beneficiary of sanctions on Russia as Russia is one of the world’s largest enrichers of uranium. I believe that as the West is forced to enrich more of the uranium that ultimately goes into reactors, underfeeding of tails will flip to an overfeeding of tails. In my opinion, the net effect could be anywhere between a 10% and 30% swing in the global supply and demand balance of uranium—which may dramatically accelerate the timing of my thesis while increasing the ultimate magnitude of the upward swing in uranium prices.
Oil Futures, Futures, ETFs, ETF Options and Call Spreads on Futures
I believe that years of reduced capital expenditures, along with ESG restricting capital access, combined with Western governments that are openly hostile to fossil fuels, have created an environment for dramatically higher oil prices. While we could purchase oil producers, and we are long shares of Journey Energy (JOY – Canada), I feel it is far more conservative to simply own the physical commodity itself.
I believe that this leveraged play on oil gives us the most upside to oil and ultimately inflation, while exposing us to reduced risk when compared to producers.
Energy Services Basket (Positions Not Currently Disclosed)
In 2020 when oil traded below zero, drilling activity ground to a halt and many energy service providers declared bankruptcy. Many of these businesses had teetered on the verge of bankruptcy for years due to reduced demand and over-leveraged balance sheets. The bankruptcies led to consolidation and reduced future industry capacity, removing future competition in the recovery.
With oil prices now recovering, I believe that demand for drilling and other services will increase from subdued levels. While producers have been slow to increase spending on exploration despite recoveries in energy prices, I believe that this only extends the timing on the thesis. In the end, the only way to reduce future energy prices is to see a dramatic increase in global oilfield services spending. Any postponement of this spending only leads to higher prices and more wealth transfer from the global economy to the oil producers, which will likely end up resulting in an increase in spending on exploration and production.
We purchased many of these positions at fractions of the equipment’s replacement cost, despite restored balance sheets and positive operating cash flow. As spending in the sector recovers, I believe that the potential for cash flow will become more apparent and this equipment will trade up to valuations closer to replacement cost.
St. Joe (JOE – USA)
JOE owns approximately 175,000 acres in the Florida Panhandle. It has been widely known that JOE traded for a tiny fraction of its liquidation value for years, but without a catalyst, it was always perceived to be “dead money.”
Over the past few years, the population of the Panhandle has hit what I believe to be a critical mass where it now has a center of gravity that is attracting people who want to live in one of the prettiest places in the country, with zero state income taxes and few of the problems of large cities.
The oddity of the current disdain for so-called “value investments” is that many of them are growing quite fast. I believe that JOE will grow revenue at 30% to 50% each year for the foreseeable future, with earnings growing at a much faster clip. Meanwhile, I believe the shares trade at a single-digit multiple on Adjusted Funds from Operations (AFFO) looking out to 2024, while substantial asset value is tossed in for free.
Besides the valuation, growth, and high Return on Invested Capital (ROIC) of the business, why else do I like JOE? For starters, land tends to appreciate rapidly during periods of high inflation—particularly an inflationary period where interest rates are likely to remain suppressed by the Federal Reserve. More importantly, I believe we are about to witness a massive population migration as people with means choose to flee big cities for somewhere peaceful.
I suspect that every convulsion of urban chaos and/or tax-the-rich scheming will launch JOE shares higher, and it will ultimately be seen as the way to “play” the stream of very wealthy refugees fleeing for somewhere better.
Legacy to Digital Transformation Securities Basket (Various Positions)
Most global print newspapers have seen their readership decline for decades as subscribers seek out alternative digital sources of information. In response to this, newspapers have tried to build up their digital presence. Historically, this digital revenue stream was always rather negligible as it was coming from a small base, especially when compared to steep declines from the print side.
Over the past few years, digital revenue growth has accelerated to the point where I expect that the newspaper companies in our basket are within a few years of their digital revenue overtaking their print revenue—assuming recent trends hold. Digital revenue represents a higher margin and higher return on capital business when compared to the capital and manpower intensity of printing and distributing physical newspapers. My belief is that, as these digital businesses come to dominate the revenue stream, newspaper company valuations will re-rate—particularly as many of them trade as if they are dying businesses, when in reality the digital side of their businesses is growing quite rapidly.
While many well-known global newspapers have successfully made this digital transition and seen earnings growth for a number of years, many smaller papers have continued to see earnings decline. I believe that these smaller papers are now on the cusp of an inflection to earnings growth as digital growth overtakes print declines. Should this happen, I anticipate it will dramatically change the narratives for these companies, along with their valuations, much like what occurred at more well-known papers. The Fund owns a global basket of these smaller newspaper companies

(2) Klement on Investing: Which asset allocation works best? A rear-view mirror back to 1926

There are too many details to cover in the paper, so have a look for yourself if you are interested, but here are some of my main takeaways:
Diversification works: As if this needs any proof, but it is nice to see that the more diversified a portfolio gets, the better it is compared to the US 60/40 starting point. The Diversified 60/40 portfolio has about the same return (8.7% p.a.) as the US 60/40 portfolio but lower volatility (10.4% vs. 11.6% for the US 60/40). And while the more diversified portfolio doesn’t necessarily have less drawdown in a crisis, it gets out of the hole significantly faster than a less diversified portfolio. The diversification benefits increase if we move towards a risk-parity portfolio or an endowment-style portfolio.
The lowest drawdown risk exists in the dynamic portfolio allocation indicating the importance of adjusting portfolio weights in changing environments to reduce losses.
The highest return is shown by the endowment portfolio, which in no small part is due to the high returns in alternative asset classes like private equity and venture capital. However, this higher return comes at an important cost. Drawdowns and time under water for endowment portfolios are substantially bigger than for more conventional portfolios. If you don’t have a very long time horizon of several decades and an iron discipline to stick with the strategy in what can be years and years of underperformance, these portfolios are not for you.
Mixing systematic factor exposures in a portfolio can be a good middle ground between less diversified 60/40 portfolios and the more complex endowment portfolio. And they have the lowest drawdowns and time under water of all static portfolios. So, if you are not into dynamic asset allocation, why not look into a combination of many different factor portfolios from value to momentum, low volatility, etc.?