Murray Stahl on Inflation, The Compounding Capital Review on Target, Smead Capital on The Green Futures’ Chernobyl Moment, Clark Street Value on IMARA; Tweets That Make You Go… Hmm 🤔
Stahl collects facts and builds investment hypotheses. Not exactly a theorist, he creates a worldview from micro and macroeconomic observations…. Listen to Stahl talk about inflation and you’ll learn something about the following subjects: diamonds, food stamps, the nature of 21st-century work, the end of the Cold War, interest rates, impediments to seaborne commerce, the government’s social contract with the electorate and the common stocks of businesses that work with the bare minimum of human hands. The list commingles inflation-themed investment opportunities with thoughts about the causes of the inflation that gives rise to opportunity.
Since inception, INFL 0.00%↑ has delivered a cumulative return of 24.5% versus 11.2% for the S&P 500 and 0.3% for the Bloomberg TIPS Index. Energy royalty companies such as Viper Energy Partners, L.P. ( VNOM 0.00%↑ on the Nasdaq) and Prairie Sky Royalty, Ltd. ($PSK.TO on the Toronto Stock Exchange) have significantly contributed to those gains. So, too, has Texas Pacific Land Corp TPL 0.00%↑, on whose board Stahl sits and whose praises Horizon Kinetics sang in the first research report it published 20 years ago. Detractors to performance include Japan Exchange Group, Inc. (8697: Tokyo), owner of the Tokyo Stock Exchange, and Intercontinental Exchange, Inc. ( ICE 0.00%↑), owner of, among other worldwide bourses, the New York Stock Exchange.
The [securities] exchanges, like royalty trusts, are toll-takers, he observes. They do not produce a product but earn a contractually fixed share of the revenue of the counterparty that does. He asks, knowing the answer: Would you rather own a gold mine, with the attendant gold-price risks, or a royalty company like Franco-Nevada Corp. that earns a share of mining revenue whatever happens to the gold price?
Inflation victimizes most businesses, especially the fully staffed and capital-intensive ones. Better, then, to invest in the lightly staffed, asset-lite inflation beneficiaries. “It’s still a thesis,” Stahl concedes of the intellectual underpinning of the INFL portfolio. “It has to be proven that the companies with the lowest labor-cost components can be [inflation] beneficiaries. I don’t think the world, in general, is looking at stocks through that lens. . . . So I have this construct, this mental construct, of the world. And like many times in my life, I think I’m in the minority.”
Cast your eye back to the transformation of the world’s product and labor markets some 40 years ago, Stahl beckons. From 1990 to 2021, according to the World Bank, the global labor force expanded to 3.46 billion people from 2.32 billion. The central banks had nothing much to do with this disinflationary jolt, nor with the related opening of worldwide commodity markets to former totalitarian pariah states. The decline and fall of inflation-inducing political systems (e.g., Soviet Communism and unreformed Chinese Communism) was rather the catalyst for the disinflation that the tides of geopolitics are now reversing.
Far from being the norm, then, Stahl contends, the past several decades were the anomaly: “Anomalous as to the conditions that created the historically extreme corporate profit margins. Anomalous as to the 40 years of declining interest rates that supported extreme stock and bond valuations and that enabled governments to finance spending levels in excess of tax revenues and otherwise unsupportable levels of debt.
So it’s back to the future, though not, as an inflation hawk may reflexively assume, to the 1970s. The ratio of gross public debt to GDP, which closed the 1970s at 32%, today stands at 123%, slightly higher than the post–World War II peak. The government would surely meet the next recession with a gust of spending, just as it did the pandemic. How would it pay the bills? Not without more monetary magic… We requote those remarks (Grant’s, June 24), because they speak to Stahl’s contention that the money-printing impulse is ever present. Only its institutional form changes.
Then inflation, with apologies to Milton Friedman, is always and everywhere a complex phenomenon and above all a human one.
Summary: Resilience and Growth Through Turmoil, Asymmetric Opportunity Today
Competitive Advantage: Target’s Real Estate and Brand
We would argue Target's competitive advantage is reflected in its return on invested capital, which was consistently 14-15% pre-COVID and began inflecting in 2018 when the company launched its omnichannel strategy in earnest with the acquisition of Shipt in December 2017. TGT earned 25-30% ROIC during COVID and is now pacing closer to 20% while dealing with massively bloated inventory and trough margins.
So what competitive advantages enable the company to earn these attractive returns on capital? We believe 1) real estate and 2) Target’s brand are the two differentiators.
Conclusion
TGT is a differentiated business with an irreplaceable real estate footprint and unique brand. These competitive advantages have shepherded the business through extraordinary upheaval in the past. The current turmoil should be no different.
While a recession would be a set back for TGT, we view this risk as temporary in nature.
As a result, we believe TGT’s growth algorithm laid out at its investor day earlier this year is still intact assuming no near-term recession, with mid-single-digit annual revenue growth, ~8% operating margins over the next several years, and after-tax ROIC in the high 20% to 30% range.
At 20x trough earnings, we believe TGT shares offer compelling upside with limited downside given that we are passing through a period of extraordinary margin pressure.
What has taken place in 2022 is nothing short of a man-made problem. The question is if you looked upriver, could this have been avoided? While it could be argued that Putin invading Ukraine was unexpected, the policy decisions and structure of the global energy markets have been shaped for years. It reads like the lamp in the movie A Christmas Story: Fragile. Besides structural issues, there have been pressures imposed on these structures that were unforeseen when they were built. These were exactly the pressures that caused what we now know as Chernobyl.
The rhymes of these words are ringing in our ears as we see the policy prescription from the western world collide with the realities of the devastation being brought to the economies of the world. When investors hear things like net-zero by 2050, it screams like Soviet-style mandates on market economies. When pressures collide in economics, there is only one way to rectify these forces: price. An example would be European electricity prices. The price being paid by businesses and consumers is being brought by mandates and quotas that aren’t market-based assumptions.
To evidence how far away from the market these policies are, look to the recent news. In the same month that California announced they will not sell gasoline cars beginning in 2035, they also told residents to not charge their electric cars in fear of blackouts. Again, quotas and mandates that are unreasonable for consumers and businesses. This radiates confidence in the economic structure and the decision-makers pushing policy.
We look at these decisions and pressures being brought by today’s Gorbachevs much like Warren Buffett does. “People that are on the extremes of both sides of are a little nuts. I would hate to have all the hydrocarbons banned in three years. You wouldn’t want a world, uh, it wouldn’t work and on the other hand what’s happening will be adapted to over time just as we have adapted to all kinds of things.” He goes on to say, “I think we are going to have a lot of hydrocarbons for a very long time and will be very glad we got them, but I do think the world is moving away from them. That could change.”
Buffett understands how fragile this ultimately is. The most important words he utters are “that could change.” The reverberation and radiation of 2022 may cause a change in the policy prescriptions from today’s Gorbachevs. I don’t expect things to get better in the Soviet-style decision-making of the West as we read about price caps in Europe. If you want economics to stop supply from increasing, use price caps. Or better yet, set mandates and quotas for households of the world after a two-year period where you controlled their face attire and their movement to slow a pandemic. As Tanzi makes the case, Chernobyl was the beginning of the end of the Soviet Union. It was the government folding. It was bad decisions coming home to roost. Alarmists in the green future better take heed. If they take one step too quickly as Gorbachev did, they may prematurely end their cause.
IMARA Inc (IMRA) ($43MM market cap) is a clinical stage biopharmaceutical company that announced back in April their decision to discontinue further development of their sickle sell disease treatment (IMR-687) and initiate a process to evaluate strategic options. The stock then crashed and traded at about half net current asset value. In 2022, that's nothing exciting on its face, there are lots of broken biotech stocks trading well below cash that it is difficult to parse between them for actionable ideas other than taking a basket approach.
But IMARA is interesting because today they announced via an 8-K (no press release) that they've sold IMR-687 to Cardurion Pharmaceuticals for $35MM, plus some contingent payments if things go well. Excluded from the asset sale is IMARA's cash pile:
Excluded Assets. Notwithstanding the provisions of Section 2.1, no right, title or interest is being sold, assigned, transferred, conveyed or delivered to Cardurion in or to (a) any property and assets of Imara that are not Purchased Assets (including any and all amounts of cash and cash equivalents of Imara), (b) any rights or claims of Imara under this Agreement or any of the Ancillary Agreements, (c) all assets of Imara exclusively related to IMR-261 and (d) all assets of any Third Party with whom Imara enters into a transaction on or after the Execution Date pursuant to which it becomes (or will become) an Affiliate of such Third Party (collectively, the “Excluded Assets”).
Prior to this surprise asset sale (I normally assume a broken biotech's IP is worthless), IMARA had a net current asset value at 6/30 of ~$60MM and 26.3 million shares outstanding, or $2.30/share in net cash. After the asset sale closes, that number jumps up to $3.65/share (pre-cash/expense burn), yet the shares only trade for $1.67 today. Hidden in the 8-K, the company mentions the below:
In connection with stockholder approval of the Asset Sale and the plan of liquidation, the Company intends to file a proxy statement and other materials with the SEC. Stockholders of the Company are advised to read the proxy statement and any other relevant documents filed with the SEC when they become available because those documents will contain important information about the Asset Sale and the plan of liquidation.
They did a few other things that hint this it for the company, they amended their retention plans to pay 50% out now on the execution of the asset sale and 50% on the closing of the asset sale, versus paying out on any subsequent reverse merger or other action. And it appears their advisors are done too. The current price seems far too cheap if the company is going to return their cash to shareholders, I bought some shares today.
