MOI Global - Mohnish Pabrai on His Coal Thesis and the Mental Model Behind It
The speaker discusses the cyclical nature of industries like real estate and shipping, focusing on how gestation periods affect boom and bust cycles. In real estate, particularly with office towers, the long gestation period of 3-5 years leads to pronounced cycles. When demand is high, many projects start simultaneously, but they all hit the market at the same time, causing oversupply and subsequent downturns. This pattern is less pronounced in industrial real estate due to shorter gestation periods. Similarly, in the shipping industry, particularly with very large crude carriers (VLCCs), long construction times lead to similar cycles. When demand drops, many ships are scrapped, reducing supply, but when demand rises, new orders flood the market, leading to oversupply again. The speaker also touches on the impact of ESG pressures on coal companies, making it difficult for them to secure financial services despite being profitable.
Key Points:
- Real estate cycles are influenced by gestation periods; shorter periods in industrial real estate lead to less volatility.
- Office towers experience pronounced boom and bust cycles due to long construction times.
- Shipping industry faces similar cycles due to long build times for large carriers.
- Understanding these cycles can provide a strategic advantage in investment decisions.
- ESG pressures are impacting coal companies' ability to secure financial services despite profitability.
Details:
1. 📈 Investment Strategies & Market Insights
- The discussion emphasizes the strategic approach of being buyers in the investment space, which helps in reducing competition and potentially increasing market influence.
- The importance of developing and maintaining a mental model is highlighted as crucial for making informed investment decisions.
- Educational perspectives are discussed as essential tools for enhancing understanding of complex investment dynamics and market behaviors.
- Listeners can benefit from these insights by applying them to their own investment strategies, potentially leading to more successful outcomes.
2. 💼 Warren Buffett's Investment Anecdote
- Warren Buffett auctioned his wallet for charity approximately 25 years ago, including a stock tip for First Industrial, an industrial REIT based in Chicago.
- Despite Berkshire Hathaway's policy against investing in REITs due to tax inefficiencies, Buffett's personal recommendation of First Industrial highlights his willingness to make exceptions when he sees potential.
- The auction not only raised funds for charity but also demonstrated Buffett's influence and investment acumen, as his endorsement likely attracted significant interest in First Industrial.
3. 🏢 Real Estate Market Dynamics and Cycles
- Industrial real estate, such as warehouses and factories, has a gestation period of less than a year, allowing for quick market adjustments and fewer boom and bust cycles.
- Office real estate, with gestation periods of 3 to 5 years, experiences more pronounced cycles due to delayed market entry and overbuilding risks.
- The rapid supply response in industrial real estate helps stabilize the market quicker, while office markets may suffer longer periods of imbalance due to their slower response time.
- Economic growth can absorb excess capacity in industrial markets faster, leading to a stable baseline before the next cycle, whereas office markets may take longer to recover.
- Recent trends show industrial real estate quickly adapting to e-commerce demand, while office markets face challenges with remote work trends.
4. 🔄 Business Cycles in Construction and Real Estate
- Office vacancies becoming tight leads to a surge in tower constructions due to high rents.
- The construction of office towers takes 3 to 5 years, leading to simultaneous market entry.
- The boom and bust cycles are pronounced due to the delayed impact of new inventory.
- An example from Austin shows residential towers going through similar cycles as office towers.
- Gestation periods and the cycle dynamics are crucial in understanding real estate market fluctuations.
- Separate cycles for residential and office towers illustrate varying impacts on market dynamics.
- Real estate developers should monitor market signals to better time project initiations.
5. ⛴️ Oil Shipping Industry: A Case Study on Cycles
- In 2001, the industry faced an oversupply with 400 VLCCs, causing rental rates to plummet to $7,000-$8,000 per day, below the operating costs of $15,000-$20,000 per day. This illustrates the severe impact of oversupply on profitability.
- Ship owners responded strategically by scrapping ships, reducing the fleet from 400 to 350, which helped tighten the market as demand recovered, demonstrating effective supply management.
- The significant time lag in tanker delivery (3-4 years post-order) exacerbates market volatility, highlighting the need for strategic planning in fleet expansion.
- Rental rates surged to $250,000 per day during a demand boom, leading to a rush in orders at Korean shipyards, which increased new tanker prices from $70 million to $120-150 million. This underscores the pricing power of shipyards in high-demand periods and the cyclical nature of the market.
6. 🌍 ESG Challenges in the Coal Industry
- The coal industry, particularly metallurgical coal, faces severe reputational challenges due to environmental concerns, adversely affecting its public image and investor confidence.
- Consol Energy, a 150-year-old thermal coal company, has successfully maintained high-quality, low-cost operations and avoided financial distress and bankruptcy despite industry volatility, highlighting its operational resilience.
- Despite Consol Energy's strong financial standing, its long-standing banking relationship with JP Morgan Chase was terminated due to ESG considerations, illustrating the significant impact of ESG policies on financial partnerships.
- ESG policies are increasingly influencing financial institutions' decisions, leading to the reassessment of partnerships with coal companies, affecting their access to capital.
7. 🏦 Modern Mining Sector: Financial Hurdles
- Mining companies struggle with irrational challenges due to ESG pressures, such as obtaining workers' compensation insurance, despite being willing to self-insure for millions per incident.
- ESG concerns lead to mining companies being treated like pariahs by insurance and surety companies, making it difficult to receive quotes.
- Financial institutions like JP Morgan are hesitant to engage with mining companies for lending purposes, affecting their ability to raise debt for capital expenditures and growth.