Cloning the cloner: Posco

"If there wasn’t a Warren Buffett, there wouldn’t be a Pabrai Funds… It is hard for me to overstate the influence Warren Buffett and Charlie Munger have had on my thinking… I can never repay my debt to them for selflessly sharing priceless wisdom over the decades." 

Mohnish Pabrai

Mohnish Pabrai is a fund manager I have followed a fair bit over the past years and who I think is very interesting in both his investing and life philosophy. He started an investment fund in the mid 90s after making money as an entrepreneur and he set out to copy Buffett in his value investing style and he even copied how Buffett initially set up the fee structure in his investment fund. He charges 25% for performance over the first 6%, so a 15% return on the fund would charge 2.25% (i.e. 0.25*(15%-6%))

His goal has always been to compound his wealth at 25% per annum, that's one hell of a target and he is pretty much on course for that. This even includes a severe downturn 2008-2009 where he openly says he compounded at minus 35% for a couple of years! In his own words 'I was handed my head on a plate'.

He has a modified his positioning strategy a bit from a 10*10 (ten stocks with 10% positions) to one where the more he is invested the higher the expected reruns must be. If I remember correctly the first 50% of the portfolio must be thought to return x2 fold, the next 20% x3 fold, the next 10% x4 fold. So to be 90-95% invested the investment must be expected to return x5 fold.

The idea is to avoid being fully invested in bear markets, unless there are very compelling ideas, as he was during the financial crisis. He was not able to buy stocks as they got cheaper and the problem was compounded by investors pulling money out of the fund. He found himself in the painful situation of being forced to sell when he wanted to buy more!

I can highly recommend his presentation videos that can be easily found on the internet. His most recent (but in my opinion not his best) was at google here. Another two which I enjoyed more are here and here.

His fund portfolio can be easily found on guru focus.com (for example) here. He hadn't added a new significant position since end of 2012 until now! I'd been waiting for this. The latest 13F for his fund for second quarter 2014 shows he has bought shares in Korean steel company Posco. The position is about 15% of his portfolio.

The following will be a brief outline of the company to try to understand his motivation for buying. I will not claim to have done a very deep analysis (I've actually just found more detailed analyses here by Swedish bloggers this year here and here).

To start with Posco (PXR) is a steel company that manufactures of hot rolled steels, steel plates, wire rods, cold rolled steels, galvanized steels, electrical galvanized steels, stainless steels, titanium products, magnesium products. However, it doesn't stop there, it's kind of an conglomerate that spans a trading business, commercial and residential property, operation of power plants and distribution of energy.

In Jan this year the ex-chief technology officer Kwon O-joon become the new CEO and he seems intent in ushering a new strategy of cutting down the debt (0.65 debt/equity ratio), increasing ROE and dismantling his predecessors 'empire' by selling off non-core assets here and here. This is a potential catalyst that Pabrai could be banking on, but that is speculation on my part. 

It didn't take too long to find out that Pabrai has followed Warren Buffet and Charlie Munger into this stock. Berkshire Hathaway bought about 4% back in 2007 here whereas Munger has invested about 4% of the investment portfolio at Daily Journal Corporation here and here. It's interesting to note that this portfolio only has 4 stocks in it; talk about a concentrated strategy!

That's think about that for a moment. Of all the stocks to choose from in the world, he has chosen just four - Wells Fargo 61%, Bank of America 30%, US Bancorp 5% and Posco 4%. That's a pretty strong ringing endorsement. I've not found at what price the shares were bought, but that should not really matter. Ideally the stocks you have in your portfolio should be the exact same ones you would buy if you started over and had cash.

A small glimpse of Munger's thinking can be seen here in the following quote back in 2007 at the Wesco annual meeting

"I would argue that what POSCO does is not a commodity business at all – it’s a high-tech business. They learned from Nippon Steel and they’re now even more advanced. I’d argue that if you have the most technologically advanced steel company in the world making unusual, [non-commodity] stuff, then business can be quite attractive for a long time."

If we look at some financials, it is not a pretty sight with shrinking margins as well as ROA and ROE which now sit at 1.4% and 2.9% respectively. It is not surprising to read that it trades below book value P/B 0.6. Historically the stock has typically traded around book value which is being suggested as a reason for potential upside in the stock. 

A quick check shows the book value of equity increased at an annual 12% from 2009 to 2013, so some value has been returned to shareholders over that period.

Posco has very little intangibles on it's balance sheet so trades below tangible book value at a ratio of 0.8. This is implying you could sell of all its hard asses such property and plant, pay off all its loans and still have cash left to pay equity holders at around $107 a share here. This of course assumes the book value of these assets is the same as their market value. I would need to check deeper, for example the depreciation and amortisation methodology. Equipment and plant could be less, especially in a forced sale but property could be worth a lot more. This also doesn't put any value on Posco's technology, R&D and in-house knowledge.

Oddly enough Posco's Q2 results are a mixed bag depending on which time frames are used. Earnings were down 20% and below expectations here when comparing to same quarter last year but nearly doubled compared to previous quarter here.

Interestingly Posco will also start to share in the profits from the Daewoo Myanmar gas fields, which will start to kick in this year at around $150M and next year at $300M here. This would represent about a 15% increase in the reported 2013 pre-tax profits. This could add a buffet to the income statement if the steel business continues to suffer.

On a final note, Pabrai has interestingly stated in a couple of videos (I'm paraphrasing here so I hope I don't misunderstand what he meant) that buying the best companies (e.g. lowest costs, best pricing power) in a struggling and consolidating industry can still end up a good investment. It's possible that's what he's thinking in this case. It is worth mentioning that Posco was recently voted the No. 1 competitive steelmaker in the world for the 5th year running here. 

In the interests of transparency I bought shares in Posco on Wednesday 13th Aug soon after reading the latest Pabrai fund 13F and doing a quick check on the company. One purpose of this blog article was to force me to go through the process of understudying the company better before deciding to buy any more shares.