October 8, 2008
SouthernSun 3Q08 Commentary
Dear Clients and Friends,
I am writing to you this morning from Dubai in the United Arab Emirates. It strikes me that we must soberly evaluate what we are told by the media and politicians whose lives depend on less-than-verifiable evidence, along with their extrapolation of the obscure. Otherwise, we may be convinced that all business has ceased. Contrary to that belief, all one must do is peek over my hotel balcony and one would see massive infrastructure projects in all phases of construction. Now this is not to say that activity has not slowed and in some places seized up altogether. It is to say that what is in front of you on that TV or in the newspaper may not be all that there is. (By the way, this is not intended to criticize only the media or politicians or “Wall Street” or poor corporate governance or easy credit, as we all may have shared in our little piece of this pie.) However, the news media, generally speaking, must make choices about what and what not to emphasize within a limited time – although I must say that, as I have seen the massive increase of 24 hour per day news made available to viewers increase multiple fold over my lifetime, I do not sense that I am significantly more informed, but maybe that’s just me. Isn’t it odd that so called “financial reporters” have attained “rock star” status in our culture. We feel Margaret Manning framed this accurately last month when she wrote the following for A Slice of Infinity:
The world is run by information. When I first heard this quote, I immediately thought it was an overstatement. Daily news of weapons of mass destruction, continuing disputes over land and territory, and struggles over energy resources remind us of “wars and rumors of war” all around. Surely, we are in the midst of multiple wars.
But the way in which these news stories are told underlies the insidious perpetuation of conflict. The instant access of information and news as a result of the Internet makes every blogger a knowledge guru and every website a “purveyor” of the truth. Those “in the know” craft news and spin their stories. Indeed, the more I see the way the world interacts with the wealth of information available through the power of the Internet, the more I become convinced of the truth of this statement: The world is run by information, and the world is embroiled in an information war.
I am in Dubai, along with thirty key governmental and industrial figures in agriculture, where I will spend the next few days discussing various near and long term challenges facing global agricultural infrastructure and trade. We will deliberate the multifaceted trade landscape and the requirements for eventual price stability, and if that indeed is possible. We will also discuss both potential and real-time demand for a palette of agriculture trade in the Middle East, Africa, China, and India specifically; to be followed by in-depth dialogue on explicit core demand inputs for livestock. We will also devote meaningful time to the investigation of the Palm (CPO) and oil seed sectors. Also on the discussion docket will be an attempt to evaluate the possible impact of investor activity on commodity price dynamics complemented by efforts to frame developments in the freight and shipping industry. To complete our two days, we will dissect the global coffee, poultry, meat and livestock and dairy markets from a supply/demand and input cost basis.
Frankly, it seems almost trite to posit any opinion whatsoever in this environment. Reasonably describing near-term events in proper context is difficult even in the most docile of times; however, we must be clear – there seem to be at least two areas where credit issues may directly impact agriculture; 1 – De-leveraging of hedge funds and subsequent fund liquidations, and 2- Re-pricing of credit lines. (I would specifically note that a large Middle Eastern trader suggested that he has seen a 200 basis point rise in his cost of funds over the last ten days as one specific case in point.) We would be hard-pressed to suggest that there may not be a “new” relationship between oil (energy) and agriculture, primarily due to the influence of alternative fuels, underdeveloped infrastructure and a global marketplace that places exceptional pressures on transport fuels.
That said, you may recall that we have consistently suggested that, eventually, when food and energy prices came down, these prices would find higher floors. (Note: We did not say what would create this return to fundamentals other than high prices, or when it may occur.) We do continue to contend that this will in fact be the case - even though they may overshoot a bit on the downside. The emerging middle class in developing markets, almost three decades of underfunding and underdevelopment of food and energy infrastructure, the future demand for renewable sources for energy (whatever the ultimate mix may look like) when coupled with the longer term nature of product development, commercialization, and implementation would seem to support, at least in part, our long term view on these themes.
It strikes me that these have been the types of times that our firm has been inclined to quickly admit that we have no idea what the market place, in all its collective wisdom, is trying to say. We will not pretend to do that now - even though we have new and bright young analysts that bring a magnificent freshness to our internal debate on these matters. What we have done, and what we are doing, is focusing our efforts and debate on our portfolio businesses’ health and prospects, given a host of potential scenarios.
For example, Phillip Cook and Elliot Cunningham are currently in Russia visiting with one of our portfolio businesses who, as many, have seen their stock price come down appreciably in the past few months. Fundamentally, one of the primary skills we always hope to deliver to you is to commit significant time in our portfolio businesses’ plant and facility to test the tangible, on the ground, realities they face on a day to day basis. Phillip and Elliot are doing this on the heels of having been in Western Europe two weeks prior, while subsequently, Phillip, Peter Matthews and I were in the UK meeting with several of our key holdings and one prospective new business. Mike Cross and Elliot have also been busy visiting with multiple management teams of current and prospective companies. The point is clear. Our job in this market environment is the very same as it has been in every other one we have faced - know our businesses - and then determine what they are worth three to five years out - how?, what?, where?, who?
We recognize that there is little way to sugar coat the awful feeling of seeing/hearing about the rather large percentage declines in global indices day after day. It is tempting to offer some of the observations we have made and are making to bring this behavior into an actionable context, but neither space nor your patience would allow such a speculative diversion.
Therefore, we must say that we believe, as a result of the rapid decline in market prices, we are seeing quality values such as we have rarely seen before - even post '87, '90 -'91, '98, or 2000 - '03. As is often true in times like these, it may be tempting to rush into putting cash to work even though many of the reasons for the fall may persist and depress prices yet further. Our approach is to diligently allocate and redistribute cash to take advantage of opportunities in specific businesses that we believe offer significant upside over the next three to five years. We recognize it unlikely that we will pick the bottom, however. Nonetheless, our rationale behind the long term demands on food, energy, and infrastructure do not go away even if one might argue a more extended global slowdown. We can attest to the fact that commerce is happening, and companies are securing and raising necessary capital to take competitive advantage of the downturn. The businesses left standing may well have a unique opportunity to dominate their core markets as a result. We do believe that, while many of our businesses will report satisfactory profits in the third quarter, we also think that many may lower their guidance primarily due to macro uncertainties. We might also point out that, because most of our businesses have been generating strong cash flows for quite some time, they may actually choose to keep pricing in check in order to capture market share while competitors are struggling, particularly those competitors who require significant capital market access.
Although not one of our portfolio companies, the following comment made by Monsanto in the following Financial Times article by Hal Weitzman speaks to some of the aforementioned issues.
Monsanto, the world’s largest seed producer, shrugged off the financial crisis yesterday by saying that credit markets were working well in the US agricultural sector, enabling farmers to continue to borrow normally to pay for seeds, fertilizer and herbicide.
“Fundamentally, a farmer on solid financial footing should be able to access any credit they need,” said Terry Crews, chief financial officer of the St. Louis-based company.
Mr. Crews said Monsanto had just completed a round of conversations with agricultural lenders. “These lenders are telling us that in the normal course of business, they are already renewing and increasing credit lines with customers, so the purchases for [the 2009] season can begin.”
“In terms of the farmer globally, his access to credit is a growing concern, given the credit risks,” Mr. Crews conceded. However, he pointed out that a third of US farmers receive their loans from the Farm Credit System, a US government-backed lending organization specifically for agriculture.
He said a further 40 percent of US farmers borrowed from small community banks in rural areas. Mr. Crews said those banks were tending to hold interest rates steady and were offering new loans.
Finally, amid the battle, we most appreciate you, our clients, for your confidence in our investment approach and the team that is charged with its execution. You have continued to convey that confidence by the considerable net inflows in the 3rd quarter as well as in the initial days of the 4th quarter. We believe today’s opportunities are outstanding but not without risk. We further believe that, in the not too distant future, patience, maybe even more than any time in the past fifty years, should be rewarded.
Michael W. Cook, Sr.
CEO & Chief Investment Officer
SouthernSun Asset Management
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