Buffett finally puts some money to work … it’s another old-school business … how Eric Fry’s recent winner compares … will Buffett’s play be another Kraft Heinz disappointment?
Buffett is back.
After being noticeably quiet during the market volatility in February and March, the legendary investor just bought Dominion Energy’s natural gas transmission and storage business for $10 billion. That makes it his largest acquisition in more than four years.
The deal comes at a low point in the natural gas market. Last month, futures fell to levels not seen in 25 years.
You can see this in the chart below, which shows natural gas futures spanning roughly two-and-a-half decades.
***So, what’s there to say about Buffett’s purchase?
Well, to begin, it’s hard to bet against one of the greatest investors ever.
Plus, given the timing of this acquisition, the investment will likely prove to be a solid contributor to Berkshire’s bottom-line when the natural gas industry rallies (of course, experts are mixed on when that will be given the global glut of natural gas).
But what we can say is that Buffett’s purchase echoes the theme of our June 15th Digest.
In that issue, we highlighted work from global macro expert, Eric Fry, comparing Buffett’s fortunes to those of Jeff Bezos.
In short, while Bezos represents “next-gen tech companies” and their related, massive investment gains, Buffett represents “old school investments” and their related average-to-underwhelming returns.
Here’s Eric, noting the outcome of this different investment focus:
Just a few years ago, Bezos was a relative pauper compared to Buffett. In 2014, Bezos’ Amazon holdings were worth $25 billion, while Buffett’s Berkshire Hathaway holdings were worth three times as much.
Six years later, Buffett’s stock market wealth has barely budged, while Bezos’s wealth has increased sixfold.
The vast and widening divide between technology-powered industries and everything else is responsible for this divergence.
Buffett buying Dominion — while potentially profitable — is yet another Berkshire old-school investment.
As compared to tech, where a company’s assets are often based on an intangible technological edge that enables massive scaling (think software), Dominion’s assets are tangible — the pipelines and storage facilities. There’s a cost to maintaining these physical assets that impacts earnings.
A physical-asset-focused business model also limits growth. That’s because these pipelines and storage units have finite capacity.
So, assuming the price of natural gas remains constant, major growth is either capped, or it requires a huge capital outlay to buy even more infrastructure assets.
In other words, this business doesn’t easily scale.
Now, compare that to, say, a software product that can be sold to millions of new customers for practically zero additional fixed cost. That business model is massively scalable.
***Notice how this difference in business models impacts investment gains
Below, we look at AMLP, which is the Alerian MLP ETF. It contains stocks of the biggest pipeline companies in the United States, including Magellan, Enterprise, Energy Transfer, NuStar, and Shell Midstream to name a few.
We compare AMLP to IGV, which is the iShares Tech-Software sector ETF.
It’s pipelines vs software … old school vs new school … tangible vs intangible assets …
As you can see below, over the last three years, an investor in AMLP would have lost half of his money. Meanwhile, an investor betting on IGV would have enjoyed 120% gains.
But Buffett’s purchase isn’t just old school based on the heavy “physical asset” nature of a pipeline company. It’s also reminiscent of yesteryear’s business models thanks to huge debt.
Though Buffett spent $4 billion cash in the deal, the true cost of the purchase is almost $10 billion. That’s because Buffett is now assuming all $5.7 billion of Dominion’s debt.
Interestingly, it was back in May that we quoted Eric, warning about heavy company-debt levels found in many portfolios (bold added):
Today there are so many ticking time bombs in so many people’s portfolios, because of bad business structures … heavy debt loads … and completely outdated business models that are being disrupted by fast-moving and creative, technological startups.
Given all this, it appears Buffett is continuing to focus on the type of investment that made him wildly successful in the past … not necessarily the type of investment that is likely to make investors wildly successful in the future.
***Don’t make the mistake of thinking that Buffett’s energy play couldn’t have had a more cutting-edge “tech” component to it
Contrary to public opinion, “tech” isn’t really its own sector. That’s because technological advancements can improve and streamline a wide assortment of sectors — from retail, to consumer goods, to health care, you name it.
In that way, tech is more of an overlay that can benefit any sector nimble enough to adapt.
So, where do we see the nexus between tech and the energy today?
It’s somewhere that’s been on Eric’s radar for years … somewhere that’s going to enjoy massive growth this decade … somewhere that just produced Eric’s latest 100%+ winner …
Solar.
***The transition toward clean energy
It was a year ago this month that Eric’s issue of Fry’s Investment Report profiled the energy sector.
From Eric, in that issue:
“Burn something.”
For more than 300,000 years, this simple phrase has been humankind’s answer to the question “What’s the best way to produce energy?” …
This basic concept evolved slightly with the invention of the internal combustion engine. At that point, “burn something” morphed into “explode something … carefully.”
Even today, in the most modern of modern eras, “burn something” and “explode something” remain the dominant energy technologies …
But the “burn something” era is drawing to a close. The “burn nothing” era has arrived, led by solar power.
In that issue, Eric recommended one of his favorite ways to play solar, Daqo New Energy Corp. (DQ). It has not disappointed.
From Eric, to subscribers last week:
Based on the company’s most recent earnings report, Daqo New Energy Corp. (DQ) is performing as flawlessly as I thought it would when I recommended the stock just about one year ago in the special “all solar” July 2019 issue of Fry’s Investment Report.
The results for the first quarter featured the following highlights:
- Record polysilicon production of 19,777 metric tons
- Record-low cost of production of $5.86 per kilogram
- Record-high revenues of $168.8 million — up 42% from the prior quarter
- Record-high gross profit of $56.6 million — up 61% from the prior quarter
- Record-high earnings per share of $2.37 — up 63% from the prior quarter
These record numbers have resulted in record highs …
Below, you can see Daqo surging since Eric’s recommendation last July. While the S&P is basically flat at 6% gains, Daqo is approaching 150% growth.
Given DQ’s recent move, Eric recommended closing half the position last week, locking in an official gain of 104%. The remaining half continues to climb.
Now, though we showed a chart of AMLP earlier in this Digest, let’s bring it back.
To help visually compare “old school” energy with “new school, tech” energy, here’s AMLP and Daqo over the last 52 weeks.
One is soaring, the other is languishing …
A big “congrats” to Eric and his Fry’s Investment Report subscribers on the gains. By the way, Eric’s other solar play is currently up nearly 50% as I write. To learn more, click here.
***One more note as we wrap up …
This isn’t the first time Buffett has made a big-dollar purchase of a company from yesteryear.
Back in February of 2013, he bought Kraft Heinz. And what has it done in those seven years?
Up an anemic 12% …
Now, guess who predicted Kraft Heinz’s stock price collapse a few years ago, and made his subscribers 101% through a bearish recommendation on it?
You guessed it.
Below you can see Eric’s well-timed recommendation to go short Kraft Heinz, which doubled subscribers’ money in just under four months …
While we don’t anticipate a similar collapse for Buffett’s Dominion play, neither do we anticipate the same kind of huge gains we believe investors will see from Eric’s solar winners like Daqo.
It’s not wise to bet against Buffett … but it’s downright foolish to bet against tech.
Have a good evening,
Jeff Remsburg
