Thursday I took profits in the Chilean mining company, Sociedad Quimica Y Minera de Chile (SQM) selling 40% of the EIS portfolio’s holdings. It remains one of the five largest holdings in the portfolio and I have the highest respect for the company. But the price had appreciated more than 300% since my first purchase just last February, the chart looks like a fully grown hockey stick, and it is now selling at over 50 times running earnings.
I bought SQM initially as an alternative energy play. Lithium is only 15% of the its business but SQM is the largest lithium supplier in the world and lithium is a central component of the lithium-ion battery that will power the next generation of hybrid-electric vehicles which will be coming to market in less than two years. Such vehicles represent the future direction of the automotive world. There will be many millions of them sold between 2010 and 2015. I expect SQM’s lithium business to be a much larger part of the company’s sales and its identity in a few years.
The largest part of SQM’s business now is fertilizer chemicals, perhaps the hottest part of the stock market this year. That is a wonderful business given the pressure on farmers worldwide to produce more food. Another important part of SQM’s business is iodine which, interestingly, is also potentially an alternative energy play since iodine is mixed into the liquid that is heated to make steam in some concentrating solar thermal systems. Concentrating thermal solar is my candidate for the best alternative energy solution long term, so I think this part of SQM’s business also has very high growth potential.
It should be clear from the above that SQM is one of the best positioned companies on the planet in my opinion. I may well live to regret the sales I made Thursday. On the other hand, the position had become overly large relative to the portfolio. In addition it has been publicly hyped by some well known analysts which, along with the stock’s nearly vertical chart, often points to short term weakness in a stock. Finally, there is evidence that the general condition of the stock market as a whole is weak and getting weaker. Companies like SQM that are selling on multiples of earnings that are years down the road and that have risen rapidly often are hit the worst during a severe market correction, which may be in the process of happening.
In sum, selling a great stock like SQM is a difficult decision. I hope to have an opportunity to buy it back at a lower price, but I recognize the risk that may not happen.
A stock that has become an EIS top five holding is Dryships (DRYS). It is generally considered a dry bulk shipping company and indeed it is. But in the past year the company has also added a second and related line of business, deep offshore drilling rigs. It expects to operate a fleet of six rigs that will make it one of the most substantial companies in that terrific business, a great summary of which appeared in today’s New York Times. Dryships intends to spin off to stockholders its drilling business within the next twelve months.
The dry bulk business is attractive because of the increasing needs of China and other rapidly growing countries to import coal, grains, and steel. Moreover, the company’s dry shipping business has been extremely well managed since it went public just a few years ago. Management has adopted a gutsy entrepreneurial, opportunistic approach to its business in terms of upgrading and enlarging its fleet on attractive terms and cleverly managing its spot vs. charter approach to leasing its assets. DRYS’ fleet has grown from six ships averaging 19 years old before the public offering to the current 48 vessels averaging 8.4 years.
In fact, the management style at DRYS features a gutsy spirit that reminds me a little of the young Ted Turner who, in the early ’80’s wore a button to a cable television convention that read, “I was cable before cable was cool.” Like Turner, DRYS’ George Economou is the largest stockholder and totally dominates the management effort. Unlike Turner, however, Economou is not only a brilliant strategist, but also a detail oriented and accomplished manager. Some on Wall Street may think he is too much of a buccaneer, like Turner was, but I believe he adds a huge measure of value to this company.
Selling at under 5 times 2008 projected earnings, DRYS seems cheap to me. Given that Economou has managed to increase earnings at very high double digit rates per year since becoming a public company and that a great part of its new drilling business’s earnings have not yet become apparent, a multiple of 5 looks to me a little like the company is being given away.
Let’s remember that in the end Turner created enormous value for both himself and his stockholders. I think Economou is doing the same thing. Of course, I could be wrong and obviously a lot of the investment managers who are not grabbing this stock at under five time earnings think I am wrong.
The EIS portfolio has held (and still does hold) another shipping company, TBS International (TBSI) which is pursuing a different but still entrepreneurial strategy. I think shipping is appropriate for an energy portfolio because it is a play on the rapidly developing countries that are benefiting from globalization. That is exactly the same set of trends that is making energy and other commodities very scarce. But, in the case of DRYS, of course, the company is now heavily involved directly in the energy business through its drilling assets that will soon be spun off and will be recognized in time, I think, as a core holding for energy investors.